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REA
January 15, 2020  

High-Yield Buyers Warm to Fla. Bulk Condos

Amid heated competition for Florida apartment complexes, value-added investors are showing increasing interest in “fractured” condominium properties.

Brokers and buysiders say bulk purchases of unsold units can produce higher yields than traditional rental deals. Capitalization rates are typically higher than for comparable apartment properties, in part because there are so few bidders. And there’s potential to increase value substantially by converting the unsold condos to rentals.

“Florida is so hypercompetitive right now, and fractured condos are a way to separate yourself from the competition,” said Luke Wickham, a market veteran who this week joined Marcus & Millichap’s Institutional Property Advisors as a senior managing director (see The Grapevine on Page 19). “Sometimes these deals are a little hairier because they aren’t as straightforward as buying a normal 300-unit apartment complex, but it’s a good way for people to get a marginally higher yield and a cheaper price per pound.”

A typical deal involves an inland, suburban complex that was converted from apartments to condos in the mid-2000s boom but failed to sell out before the market crashed. In many cases, the properties subsequently changed hands in distressed plays and have since been stabilized, primarily as rentals.

To be sure, buying bulk condos is very much a niche strategy. Wickham, who spent the past 13 years at CBRE, said there were about 30 such sales across Florida in 2019, and he expects similar volume this year. But he and other brokers said offerings are drawing more bids from investors eager to gain exposure to coveted Florida rentals, including private equity groups and some institutional investors.

“In the past, when we used to market a listing, 80% would delete the email if it said condo or fractured condo,” Wickham said. “Now, 50% will take a look at it.”

Cap rates on fractured condos are running about 25-50 bp higher than those on comparable apartment properties, market pros said. That’s down sharply from a gap of as much as 200 bp during the recession, and has been tightening as interest has picked up.

“They tend to trade at a higher cap rate than a traditional value-add play,” said Matthew Mitchell, senior managing director on JLL’s capital-markets team in Tampa. “It’s a marginal difference, but enough to compensate investors for the additional complexity.”

The complexity stems from the fragmented ownership. A buyer of the majority of a property’s units must work with the individual unit owners through the property’s condo association.

One of the most-active condo-to-apartment investors is New York-based ESG Kullen, which has made 23 bulk purchases in Florida over the past 10 years. Co-founder and managing director Eric Granowsky said there’s so much equity chasing multi-family properties in the state right now that investors who shied away from such deals are giving them a fresh look.

“Condos are a dirty word for a lot of equity investors because they see the fiduciary responsibility of the condo board to the individual unit owners as potential exposure,” he said. “But it’s just so competitive right now and the valuations are so frothy, it’s forcing people to think creatively. ‘How do I invest in multi-family assets in these markets and get some kind of discount?’ Bulk condos are a legitimate answer.”

All of ESG’s Florida acquisitions were of former rental buildings, converted to condos between 2004 and 2007, whose developers had sold 50-75% of the units before the market seized up.

“In most cases, the original developers went bankrupt or simply gave the keys back to their lender,” he said. Granowsky and his partner, Tom DelPonti, acquired those properties from lenders and special servicers. In other cases, investors such as wealthy individuals or families had “bought the bulk units all-cash and waited a few years for groups like mine to start buying,” he said.

At seven of the properties, ESG was able over time to purchase all the separately owned units, terminate the condo associations and “deconvert” the complexes to all-rentals. That strategy is called a “round trip,” referring to the property’s rental-to-condo-to-rental journey.

“People have had a lot of success doing them, but they’re not a walk in the park,” said Wickham.

ESG’s most successful round trip came at the 250-unit Madison Oaks complex in Palm Harbor. ESG purchased 205 of the units in 2012 for $16 million, or $78,000 per unit. After buying out the individual unit owners, it sold the property in 2018 for $40.5 million ($162,000/unit) to Residential Management of New York.

In April, the firm sold the 224-unit Bloomingdale Woods complex in Valrico, east of Tampa, to an affiliate of Richards & Robbins of Morristown, N.J., for $30 million. It had purchased 173 of the units in 2015 for $9.7 million, then completed a deconversion.

In Florida, termination of a condo association formerly required approval of 100% of unit owners. Amid growing distress in 2007, state legislators changed the law to allow for deconversion if the owners of 80% of the units approved. But complaints of abuses, such as owners being pressured to sell at below-market prices, prompted lawmakers to amend condo laws twice more. Today, owners of just 5% of a property’s units can block the termination of a condo association. How much of an obstacle that presents depends on how many units are separately held and whether their owners are interested in cashing out.

“We don’t mind getting into hairy deals if we see a clear path to a successful exit,” said Juan Franco, who heads acquisitions at Mattoni Group, a Miami private equity firm that recently started pursuing fractured-condo purchases. “The returns are better and the value-add space is really crowded right now. If you are trying to deploy capital with more-opportunistic returns, and you want exposure to multi-family, it’s an excellent way to do that.”

While some bulk-condo buyers target eventual deconversion, others see value-added potential in sprucing up the properties and continuing to rent the unsold units. That’s encouraging owners to list fractured properties that can be pitched as rental investments, said Mitchell at JLL.

“You are seeing groups that brought these fractured condos in more-distressed situations 5-10 years ago, have now stabilized these properties and executed business plans, and are now exiting their investments,” he said.

Last month, JLL represented Crescent Real Estate of Fort Worth, Texas, in the $122 million sale of 883 units at the 1,000-unit Grande Oasis at Carrollwood in Tampa. Crescent had bought the garden-style complex in 2012. The rental units are 95.6% occupied. The buyer was Boston multi-family shop West Shore.

Helping to grease the skids is the availability of financing, which just a few years ago was hard to come by. Market pros say that lenders have become more comfortable financing bulk condo purchases, and that’s paving the way for more entrants into the space.

“If you can deliver to the market a bulk of condos that represent 80% or 90% of the ownership, [a buyer] can basically finance it as inexpensively as a regular multi-family deal,” said Granowsky. “That means you no longer need to underwrite a complete termination to end up with a big win and capture all the upside.”