Condo Conversions Revert to Rentals

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Condo conversions revert to rentals

By Ed Duggan

South Florida Business Journal

Updated: 8:00 p.m. ET April 16, 2006

Six communities with 1,571 units - three in Broward and three in Palm Beach County - have made the switch from condo conversion sales back to rentals.

Some are dubbing it "the great conversion reversion of 2006." It's a move to reposition rental communities, which were slated for condominium conversion sales, back to apartment rentals.

A slowing sales market and a high-demand rental market with rising monthly rates are the motivations for the switches, said Jack McCabe, CEO of McCabe Research & Development in Deerfield Beach. He is the author of the Condominium Conversion Report and the Commercial Apartment Market Report, quarterly data services that track South Florida multifamily communities of more than 100 units.

"It's an early-stage trend that will probably accelerate as the market slows even more," he said. "For well-managed communities, the improved cash flow from enhanced rents may help carry them until the conversion sales market comes back into balance."

In other words, converters might try again in a few years.

The three Broward County communities that have switched back to rentals are the 144-unit Crystal Lake in Oakland Park, the 268-unit Fisherman's Landing in Coconut Creek and the 140-unit Summit Chase in Coral Springs.

In Palm Beach County, switchbacks include the 224-unit Enclave at Delray Beach, the 319-unit Gateway Club at Orchid Lakes in Boynton Beach and the 476-unit San Merano at Mirasol in Palm Beach Gardens.

McCabe said the reversion decision has to be made early in the conversion process in order to capture cash flow, market share and minimize expenses.

Mechanics of reversion

There are also important financial considerations in switching from short-term financing to longer-term loans.

James Dockerty, executive VP of real estate lending for Mellon United National Bank in Miami, said there are a number of factors to consider when repositioning a failed or stalled conversion that has been financed with a short-term loan. His office does not handle conversion financing, but he is quite familiar with the niche and its risks.

"A bank that has made a short-term loan for a converter would want to be sure the rental cash flow would cover the new, longer-term loan's servicing," he said. "Many conversions were bought at very high prices at a cap rate to yield 3.5 to 4 percent, and the developers may find themselves 'upside down,' with more loan than equity in a changing market."

The cap, or capitalization, rate is a rental property's profit yield based on its purchase price.

Dockerty said with the climbing prime rate and LIBOR - the London Inter Bank Offered Rate - a developer would expect to pay a floating rate of 6 percent to 7 percent, or more, for new financing.

The problem arises when a project rental income won't pay off the loan, taxes, insurance and maintenance.

Dockerty said that a bank might refuse a new loan, could ask for additional collateral before changing the loan or might demand that the loan be partially paid down before any refinancing.

It won't happen without some strings attached and additional costs.

Borrowers, he said, would surely be charged a "modification fee" that could be anywhere from one-half to 1 percent or more of the new loan amount.

Some banks that are active in conversion lending also charge the developer a partial release fee when each condo unit is sold.

"A bank that is asked to change a short-term loan for a conversion project to a longer-term loan for a rental project would also probably want to recoup those lost partial release fees at the time of the new loan," Dockerty said.

Evan Rees, Regions Bank president of Broward and Palm Beach, does conversion loans, but said he is very selective in terms of the borrower's previous conversion experience. He said the ability to switch would depend upon how far along a community was in the conversion process among other things.

"There are developer logistical problems managing people in the buildings, either owners or renters, over a longer period of time and making sure the cash flow will cover all expenses," he said.

Rents rising

Since January 2004, about 63,000 apartments in South Florida have been converted or are currently undergoing conversion to condominiums. That has resulted in a nearly 40 percent reduction in available rentals, according to data from McCabe Research.

"We are seeing big jumps in monthly rental rates - on the order of 13 to 28 percent in the last six months," McCabe said. "That's a huge turnaround from just three years ago, when landlords were offering major rent concessions, including up to three months free rent."

At the Enclave in Delray Beach, rents are up 11 percent to 12 percent.

At the nearly new San Merano at Mirasol in Palm Beach Gardens, rents on the one-bedroom units have been increased 10 percent to 15 percent.

At Fisherman's Landing in Coconut Creek, monthly rents that were formerly $745 to $1,070 now range from $855 to $1,195 - and the first vacancy won't occur until June 20, according to a company spokeswoman.