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Daily Business Review January 17, 2013

Condo conversions have hit the wall
By Jack McCabe

During the residential real estate boom of 2002 through 2006, the run-up in prices of single-family homes and new condominiums created a separate residential market segment: the conversion of apartment complexes into condominiums for sale.

Miami-Dade County was the incubator and epicenter of the trend, which spread to Broward and Palm Beach counties, then across the state and throughout the country. The area also was a leading-edge market indicator of what would happen nationally when the boom ended.

Condo conversions initially originated in South Florida in the early 1990s with Miami-based Crescent Heights Inc., as a more affordable and attainable form of home ownership. During the boom of the last decade, leaders of most major condo conversion firms worked for Crescent Heights and learned the conversion business.

As new condominium development prices skyrocketed, these converters began buying apartment complexes and restructuring ownership to individuals.

Because of the relatively low purchase cost compared with new construction and the ability to convert to for-sale product quickly at a lower price to the consumer, they became extremely popular. However, just as new condominium projects and single-family home demand was primarily from investor speculators, this market segment became heavily dominated by individuals and groups planning quick flips for double- or even triple-digit increases in "perceived" future market value.

In my opinion, no product segment had a higher rate of toxic adjustable-rate mortgages utilized for purchasing units. Some loans were given to borrowers with a heartbeat and the ability to fog a mirror and sign their names. Often, no down payment (or a minimal payment) was required, no income verification or credit check was needed - but with potentially skyrocketing rates and negative amortization.

As some buyers camped out to buy as many properties as they could, my firm's research in 2005 showed 63,277 units in 247 major apartment complexes in Miami-Dade, Broward and Palm Beach counties had been converted. Prices for these units had increased by 173 percent in the previous three years; some units tripled in price. This compared to a normal market appreciation rate of 3 percent to 4 percent annually. Coupled with 78,000 new condominiums in the three counties, also primarily purchased by speculators with plans to flip-sell them quickly, it was obvious the supply was five times normal absorption.

Entire 200-unit and larger complexes would sell out in a weekend, a week or month - until the bubble burst.

What has happened since is perhaps the greatest tragedy of the debacle that preceded the U.S. housing crash and then the Great Recession.

Palm Beach Research

My firm recently performed a study on several conversion projects in Palm Beach County. Some 81 percent of the condominium conversion units have had banks file for foreclosure since 2006. In a normal market with normal conservative financing, the foreclosure rate is about 2 percent.

Prices for recently closed sales and current listings are 20 percent to 25 percent of 2006 sales prices. Yes, that's right. Prices are down 75 percent to 80 percent.

There is absolutely no mortgage financing available to buy a condominium conversion unit. Therefore, the only buyers are cash buyers. The few buyers trapped by last decade's purchases - those who intended to live in their units and build equity the old-fashioned way - have either lost them to foreclosure or will never see prices rise above what they paid.

Is there a silver lining for this most distressed segment?

Yes and no. Many units that previously sold for $150,000 to $250,000 are now selling at $40,000 to $75,000.

In newer Class A communities built since 1996 to improved hurricane building codes, those that have been well-maintained and whose homeowner associations are in good financial position, there is an opportunity for investors with cash to purchase units and receive a 10 percent to 18 percent return on investment. But the pitfalls are many, and the unsophisticated or inexperienced could be burned.

These projects will remain underpriced and undervalued until reasonable mortgage financing is available. That could spur excellent increases in market value.

But don't hold your breath.

Jack McCabe, CEO of McCabe Research & Consulting in Deerfield Beach, is an analyst, consultant, author and commentator. He can be reached at jack@mccaberesearch.com. His column appears the third Thursday of the month.