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Fundamentals of Condominium Deconversions
By: Bruce Theobald, Attorney At Law
The purpose of this memo is to give a brief overview of condominium deconversions, and answer commonly asked questions. Much of this is based on my personal experience of being involved in two deconversion transactions, one at the Kennelly Square Condominium (1749 N Wells, Chicago) which was successful and one at the Park View Tower (2740 N Pine Grove, Chicago) which was not.
This document is intended to provide objective, unbiased, and position-neutral information on condo deconversions to unit-owners and associations. This document is not aimed at any particular condo building. Additionally, this document is not intended to advocate either for or against any specific deconversion offer, received or anticipated.
What is a condo deconversion?
A condo deconversion is a transaction where all the unit owners of a condo association sell all their units, in bulk, to an individual purchaser.
Why are condo deconversions so popular now?
As a historical backdrop, condo converters used to be able to buy apartment buildings for a fixed price, cut the building up into condos, and then sell the condos at a higher price, thereby realizing a profit. Today, the situation is reversed in that condo buildings are worth more as a whole than the sum of the individual unit values.
Further, changing consumer preferences, away from home ownership and towards renting are fueling increased demand for rental apartments.
How much will I get for my unit?
As a starting point, take the amount of the bid for your building and multiply it times the percentage of ownership for your individual unit. The percentage of ownership for your unit can be found in the Declaration of Condominium for your building. If you have a rough idea of what your unit is worth, the result of this calculation will typically be 20-30% more since deconverters typically pay a 20-30% premium when they buy.
I live in my unit. Will I have to move?
No. Condo deconverters typically buy condo buildings to operate them as rental apartment buildings, so the deconverter would be happy to have you continue to live in your apartment as a renter.
How much will I have to pay in rent if I stay after the deconversion?
Every transaction is different but using the Kennelly Square deconversion (1749 N Wells, Chicago) as an example, unit owners were allowed to rent back their apartments for up to 18 months after the closing of the purchase and sale transaction, at a below market rate.
I rent out my unit. What happens in that situation?
The deconverter would be obligated to honor the terms of your lease with the tenant, provided the lease is an arms-length transaction at a reasonable rate. After the lease expires, the new rent would be a matter of negotiation between the deconverter and the tenant.
Is a unit-owner vote required to deconvert the condo association?
Yes. The Illinois Condominium Property Act requires approval of a minimum of 75% of the unit owners to approve a sale. (765 ILCS 605/15). If 75%, or more, of the ownership votes to sell, the remaining owners must sell as well.
If the unit owners vote on an offer, and vote is not approved, will that have a negative impact on the building?
No. This actually happened at the 2740 N Pine Grove building in Chicago, also known as Park View Tower. A vote was held and only about 45% of the building voted to sell, falling far short of the required 75%, thus the building did not sell. The building continues to operate as a condominium and there has been no negative impact on sales or rentals in the building. Few people outside of the building knew about the vote, or the fact that the vote failed. And if the question comes up, it is easily explained away by saying that there were obviously a healthy number of people who really liked the building, which is why the vote did not pass.
How long does it take to get my money?
It depends. But it could easily take three to six months past the date the vote to approve the sale is held.
What if I am not happy with the price I am offered for my unit?
In the Kennelly Square deconversion, a certain portion of the sales proceeds ($700,000) was set aside as a “special situation fund” to handle unit owner valuation complaints. Any unit owner who felt that they were not being adequately compensated had a right to request a meeting with the deconverter, and have the deconverter personally visit the apartment. Thereafter, the deconverter would make an offer to the unit owner and hopefully come to agreement.
In the event that the unit owner and the deconverter were not able to come to agreement, the unit could also invoke his rights under Section 15(b) of the Condo Act (765 ILCS 605/15b). Under Section 15(b), the owner and the deconverter would each hire their own appraiser to come up with a value, and the two appraisers in turn would hire a third appraiser to make a final decision.
What happens to units that are “under water”, i.e. the mortgage balance is higher than the value of the unit?
At Kennelly Square, the same “special situation fund” was used to help bail out any under water homeowners, of which there were only a handful. Essentially, the owner got paid their fair share of the sales proceeds (which all went to pay down the mortgage) and then a disbursement was made from the Special Situation Fund to cover the difference between the purchase price and the owner’s mortgage balance.
What happens to the cash reserves of the building?
You will receive your pro-rata share of the cash reserves of the building, in addition to the value of your unit.
Have other buildings in the area deconverted?
Yes. The following buildings have fully deconverted:
1749 N Wells (across the street from Nookie’s restaurant, formerly known as Kennelly Square).
2625 N Clark St (just south of McDonalds and across the street from the Weiner Circle, now known as The Kent building).
420 W Belmont (located just went of the 3200 N Lake Shore Drive building).
As of this writing, the following buildings are considering deconversions:
1400 N Lake Shore Drive (a vintage high rise),
1250 N LaSalle,
and 800 S Wells (known as River City).
What are the federal tax implications of a deconversion?
The sale of a condominium in a deconversion is no different from a federal tax standpoint than a sale unrelated to a deconversion.
For owner-occupants, Section 121 of the Internal Revenue Code (26 US Code Sect 121) allows a homeowner to exclude the first $250,000 of gain if the taxpayer is single ($500,000 if married) provide the taxpayer used the property as his personal residence for at least 2 of the last 5 years. Other terms and conditions apply as well.
For investor owners and done properly, Section 1031 of the Internal Revenue Code can be used to exclude all the gain on a sale. For more information, visit www.1031ExchangeVideo.com
Be sure to consult with your tax advisor prior to closing on your transaction.
Are there other advantages of doing a condo deconversion?
Condo deconversions will yield the condo owner a price higher than market value. As an example, I owned a unit at Kennelly Square. I estimated the current market value at $125,000. Yet, in the deconversion, I received $153,399. That’s 22% over market value.
Deconversions also have lower commissions and fees. A typical real estate commission might be 5%. Yet in the Kennelly Square deconversion, the commission was only 1%. Based on my $153,399 sales price, that is a savings of $6,135.
Deconversions also offer owners the ability to sell without the hassle of showings and open houses.
About The Author.
Bruce Theobald is both an Illinois attorney and an Illinois real estate broker. He graduated with a bachelor’s degree in Real Estate Finance from the University of Illinois in Champaign-Urbana. Mr Theobald received his law degree from the John Marshall Law School in Chicago.
As an attorney, Mr Theobald is the author of a professional publication "Security Deposits and the Chicago Residential Landlord Tenant Ordinance" (2014). Copies available on request. He also produced a video "Fundamentals of Section 1031 Tax Deferred Exchanges” (2017) which can be seen at www.1031ExchangeVideo.com
He can be reached at 312-286-7402, firstname.lastname@example.org and www.BruceTheobald.com