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Sunday, Feb 25, 2024

‘Broken’ Condos: Upside Down Multi-Family World

Decreased property values, slow housing sales, and lack of access to financing are a few of the factors that have led to a spate of “broken” residential condominium projects in the Los Angeles area. Some dot the landscape as incomplete raw lumber shells, while others are finished. Regardless, the term refers to projects where developers owe more money than they can make on the venture. “The property is not worth the cost the developer has incurred,” said Steve Bram of the Los Angeles-based real estate investment bank, George Smith Partners. “And at that point the developer may walk away.” What happens to these distressed assets? Industry pros said while some of the debt is worked out, and properties put on the market or converted into apartments, others remain just as the name implies broken. Banks are holding onto many properties until the economy gets better and they can recoup as much of the loss as possible. Others are such a legal or logistical mess that prospective buyers are unable to get financing to purchase them. “So far there are not a lot of broken condo deals closing, because they are lender controlled construction loans worth more than the property’s value,” said Jim Fisher of Lee & Associates. “But there are people out there who want to buy them.” Speculative homebuilders who purchased land and began construction late in the housing bubble, when property values were at a high, are the ones who got hit the hardest. The multi-family condo projects were often heavily leveraged, and as property values dropped, they quickly found themselves underwater. In the case of “fractured condos,” developers sold some of the units. But homeowner’s association rules limit their ability to rent the remaining units as apartments and generate revenue to pay off debt. Developers may also have to pay HOA dues on the unsold condos, said Bram. The total number of broken condos in the greater San Fernando Valley area is hard to pin down because the issue is often dealt with privately between the developer and bank, and not all properties go into foreclosure. Billions in default But troubled commercial properties in the Los Angeles area, which includes broken condos, have been increasing this year with the value of assets in default, foreclosure or bankruptcy topping $4.5 billion, according to Real Capital Analytics (RCA). “Distress is not only widespread geographically and by property type, but also by borrower type,” said RCA about the problem nationally. “Excess leverage is endemic to every type of investor, all of which are facing difficulties refinancing mortgages as they come due.” Fixing these underwater properties is no small undertaking. The easiest developments to sell and purchase are the ones that can be 100 percent converted into apartments, said Bram. The term “condominium” simply refers to an individually owned piece of real estate that’s in a multi-family apartment-like complex. The term “apartment” refers to a self contained residence in a larger complex that’s rented. “What we’re seeing transact now are completed unsold condominiums that are being completely rented as apartments,” he said. “If it’s half sold and the developer wants to rent the other half, it’s difficult to get a loan.” In the case of fractured condos, Fannie Mae and Freddie Mac will not finance the purchase of the property unless at least 50-70 percent of the other units in the development are sold, according to Bram. And investors are not paying more than what the property is worth as apartments. Fisher knows the buyers of a formerly distressed property located at 4950 Laurel Canyon in Valley Village. Originally slated as a condominium development, the buyer has since converted it to apartments, he said. The seller/developer originally wanted a higher price than what was paid for the property, said Bram, but the buyers dealt in cash to move the deal along quicker. “There’s often a lot of reluctance on the part of developers,” said Fisher, because they are trying to minimize their loss as much as possible. “They’re not easy deals to put together.” In the case of half-built projects, banks are reluctant to provide financing to complete construction. And it’s hard to find a general contractor willing to put his name on a project started by another company, because he’s liable for 10 years following the completion. “Most of the good deals have already been snatched up,” said Bram. And Fisher predicts banks will be selling off more of these broken condo properties in the future through short sales.

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