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Theo Hicks: Hello, Best Ever listeners and welcome to another episode of the Syndication School series – a free resource focused on the how-tos of apartment syndications. As always, I’m your host, Theo Hicks. Each week, we air a syndication school series episode that focuses on a specific aspect of the apartment syndication investment strategy, and for a lot of these episodes, we offer free resources. These are free PowerPoint presentation templates, Excel templates, PDF how-to guides, something that will help you along your apartment syndication journey. So make sure you check out those free documents as well as past syndication school episodes at syndicationschool.com.
In this episode, we’re gonna talk about an interesting strategy; an interesting, unique syndication type of deal where you’re buying an apartment, and rather than doing a turnkey where you hold it for cash flow or doing the opposite end which is an entirely distressed deal, and then stabilizing the deal and either selling it or holding on to it and that’s how you pay your investors, or the in-between value add where you have a deal that’s stabilized, but needs some care… Maybe you just renovate some of the units, upgrade some of the amenities, and then increase the cash flow to pay your investors. This strategy is a fourth, which is– well I guess, another one would be developing. So you buy a piece of land and you develop the apartment. So you raise money for that, develop the apartment and either sell or hold… And then I guess the fifth strategy would be to buy apartments and to convert them into condos. So this is going to be about condo conversion.
So this is apartment syndication and technically you are doing an apartment syndication, because you’re buying an apartment with other people’s money, but on the back end, you’re not selling it as an apartment, you’re selling it as condos. So like a development deal, the condo conversions is going to be a little bit different and require more effort. I won’t say more effort, but there’s more things you need to do for development deals and for condo deals; as you’re doing heavy construction, the units are gonna be vacant.
So if you are looking at a deal and it’s in a market where there are a lot of condos, or condos are popular, or you just want another option when you’re analyzing deals, because the more options you have, the more deals you can do – I wanted to do an episode that went over some of the things that you need to think about before you submit an offer on an apartment deal that you intend on converting to condo.
So I’ve got a list of things that are a little bit different for condo conversions than for your traditional turnkey, distressed or value-add apartment syndication deal. The first one, and this is kind of the all-encompassing, which is to speak to an attorney. So the process for converting a condo is going to vary from state to state and from city to city, county to county. In some states, it’s a lot easier to convert to condos; other places, it’s a lot harder. So you’re gonna want to speak to an attorney that specializes in these types of condo conversion projects. That way, you can ask them what the entire process is, what the steps are, how long the steps take, what the costs are for the various steps, just to get a general understanding of one, is it even possible to do a condo conversion project in the market, and then if you are, what are some of the things that you need to do in order to get to the point where the condos are completed and ready to be sold.
On a similar note, you’re also going to want to talk to someone who actually specializes in condo conversions on the investment side. So an investor who has done condo conversions before, because you’ve never done it before – well, you might not necessarily know what you’re doing, you might run into a lot of mistakes, and when we’re talking about using other people’s money, well, every mistake is less money that goes to your investors and potentially eating into the capital that they invested. So it’s always good to have someone on your team that has experience doing what it is you’re trying to do, and even if you’re doing value add, you want to have someone who has experience in value-add syndication. So in addition to the attorney, make sure you have someone who’s done these types of deals in the past, and ask them also, “What’s the process like? What are some of the things that I need to think about? What are some of the things that most people miss?” just your traditional conversation.
Now, one of the biggest differences between your traditional syndication deal and these condo conversions would be the process for vacating the property. So it’s going to be more or less challenging depending on the laws surrounding condo conversions in that market. So that’s why you’re gonna want to talk to your attorney to ask them what the laws are, because some places there are a lot of laws that protect the rights of the people that are currently living in the property. So let’s say you see a property that you think is a good potential condo conversion deal and every single unit is occupied, but they’re all month to month, and so you say, “Oh well, I can just go in there and I can give everyone a notice to vacate, and then within 30 days the entire property is vacated, so I can start with my renovation. So I’ll have a 30-day window where I can’t do anything, but then after that, I can add in the renovation time, and then I can calculate the hold period.” Well, depending on the market, you might need to give a longer notice to vacate time than your traditional 30 days if you plan on converting to condos, and then in some places, even if you are able to send out these notice to vacate, you might, depending on the laws, have to cover relocation costs. You might even have to give them a chance to purchase the completed condo. You might not even be able to give them a notice to vacate depending on how strong these laws are. So if you buy a property with the intent of doing a condo conversion and you don’t know what the process for vacating the property is, and you’re in one of these localities that make you pay them $1,000 or whatever to move, or you can’t have them move at all and you have to organically move, then obviously your whole period is going to be way longer, those holding costs are going to be way higher, and you might not even be to do the condo conversion project at all, and obviously, that’s going to affect the returns to your investors. So that’s probably one of the first things you’re gonna want to look at if you are considering a condo conversion project, is what’s the vacating the property process like?
Next, you’re gonna want to understand the hidden fees. So there’s a lot of extra fees associated with condo conversion that you’re not going to see in the traditional value add type deals. Of course, your attorney can help you uncover these, but a few of these are going to be application fees with the city, surveying fees, attorney fees, and then fees related to code compliance. And then once you’ve actually done the condo conversions, the city’s gonna want to inspect the condominiums and make sure that they’re up to code, and if they’re not up to code, then you’re going to have to address those issues. So there’s gonna be a fee associated with any of those issues you need to fix.
One recommendation would be to hire a private condo pre-inspection specialist to inspect the property first, to give an opinion on potential code violations and the cost of repairs. That way again, rather than the city inspector coming saying you need to do XYZ, you do XYZ and they come back and say, “Oh well, you did this one wrong, you need to do the ABC now,” and then wasting more and more time increasing the holding costs… Have this pre-condo inspection guy come in after you’ve done the conversions. He can say, “Hey, these are the ten things you need to do.” You do all ten, the inspector comes, there’s no issues and you can move on to the next step.
One other hidden fee can be your increased insurance costs, because the insurance to cover condos is higher than insurance to cover apartments. So while you’re waiting to sell, your holding costs as it relates to insurance, is going to be higher. So make sure you’re getting a quote for the new insurance premium, and then you’ve got to keep in mind of the upfront and back-end fees that you as a syndicator are going to charge for putting the project together and manage the project, as well as the brokerage fees. So those are some of the hidden fees. Obviously, there’s more, but those are some of the main ones.
Next is going to be financing. So since you’re buying an apartment and converting it into a different property code, and it’s going to be vacant and not be generating any income, you’re not gonna be able to get your traditional loan. So you’re gonna need to speak with a mortgage broker who specializes in condo conversions so they can help you secure the right financing for the deal. And obviously, you’re gonna wanna have these conversations before you put the deal under contract, so you have an adequate estimation of the debt service, as well as the other important loan terms, like interest-only periods, what the loan term is, if there’s gonna be a balloon payment or prepayment penalties, interest rates, if they’re fixed or adjustable, financing fees, closing costs, really everything else associated with the loan. But you want to know upfront what types of loans you can get, so you can estimate that debt service so you have a more accurate holding cost.
Next is gonna be the timing. So again, you’ve got the upfront cost, the backend costs and also the hidden fees in the middle, but also the holding costs. Things like insurance, things like taxes, things like utilities, these are things that you have to pay regardless of whether or not the building is occupied or not. So in order to understand what the whole holding costs are going to be, you need to understand what the total holding period is going to be. So to determine that, you need to estimate the timelines for each step in the condo conversion process. So what’s the time it takes from buying it to vacating the building? Once the building is vacating, how long are the renovations going to take? How long does it take to convert the units to condos, to do whatever you need to do to address deferred maintenance, to do whatever you need to do in order to get the common areas up to par? And then once everything’s done, you’ve got the inspection and they’re ready to be sold. First of all, how long does it take to actually get the condos listed? So those are the things you need to do. As I mentioned, the inspections, you have to set up the HOA, any other post-conversion requirements, and then once they’re ready to be sold, how long will it take for you to sell all of these units? So that is going to be the average days on market, and then the closing timeline like. Once it’s under contract, it takes 45 days to close, or whatever.
You add all these together, and that’s going to be your hold period, and maybe you want to add an extra month or something for contingency, and then that’s how you can calculate your holding costs. Obviously, the next thing is, well, what are the holding costs? I already mentioned this, but these are going to be the ongoing expenses that you pay during the hold period. So these will be your insurance, your taxes, your utilities, your debt service. Obviously, since you aren’t going to be generating any cash flow during the conversion process, unless it takes a long time to vacate the property, maybe you got a few months of cash flow coming in, but obviously not enough to cover all of the holding costs… So these expenses must be covered in that initial equity raise. You need to make sure that you’re raising money to cover these holding costs.
Next are going to be the renovation costs, which we can break into four categories. First is the cost to convert the apartment units into individual condos. Second is the investment amount for the condo common areas. Next is the cost to address deferred maintenance and the next is going to be the contingency budget. So you’re gonna wanna make sure you have a grasp on all of these costs before you submit that offer.
So this is where you want to talk to, again, that person who specializes in condo conversions or a contractor to understand how much it costs to convert the condo, what types of common area investments should be made, deferred maintenance – you’re just going to need to get a contractor in there – and then a contingency budget; 10% to 15% is usually the traditional contingency budget.
Next is to understand the sales process. So obviously, you’re going to need to understand what the after-repair value is of each of the individual condo units so that you can determine how much money you’re going to make at sale, which requires doing a sales comparable analysis and figuring out how much condos are going in that area. Of course, you’re gonna want to do this beforehand, because you’re not gonna be able to set an offer price if you don’t know what the exit price is going to be. You’re also going to want to understand the costs associated with selling the properties, like the marketing expenses, if any, as well as the broker’s commission.
And then lastly, since this is a syndication as you are raising money, you need to figure out how the limited partners are going to be compensated, so you can determine if it’s actually a good deal for them or not. So first, what type of return are you going to offer? Is it going to be a preferred return? Is it going to be a profit split? Or is it going to be both? More importantly, when are they going to get paid? So they’re not going to get paid during the hold period, that’s for sure, because it’s not going to be generating any cash flow. It’s going to be more like a development deal where they get either a preferred return that accrues, or they’re gonna get a profit split at sale, but is it going to be after each condo unit sale or is it going to be once all the condo units are sold? So when they get paid is going to affect not only the IRR. So those are the things to think about if you want to convert an apartment into condos, and really the team member that you’re going to need to have in place prior to putting an offer in your first deal is obviously going to be the attorney that we talked about, we talked about the mortgage broker, we talked about the listing broker, we talked about the contractor, and then also, you’re going to want to find someone who’s investor who specializes in these things. And then all of those team members – attorney, mortgage broker, listing broker and contractor don’t need to specialize in the condo conversions. It doesn’t need to be the only thing they do, but it needs to be at least a part of their business. You don’t want to have a contractor who’s never converted an apartment to a condo before, or same with the attorney; especially the attorney, and the mortgage broker. Obviously, you might be able to find a mortgage broker that just specializes in condo conversions, but most likely they’re going to be some bridge lender that focuses on bridge loans in general.
So those are some of the things to think about when it comes to converting apartments to condos, when you’re raising money from investors to do this. So I think that’s everything. So we’ll conclude this syndication school episode. Thank you for tuning in. Make sure you check out the other syndication school series episodes as well as those free documents at syndicationschool.com. Again, Best Ever listeners, thank you for listening. Have a best ever day and we will talk to you tomorrow.
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