If we consider that 2017 was the year that deconversion sales in Chicago began in earnest, we are now four years into the cycle. I’m frequently asked my opinion of how much longer this cycle will last, and what it will look like going forward. To me, that comes down mainly to supply and demand, with an eye on change in the relevant state and city statutes governing these sales.
The supply of condominiums in Chicago is still plentiful, especially condominiums that were converted from apartment buildings. While there was a bit of a condo-buying frenzy in the early part of 2021 as the world opened back up, that frenzy has dissipated. Condominiums that would typically take a couple of months to sell sold in days, and often at asking price.
With that said, there was little meaningful price appreciation. The factors that hinder appreciation of these condominiums did not change: high amounts of rental units in the association; lack of amenities; and aging buildings that are either behind on maintenance or expensive to keep up. Those factors are unlikely to ever change.
The current demand for multifamily properties is quite strong. Most investors sat on the sidelines in 2020, building up large amounts of cash. This liquidity along with low-interest rate loans has now led to a scramble to invest. While multifamily is not immune to pandemics (pun intended) or business cycles in general, it is rightfully viewed as one of the safest types of real estate. Office may or may not be changed forever, and retail continues the struggle it has endured for the last decade of “Amazonization.”
Rents may grow or rents may stagnate, but everyone needs a roof over their head regardless of what else is going on in the world. Condominium deconversion sales help satisfy this demand by creating new inventory that did not previously exist.
For condominium deconversions to happen, there must be a spread between the value of an individual unit and the value of that unit if sold in a deconversion sale. Otherwise, there would be no point in the deconversion sale in the first place.
This spread is usually created by the supply and demand imbalance illustrated above — a large supply of condominiums and high demand for multifamily. While this spread varies from building to building and especially by building type, it is alive and well. A building I am quite familiar with just had a unit sell for $160,000, including parking. In a deconversion sale, that unit and parking spot would receive well over $200,000. Not every building pencils out like this, but they are out there.
There are two other driving forces behind deconversions: major deferred maintenance, or the existence of a bulk owner who owns a majority of the units.
I don’t see the deferred maintenance issue ever going away. As long as there are condominium associations, there will be boards that fail to address the physical needs of the building until it becomes a crisis. Unit owners themselves are quite often the obstacle in front of aboard. No matter the issue, people will not want to spend the money to fix it and can actually get quite hostile towards their board. In buildings with severe deferred maintenance, it’s not about the spread in value but more about the ability to sell the unit at all.
In the case of a building with a majority bulk owner, the issue of salability is pertinent as well, for both the bulk owner and the other individual owners. If a bulk owner quits paying their assessments, the building will lose a large amount of its revenue and will not be able to pay its bills. For this reason, banks either will not lend or will lend with high restrictions on condominium units where a sizable bulk owner exists.
It’s common to see units in these buildings go under contract and then fall out of contract, as the unit buyer finds out they can’t get a mortgage. If a bulk owner wants to sell all of his or her units, selling them off individually is a very poor option. If all units are put on the market at once, pricing will be negatively impacted. If the sales are staggered in an effort to not depress price, the process could take several years depending on the number of units held in bulk.
A deconversion sale removes this problem for the bulk owner and allows an exit of all units simultaneously and at advantageous pricing. Interestingly, the sale of all bulk units at once (and not the entire building in a deconversion sale) is becoming more common. I recently closed a bulk sale of 29 units in a 37-unit building, and currently have 17 units in a 67-unit building listed. Pricing for these chunks of units is less than what they would receive in a deconversion sale but still allow for the disposition of all units at once, without the hassle and time of a deconversion sale. These are still difficult transactions and can be hard to finance, but I expect to see more of these going forward.
On the legal front, the change in 2019 in Chicago’s city limits from 75 percent to 85 percent approval needed caused a shift in the types of buildings sold in deconversion sales. Big downtown high rises are much more difficult to get over the finish line. Although they are still happening, there’s not going to be a flood of them. Smaller buildings in the city are much easier to gauge in terms of the probability of owners approving the sale.
While there has been talk of extending the 85 percent threshold throughout the state, I don’t believe that change is imminent. While the lower threshold in the suburbs makes potential deconversions appealing, the suburbs present their own unique difficulties, particularly in a smaller-value spread and with the difficulty of owners to find similar replacement condominiums nearby.
As Chicagoland’s multifamily sector remains strong, the deconversion market will remain a viable investment opportunity.