Managing Fractured Condos

With the financial meltdown of 2008 came a plethora of condo-conversion failures and stalled sales, which forced developers, mezzanine lenders, banks, receivers and other parties to devise alternative methods to financially stabilize their assets.

“We went into those projects that were failed and we helped the clients stop the bleeding,” recalls Bill Worrall, vice president of the Hollywood, Fla.-based Continental Group, a FirstService Residential Management company, whose portfolio of approximately 1,500 properties has included 36 fractured condominium projects since 2006.

With a focus on reducing expenses and providing cash flow during this time, new teams were brought on board in many developments in order to lease up the units that didn’t sell, allowing “the bank or lender to take a deep breath; they know they’re stuck with this project, with this bad loan, but they’re not hemorrhaging cash on a daily basis from an operational perspective,” Worrall points out.

The challenge to managing such an asset is that there are two different types of residents—homeowners and renters—with two different stakes, under one roof. The two parties often have different demands, and they tend to analyze costs differently, points out Cindy Clare, president of McLean, Va.-based Kettler Management, which has managed several fractured condominiums since the beginning of the economic crisis.

When a new company is brought in to manage the rentals, it may be met with some resistance from the homeowner’s association and the owners themselves. For instance, there’s often a perception that the building won’t be managed to the level the homeowners expect, Clare points out, or some owners may have preconceived notions about “the type of people” that will be renting at the community.

Worrall agrees. “You’ll hear a lot of homeowners and board members dislike the institutional guys because they bring in a lot of renters. We make a point to explain to those homeowners that this is actually a good thing; you are guaranteed to receive all of your maintenance fees for all of your units every single month.”

The key, Clare adds, is to reassure owners that these renters tend to be renters-by-choice and that the building will, in fact, be well-maintained. “The biggest challenge,” she says, “is that these owners are very unhappy; by this turning into a rental they feel that the values of their properties have gone down; whether the values have gone down or not, it’s clearly going to be difficult for them to sell.”

The key to success

The first step when taking over the management of a fractured condominium is to determine for whom you are working, says Worrall. “In each project you have two different bosses. You have a board of directors and you have institutional owners, and [you] work for both of them.”

While the association is a non-profit corporation, “the guy over on the institutional side who owns a chunk of units is looking for positive cash flow. He’s looking for stabilization, he’s looking to grow his investment,” notes Worrall.

As the manager, then, it’s important to pull the two parties together by understanding each stakeholder’s needs. For example, managers need to understand the owners’ vision and goals for their community and should set up a business plan to address these needs. The same needs to be then done for the rental portion of the building.

Interestingly enough, the two plans are often similarly aligned, notes Worrall. “This is what most people in the industry fail to understand; at the end of the day, everybody involved in the project is looking for the same thing,” which is, more often than not, to see an increase in property values.

Once the two groups take note these aligned interests, a certain “spirit of cooperation” ensues, according to Worrall. “When you position the realities and show the [financial and lifestyle] alignment between the two parties … the property [can] move forward in harmony. That is the key to success in fractured deals.”

It is also critical to notify everyone of your presence and provide all appropriate contact information. Meet with the condo owners to review the budget, and inform them of their assessment fees, suggests Clare. “Understand the financial and accounting aspects of it, because from a management standpoint, that’s where it’s most complicated,” Clare cautions. “You’re generally running multiple entities: you’re running a condo budget, a rental budget and a combined [budget]. You have to make sure you understand what can be charged to the condominium, to the HOA, and what should be charged to the rental budget.”

Equally important is to explain to the unit owners that their HOA dues are unrelated to rental operations and that they are not being charged based on anything to do with that aspect of the building. Ensure that you have separate accounting books for the various budgets, cautions Clare. “Make sure that the [HOA] fees you’re charging to the condo owners are truly just for the common area maintenance, not for the leased part of the building.”

While it’s critical to attend the monthly condo board meetings, it’s also important to communicate with the renters, a task that’s much easier to do when one company is managing both the ownership and rental sides of the development.

“I may have two different contracts, one to manage the rental and one to manage the association, but at the end of the day they are all our staff … so it’s very synergized,” says Worrall. “That allows the association, which is responsible for the common areas and the maintenance of the exterior of the units, to easily communicate and coordinate with renters.”

Repositioning assets

With the economy beginning to show signs of a recovery, the focus has shifted to a repositioning of these distressed assets. “Today there are a plethora of buyers in the market in Florida,” Worrall, of The Continental Group, reports. “We have banks willing to sell because [the assets are] stabilized … so they are phasing in selling of projects.”

Absorption and price points, meanwhile, are still down from where they were, “but they are back to where the reality should be,” points out Mark Pordes, president of Aventura, Fla.-based Pordes Residential Sales & Marketing, which recently entered into a joint venture agreement on 42 condo-hotel units in Bal Harbour. “It’s just been a correction in the market—not a devaluation,” he adds.

If, and when, a building is converted back to a condominium, the ownership needs to determine what improvements need to be made. Oftentimes, units will need to be upgraded and positioned to the target market.

In many cases, the owner will ask management to stop releasing units as notices to vacate are received. To keep the project financially stable, though, Worrall recommends turning units in a phased approach, with the first stage comprising between eight and 10 units—so that inventory can be sold immediately—as well as a few model units.

Management can then see how sales are progressing and whether a particular unit type is moving more quickly than others. If one particular layout is selling faster than the others, Worrall advises focusing the sales effort, including vacating and turning units, on that particular inventory.

Not all developments that saw financial fallout due to the real estate bust were converted to rentals in the interim. In such cases, a third-party marketing and sales team might be brought in to reposition the asset, from making improvements to the exteriors to remerchandising interiors with new models and creating a new ad campaign to bring the product back out to the marketplace.

In these situations, the first step to take is identifying exactly who the target market is, notes Pordes. “A lot of the properties that have been laying flat in the market over the past year or so haven’t spent any dollars on marketing,” he notes. “They’re not sure who the buyer is because in the past they were only selling to investors.”

Prior to the economic meltdown, many of these developments were planned and purchased by speculators. Today, either end users or what Pordes calls “real investors” comprise the buying pool. “People [are] buying with the pretense to hold, not to buy and quickly resell it,” he notes.

“The fact that a lot of these projects have sold on bulk and there is new ownership is a positive thing because the new owners are taking a more serious approach to bringing the properties back to the market,” Pordes adds. “People hear about the bulk sale and think it’s negative. I think it’s positive because it brings more capital to the project; it enhances what the old group was not doing.”

In other situations, where owners chose to convert the rentals back into condo units, “the end goal is that you have a fully functional … condominium association,” asserts Worrall. “That’s part of where the synergies come into play; as the association’s responsibilities grow with every closed unit, the rental team has to pass on knowledge and information about those units to the association team.”

In any case, Worrall advises managers to “stick to the basics; stick to what you’re good at. Know that at the end of the day you need to lease these units up. No matter who the owners of these units are, they need the cash flow.”

The association side of things, though, “is a totally different animal,” he warns. Worrall’s advice to those looking to gain experience in this sector is to “hire the right professionals that have the experience and know what they’re doing on the association side.” He adds, “Eventually this thing is going to turn over to a unit owner control, so there’s a lot of liability and risk if association affairs aren’t handled correctly.”