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21 unit default - how could this happen?

TangoWhiskey

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Hi All,



Pierre Paul from the multi family investing side recently had an interesting example of a foreclosed 21 unit multi family property in Edmonton that he recently bid on. He put a description of this up on his website as part of a blog post about how to value buildings. In this case, the 21 suiter was bought in 2006 for 1.6 million and then sold again in 2007 for 2.7 million.



That's right, a 1 MILLION dollar price jump. Whoever sold this building was incredibly lucky on their timing.



How could this happen? I don't understand how a bank would ever give a mortgage with such a massive price jump unless the buyer coughed up all the cash difference between the previous year's pricing of 1.6 mill and the 2.7 mill. OR they had other properties with enough equity the bank could place debt against.



Are there any other scenarios that could account for such a massive price jump?
 
I should mention that his blog post later states that it was a failed condo conversion plan; that the buyer had 2 appraisals supporting a 2.7 mill valuation; and that the lender was a private money lender (oops!).



Many many morals in this story - the biggest one IMHO being don't put a lot of faith in an appraisal being what something is worth because its only worth what the market gives!



I'd love to hear any other stories from this time - very interesting figuring out how frothy the Edmonton RE market must have been in 2007. Similar to US RE in 2006, really.
 
Calgary was similar.



Was a case of two different methods of evaluation - multifamily (based on NOI and prevailing cap rate) and individual unit selling prices on the owner occupied condominium market. That gave each multifamily property a much higher value if it could be converted.



Alberta never should have allowed condo conversions. Nobody won other than landlords that owned these buildings who were probably rich anyway.
 
[quote user=RedlineBrett]Alberta never should have allowed condo conversions. Nobody won other than landlords that owned these buildings who were probably rich anyway.





Isn't there some value in providing ownership opportunities to people who couldn't afford anything bigger/newer than a converted condo? Obviously it removes the old renters from the building, but they'll either be replaced by new renters if investors buy the units, or homeowners.



Regards,



Michael
 
[quote user=TangoWhiskey]Are there any other scenarios that could account for such a massive price jump?
Fear and greed drive markets.



Greed in this case .. by sellers, realtors and investors !



I would like to point out that a condo converted building has a slight value premium over one that is not condo converted, as it increases the possible exit options. It is just that the premium paid was too high. Maybe it should have been $150,000 to $250,000 - around $10,000/door - but not $1.1M.



Condo conversions are very cash intensive and thus risky, to fund the following activities properly:

a) reserve fund or major item upgrades: parking lot, boiler, roof, hallways, in-suite

b) mortgage payout penalties

c) sales channel to sell units individual - say 5-10% of retail value

d) vacancies during periods of renovations

e) legal documents



Thus, the retail value of a condo is about 25 to 50% above a building price, per unit, depending on upgrades. As stated elsewhere this is how I started my real estate investment career in 1997: with a rental pooled condos as a retail buyer. It may make sense to buy such a retail condo, or it may not, depending on the upgrade work done.
 
[quote user=bizaro86]

Isn't there some value in providing ownership opportunities to people who couldn't afford anything bigger/newer than a converted condo? Obviously it removes the old renters from the building, but they'll either be replaced by new renters if investors buy the units, or homeowners.



Regards,



Michael




I'd say no, because this market segment is fraught with risk and buyers at that price point seldom have the wherewithal to fully comprehend what they're buying - very old buildings with very little work done to the structure and the minimum possible reserve fund left to the new owners. That gets lost in the mirage of owning your own place with shiny new furnishings.



I would contend that if that is the only thing you could afford then you should stay in the rental market until at the very least you could afford a similar sized unit in a purpose-built condominium complex from the same era - basically the next step up the affordability ladder. A smart first purchase can key up a lifetime of solid financial footing. A bad first-buy and it can be really ugly.



At the time prices were moving so quickly though that many buyers felt they would 'miss the boat' if they didn't jump on something right away. These feverish buyers jumping in at the bottom then stoked the flames for trade-up activity and help spurn on the unsustainable run up in prices.
 
[quote user=RedlineBrett]I'd say no, because this market segment is fraught with risk and buyers at that price point seldom have the wherewithal to fully comprehend what they're buying



That's an excellent point, as it's very hard to legislate financial competency. About half of my portfolio is composed of condo conversion units purchased out of foreclosure, and I agree that most people wouldn't have the wherewithal to start a condo board for a dilapidated project and get it back on its feet again. I feel really bad for the people who paid ~2x what I paid for units in the same building where the "developer" went bankrupt and never initiated a condo board/reserve fund. But after having talked to many people in that situation at length I think they would have made a bad purchase of some other real estate at the same time for the same reason. They may not have had special assessments afterwards, but they would have overpaid for something in the heat of the boom.



[quote user=RedlineBrett]At the time prices were moving so quickly though that many buyers felt they would 'miss the boat' if they didn't jump on something right away. These feverish buyers jumping in at the bottom then stoked the flames for trade-up activity and help spurn on the unsustainable run up in prices


Condo conversions wouldn't stoke "trade ups" in the single family market, as the sellers are people who own multi-family buildings. In many ways the extra inventory added to the bottom of the "home" market should reduce the boom time trade ups, as some of the "first time homebuyer" demand is filled through conversions as opposed to buying someone elses first home.



It's definitley interesting. I'm not an unbiased observer as I've benefited from the fallout of conversions done poorly. It seems like "no conversions" isn't the ideal choice to me, but they could certainly be done better than they were in the boom.



Regards,



Michael
 
[quote user=RedlineBrett]Alberta never should have allowed condo conversions.
I disagree.



I allows entry level home owners and investors to buy entry level condos well below $200,000, often below $150,000 !



The issue is not the conversion per se, but the sloppy execution primarily sales without reserve funds and inflated values.



Of course a small, ugly, un-upgraded condo with no view, no balcony and with no reserve fund is a bad investment if one pays "full retail" compared to an upgraded one with a balcony, a view, a decent size and a decent reserve fund, well managed.



Just because some apples are bad, does it mean one should not eat fruit anymore ?
 
[quote user=bizaro86]That's an excellent point, as it's very hard to legislate financial competency.


Certainly agree, and I agree many buyers would have just made a mistake somewhere else at that time.



[quote user=bizaro86]Condo conversions wouldn't stoke "trade ups" in the single family market, as the sellers are people who own multi-family buildings. In many ways the extra inventory added to the bottom of the "home" market should reduce the boom time trade ups, as some of the "first time homebuyer" demand is filled through conversions as opposed to buying someone elses first home.


The trade up effect doesn't show up so much from the actual money earned by the seller and what they do with it, but rather the effect that the comparable sales can have on nearby buildings and their value. If you have an 800ft unit from a purpose built building with 25 years of management history and reserve fund selling for 150k and then a converted condo comes on the market with the same useable square footage (IE same immediate benefit to the buyer) for 145k it'll drive up the price of the other units by comparison. Then those can have the ripple effect up through the market. You are basically lowering the 'price of entry' into real estate and getting a lot more transactions, and it only takes one buyer to 'overpay' in a building to skew the picture.
 
[quote user=ThomasBeyer]he issue is not the conversion per se, but the sloppy execution primarily sales without reserve funds and inflated values.


Yes, on this I agree. It's all about the operator, but it introduces the 'greed' element you brought up in an earlier post... namely the owners of old apartment buildings wanting to maximize their exit. Do whatever they need to in order to condominiumize, bury the issues in a lawyer'd up disclosure document, give it to a first time buyer to sign and off they go.



I remember reviewing condo docs for converted units when they first tried to go to the resale market. You'd look at a 25 year old building across the street and it would have a reserve fund in the order of several 100k. The minimum standard for condo conversion was a lot less. You could certainly argue that the reduced reserve fund was priced in, but that's like selling a car without a seatbelt for 4k rather than 5k.



[quote user=ThomasBeyer]Just because some apples are bad, does it mean one should not eat fruit anymore ?


If two apples are equally red are they equally delicious? they look the same, but you can't tell until you take a bite, and by then it's too late!
 
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