More on Fractured Condos

Fractured condos are condo projects where only a portion of the project is sold to individual owners, and the remaining units are rented to tenants. A couple of recent examples:

The Millworks at Novato (from the Marin Independent Journal):

Millworks, a 420,882-square-foot residential/commercial project at De Long and Reichert avenues, had a grand opening in May but has only sold two of 124 condominiums situated above a Whole Foods grocery store slated to open next spring.

"Because of the mortgage market, it's really hard to get condo loans right now," said Mike Ghielmetti, president of Pleasanton developer Signature Properties. "A lot of the folks who are interested in buying there have homes to sell, and it's just a slow market. This is what we have to do for an interim period to make this viable."

Unit financing is a huge issue – Fannie and Freddie won’t buy unit mortgages until the project is at least 50% sold out, so these days the only available financing for unit purchases tends to be the construction lender on the project. It seems likely the construction lender on this deal refused to do that (construction lenders are not keen on holding long term fixed rate mortgages in portfolio). I suspect the other problem with this project is it’s pretty big for the size and niche it fills – how many people are there who want to live in downtown Novato?

Siena in Corona Hills (from GlobeSt.com):

 

A buyer from Fontana has acquired 189 units of a broken 296-unit condominium conversion project from its lenders for $14.25 million in a deal that says much about the state of the multifamily market in the Inland Empire today, according to Paul Runkle of the Inland Empire office of Hendricks & Partners in Temecula, who brokered the sale. The property is the Siena in Corona Hills at 2125 Highpointe Dr., formerly an apartment complex known as the Crossing…"This comp says that a quality, broken condo deal that was leased up with rentals, that was not readily financable, and was widely exposed, eventually sold at at 8.93% cap on an all-cash basis," Runkle says.

There are enough numbers in the story to piece together the before and after on this deal:

The moral to the story on this one is, don’t buy an apartment project on a 3.55% cap rate.

See previous post “Are Fractured Condos a Good Investment Opportunity” for a discussion of some of the hazards of doing these deals.

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.