Is the New “American Dream” Owning a Converted Apartment?

When I first heard from someone I knew that was excited about purchasing an apartment that had been “converted” into a condominium, it really piqued my curiosity. Excited? Purchased? Apartment? Converted?? I needed to look at this situation a little closer.

I grew up living in an apartment in San Francisco during the ’80s. My parent’s dream was to one day own a modest single-family home and to move out of that apartment. Has real estate become so expensive that the vision of the “American Dream” is being downsized to ownership of an apartment for our young workers?

Many young workers in their 20’s and 30’s are finding that housing prices have climbed so quickly that they cannot afford to purchase a single-family home. In California, as of June 2005, the median home price for an existing single-family home was $542,720 for the entire State. There were 656,310 escrows closed on existing, single-family detached homes in California during June 2005.

In order to qualify to purchase the median priced single-family home in California, the applicants need have saved $108,544 for the 20 percent down payment and their income must be at least $127,500 to qualify for a 30-year fixed mortgage at 5.85 percent. The payment on that mortgage will use up nearly 70 percent of the household take home pay.

Some consumers turn to the more risky home loan solutions as a way to reducing their monthly payments. Such programs as a Variable Interest Rate Loan or an Interest Only Loan can be attractive because of the initial low monthly rates. These types of loans may contain automatic adjustment clauses that change the terms of the loan over time. If the interest rate rises, your payment amount increases.

For a vast majority of young Californians, purchasing a single-family home as their first real estate transaction is dreaming the “impossible dream”. Condominiums become the next logical choice for home ownership. They are smaller than a Single-Family home, but mostly maintenance free and all of your neighbors are owners too. You become a member of a homeowners’ association and pay monthly dues.

The median price for a Condominium in California in the month of June 2005 was $433,690 or about 80 percent of the price of a median single-family home. Owning a condo will be the solution for a lot of people, but there is still a group of consumers that cannot financially qualify for a condo ownership and do not want to just rent. For these people there is the “Apartment Conversion.”

Apartment conversions (also known as condo conversions) allow the young, single, elderly or first time buyer an entry-level market into home ownership. The median price for condo conversions is approximately half of the price of a median single-family home. This type of ownership user appeals to the policemen, fireman, school teachers, retail store managers and other blue collar occupations.

It might be helpful at this point if we looked at the median income figures for California. The median income for a family in California is currently $53,250. That means that half of the households in California make less than $53,250. The “median income family” in California will come up short of the income necessary to purchase the “median priced single-family home” by $74,250; that is known as the Median Homebuyer Income Gap.

In 2004, at least 70,800 apartment units were sold to condominium developers nationwide in 2004. That is up from 7,800 units in 2002 (Yes, the numbers are correct. That is an 800 percent increase in two years!) And the boom is not showing any signs of slowing down, with at least 43,900 units sold in the first 6 months of 2005.

Developers of apartment conversion projects believe that conversion is the “best and highest use” way to maximize the value of an apartment. From an economic point-of-view, baring any rent control laws or major structural problems with the structure, the value of the project will double after the conversion.

With the unit’s median price is about 50 percent of an existing, single-family home, these types of conversions are attractive option for the first time buyer, retiree or second home buyer. Some conversions offer great financing options to first time buyers. These properties do show an increased “pride of ownership” value over the pre-existing apartment.

Not everyone involved in an apartment conversion leaves a winner. The problem of displacement became such an issue for the City of San Diego that the City Council set aside $1.9 million for loans to displaced renters who earn the area’s median income of $64,000 a year or less. Displaced tenants receive three months’ rent to use as a down payment on another rental unit.

Some cities have restrictions on the number of rental units that can be converted into condominiums. San Francisco restricts conversion of existing apartment buildings into condominiums to only 200 units per year. Property owners must participate in a lottery system that offers first time entrants a 4 percent chance of winning. The average time it takes to get an apartment conversion done in San Francisco is estimated at 10 years.

These restrictions, however do not apply to commercial conversions, which are also seeing a great boom in growth. Commercial warehouses and office buildings are becoming new downtown condominiums for the urban renewal that has been taking place in some major cities for some time now. The Emerald-Lennar group recently reported a 76 percent return or $67 million on a 270 unit apartment conversion project in Oakland, California. It is not any big surprise that they plan on doing more conversions.

If you have the apartment building or just cash to invest, and you want to take advantage of this opportunity, there are websites that offer “turn-key” conversion projects. Please remember to know who you are buying from over the Internet, before your provide confidential personal information.

Now that the apartment owner has decided that conversion is the “best and highest use” way to maximize the value of an apartment, the process of working through the City and State requirements for the conversion begins. The apartment owner chooses a general contractor to perform the renovation of the structure. Most commercial agents who work in California know better than to utter three words in the same sentence, “California, Construction and Condos.” Sometimes you can’t even get “Condos” out before the underwriter screams “No!”

The “Condo Conversion Project” does present some unique liability exposures to general liability underwriters. On a conversion, often the existing structure needs to be brought up to current building codes during the renovation. Structural engineers will have to check the foundation and soils and make sure they are adequate for the properties intended use after conversion. The underwriters will need all of this information along with the cost of the project and what was disclosed at the time of sale.

The fact is that underwriters feel they have better control over the risks associated with a new condo project then they do on a conversion project. There are so many variables that come together on a conversion project that do not exist in a new start condo project. Those variables increase the complexity and degree of underwriting discipline it take to properly analyze each risk. Hence, there are fewer carriers willing to write an OCIP or Wrap-Up policy on a conversion project then there are willing to write a policy for a new ground up condo project.

OCIP or Wrap-Up Liability policies for these types of risks are written where all of the subcontractors and the general contractor (and also developer) are all named insured under the policy. Defense costs erode the Aggregate limit of insurance and a sizable self insured retention will apply to any claims. Minimum premiums start at $250,000 to over $1 million dollars depending on type of project and carrier.

One of the most common questions I hear is whether the general contractor/owner needs to purchase a liability policy for the conversion? After all, he has owned it more then 10 years and the statute of limitations on the original structure has expired.

While it sounds like a good argument to save some money by not purchasing a policy, I have discussed this with several underwriters and attorneys who specialize in the construction insurance, they all seem to agree that once a property is converted, the 10 year statute of limitations for construction defect claims exists for the constructors of that project, and 120 months begins with the close of escrow on each unit.

Developers are always thinking about what else they can condo? Have you heard about the Hotel-Condo hybrids? It’s the latest in hotel construction where individuals can purchase ownership in a unit (room) in the hotel and have access to all of the hotels amenities. You will need a little money as a 1,100 sq ft suite in Miami Beach goes for $735,000 in Miami Beach. Well, that is the subject for another time and another place.

Robert Olson is a broker with Bliss & Glennon

Inc. in the Palm Desert, Calif. area. Olson has
over 20 years of experience in the excess and sur

plus lines business. He can be reached at
rolson@bgsurplus.com.

Topics California Underwriting Construction