Monday, July 20, 2009

Are Fractured Condos a Good Investment Opportunity?

A fractured condo project is one in which only some of the units have been sold. They occur when sales stall, and usually the construction lender ends up owning the project. Some see these projects as a great investment opportunity. An excerpt from Unnatural Rent:

In fact, one of the more promising investment opportunities may be taking over broken condo developments, for instance, a 100-unit project that only has 20 units sold. It should be possible to acquire the unsold units in a block and then rent or sell after the market recovers.

And from Realty Times:

Hedge funds, private equity "vulture" groups and individual investors are all shopping aggressively to pick up these distressed units at deep, deep discounts that start at 40 percent and go much lower.

New Valley LLC, a Miami-based subsidiary of Vector Group Ltd., a New York Stock Exchange-traded company, says it's got $250 million in cash ready to invest in South Florida fractured condos or in troubled rental projects.

Vanessa Grout, vice president of acquisitions, told Realty Times that the situation has become so dire for some developers of prime condo projects this year that her firm sees "pivotal opportunities" right now to pick up high-quality, well-located condos at once-in-a-lifetime prices.

There are some huge drawbacks to such projects:

  • You have to deal with the owners of the units which were sold. These people are typically very unhappy. In a perfect world the project buyer repurchases these units, but often these owners will hold out for a premium price.
  • Buying a large block of units from the developer may put you in their shoes if there are construction defects. The combination  of angry unit owners and construction defects can be really unpleasant.
  • Many multifamily investors won’t touch these projects, with the result that the pool of potential buyers is smaller. This can make an exit harder.
  • The project may have failed as a result of condo market conditions or a bad price point, or it may have failed for more fundamental reason (bad location, poor design). It’s not always easy to sort out the cause of the failure, and a bad condo project is likely to be a bad rental project too.
  • For all the reasons above, it’s very, very difficult to get financing for these projects. Conventional multifamily lenders (e.g., Fannie and Freddie) won’t touch them, which doesn’t leave many sources in this market.

These deals will get done, but it’s not easy money.