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Nat Levy
Real Estate Reporter

June 12, 2014

Real Estate Buzz: Condo conversions: Are we there yet?

Real Estate Reporter

Record numbers of apartments are opening all around the Seattle area and many of them have the types of amenities and finishes typically found in condos, but the number of condos being built is still quite small.

With a low inventory and only a few new condo projects set to come on line over the next few years, talk has turned to conversions.

Will some of these new luxury apartments or existing properties be converted to condos?

Real estate and land use economist Matthew Gardner and David Herrman, a lawyer with Cairncross & Hempelmann who teaches a condo conversion class for brokers, say they don't see a new wave of conversions — at least not yet.

Converting apartments into condos is risky, expensive and time consuming, Gardner said, and apartments are hard to beat these days with rents and sale prices rising.

Perhaps the biggest obstacle to condo conversions is time. In 2008 the state Legislature passed a bill requiring owners to get everyone out of a building before starting a condo conversion. Owners also have to give tenants 120 days notice before starting a conversion. Even then owners can't break leases, so if a resident doesn't want to leave, conversion must wait until the lease is up. Owners can try to buy out leases, but can't force tenants out.

Once all tenants are gone and construction starts, owners get no revenues from rent but still owe for the conversion and any debt they may have on the building.

Some of these rules were not in place when conversions boomed in the past, and they have made conversions a riskier proposition Herrman said.

“Doing a conversion is a process, and there are a lot of hoops to jump through,” Herrman said. “To a certain degree when you lay all that out for people — all the steps to go through for a condo conversion — their first reaction is that is a lot of things to do.”

Many developers and general contractors simply don't want to do conversions, Herrman said, because of state laws about “implied warranties of quality” that cover defective materials and other problems.

These laws can't be waived in a contract so if there are defects, contractors and developers open themselves to lawsuits. Herrman said most new condo projects have had claims against them because issues come up even in well-constructed buildings.

Despite financial risks and legal issues with converting, Herrman said people are starting to talk about conversions again. He said he has received more calls from people wondering about the process in the last six months than he did in the previous two years.

When conversions start again Herrman said garden-style apartments are likely to be the first. These units often are in multiple buildings, so they can be renovated in phases and the owner can keep collecting rent from the other units. Garden-style buildings are also cheaper to acquire, so sales prices don't have to be as high to cover costs.

Smaller apartment buildings, with about 20 units, may also be candidates for conversion since the revenue loss once renters are out isn't as severe.

High rents in prime neighborhoods like Queen Anne and Capitol Hill mean Gardner doesn't expect to see a lot of conversions there, but in outlying neighborhoods — like Renton, East Bellevue and Burien — conversions make more sense.

Gardner said owners should answer two questions before doing a conversion: Is it financially viable? Is it worth the “brain damage” of going through the whole process?

And when it comes to the question of financial viability, owners should ask themselves: With rents surging, does the return on converted condos exceed the return on apartments?

For now, Gardner and Herrman say, the answer seems to be no.

Gardner said we may see more conversions when rent increases slow or stop.

“At the end of the day, numbers don't lie,” Gardner said. “It comes down to what is going to be the IRR (internal rate of return). If it is a reasonable figure and your risk tolerance is there, then you are going to go ahead and do it.”

Brookings calls SLU an ‘innovation district'

For decades, a lot of the innovation in the U.S. has occurred in suburban areas like Silicon Valley.

But over the last few years, that's changed. Now groundbreaking new technology is coming out of what the Brookings Institution calls “innovation districts.”

In a recent report, Brookings listed South Lake Union as one of the innovation districts around the country.

These areas can be different from each other but they share some characteristics. They all have anchors — in South Lake Union that would be Amazon.com, University of Washington, Bill and Melinda Gates Foundation and Fred Hutchinson Cancer Research Center — as well as startups and support businesses. They are often compact and transit-oriented, with retail and housing.

South Lake Union certainly checks all these boxes, according to the report written by Bruce Katz and Julie Wagner.

What else is on the list? Boston, Brooklyn, Chicago, Portland, Providence and San Francisco have all seen under-used, mostly industrial areas become mixed-use, transit-oriented innovation districts. In other cities like Atlanta, Baltimore, Buffalo, Cambridge, Cleveland, Detroit, Houston, Philadelphia, Pittsburgh, St. Louis and San Diego major institutions and research centers are bringing new life to downtown. The report also mentions Raleigh, North Carolina, where suburban office parks are being redeveloped to add the urban amenities that tech workers crave.

For more information, or to see the report, visit: http://www.brookings.edu/about/programs/metro/innovation-districts

Got a tip? Contact DJC real estate editor Brian Miller at brian.miller@djc.com or call him at (206) 219-6517.

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