The Mystery Of Chicago's Condo Deconversion Boom

In case you haven’t noticed there has been a real flurry lately of buildings in Chicago deconverting from condos to apartments. According to an article on Chicago condo deconversions in Rebusiness Online “nearly 2,000 units deconverted at a combined market value of approximately $437 million since late 2016 in Chicago, according to data from CoStar Group and Interra Realty.” Here are just some of the deals I’ve run across lately in my reading. The information is a bit spotty but I haven’t found a better list out there:

Often these deconversions occur in buildings that were originally apartments but were converted to condos at some point – because it made sense. Now apparently it makes sense to convert them back to apartments. I don’t have any problems with that narrative. No doubt the rental market can occasionally get out of synch with the condo market and it could theoretically make sense for the equilibrium to shift one way or another. Here is a video from CBRE, a leading commercial real estate services firm, that provides a fairly basic explanation of why this is happening now:

Note that Sam Haddadin claims that unit owners can get premiums of 20 – 100% above what their condos are worth alone on the market. I’ll come back to that later but that explains why condo owners want to do this.
What is less clear is why these opportunities exist in the first place since, theoretically, prices and rents should always be in equilibrium. If they get out of synch individual investors and/ or consumers should bring the two back into equilibrium by changing their own activity. Basically, I can only think of 4 possible explanations as to why we are seeing all this activity at this time:

  1. The investors doing these deconversions are just dumb and are not going to make money.
  2. Renters are willing to pay more rent in an apartment building managed by a large landlord than to an individual landlord
  3. Individual investors are missing a huge opportunity by not buying condos and renting them out. Consequently prices are too low relative to rents.
  4. These large investors can come in and improve these building much more cost effectively than individual owners and/ or their associations (in fact, Sam Haddadin mentions this in the video above). In doing so these investors can substantially add value to the buildings and cost effectively raise rents.

Well, I think we can safely rule out possibility #1. Investors with this kind of money are rarely stupid. And #2 seems implausible because renters would have to be pretty stupid to overpay to live in an apartment building as opposed to a condo building. Similarly, #3 seems implausible for much the same reason – like, individual investors aren’t smart enough to see an opportunity? In addition, I can tell you that I often look at the investment potential of condos and I’m hardly ever impressed with the economics of it. So it’s not like prices are any bargain.
Nevertheless, back in January Bisnow ran an article on condo deconversions that tried to make the case that the condo/ rent economics were all screwed up. Basically they said that small condos were really cheap but could rent for really high prices – like $4/ SF/ month. Uhhh. I’ve never seen evidence of this. If I had I would own a ton of these units around the city.
So that basically leaves the 4th explanation, which makes sense if you have a building that is in really bad need of repair or if you have a really dysfunctional homeowner’s association that needs to be put out of its misery. That might be the case for River City. We’ve sold units there before and that building is bad news. But how often do you have a situation like that?
I can’t claim to have done an exhaustive analysis but this 4th explanation also seems a bit implausible to me in general. I’ve just never run across a building that I thought could benefit from a wholesale upgrade – other than River City. But, in all honesty, it could just be a function of my personal experience. I did do a quick check on Clifton Village and found that the new landlords are basically charging a similar rent to what was being charged by one particular owner back in 2014. So that one data point doesn’t seem to support the idea that rents were depressed because units need a major upgrade. In fact, it looks like at least one owner was able to capitalize on the rental opportunity – which still leaves me in a quandary about what is really driving the deconversions.

A Condo Deconversion Is Not Necessarily Good For All Owners

One thing to keep in mind – not that you can do much to address the problem – is that you can actually get screwed in a condo deconversion because the proceeds are allocated according to ownership interests. So two units with 2% interest are going to get the exact same amount even if one has 40 year old finishes and the other just underwent a gut rehab and has a Sub-Zero refrigerator. Guess why it’s not always easy for associations to get the state required 75% vote to approve the deconversion. Guess who the holdouts are.
However, as with all things in life, the alternatives are not necessarily binary. I’ve heard of cases were individual unit owners with higher value condos cut special deals with the buyer in exchange for their votes. After all, this is Chicago.
Also, the developer can engage in various strong arm tactics to force the holdouts to sell to them. For instance, if they buy just 10% of the ownership interest in a building then it becomes much more difficult for individual buyers to get a mortgage. So that depresses the market value of individual units. Also, if they own 50% of the building and rent out those units that is another mortgage black mark.
If a condo owner is faced with an unfavorable buyout there may be an appeal process they can pursue. I’ve seen a reference to it but haven’t been able to find any additional information on the topic. If someone is interested in pursuing that route I’d check with a real estate attorney that is familiar with condo deconversions.
#ChicagoRealEstate #ChicagoCondos #Deconversions
Gary Lucido is the President of Lucid Realty, the Chicago area’s full service discount real estate brokerage. If you want to keep up to date on the Chicago real estate market, get an insider’s view of the seamy underbelly of the real estate industry, or you just think he’s the next Kurt Vonnegut you can Subscribe to Getting Real by Email using the form below. Please be sure to verify your email address when you receive the verification notice.

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