Vulture Funds Can Taint Condo Deals

7/24/2009

As real estate prices continue to drop, experts expect to see some great deals on condominiums, especially in overbuilt markets. While a smart purchase of the right property could be a sound investment opportunity, prospective buyers need to be cautious, say insiders.

Flat sales and defaults lead some lenders to entertain offers from investment funds to sell in bulk, changing a building's fortunes in a number of ways. Bulk buyers -- who pool resources into what are often called "vulture funds" because of their predilection for buying up distressed properties at bargain-basement rates -- have priorities that are likely to conflict with the lifestyle condominium residents seek.

When a bulk buyer invades a building, the value of every unit takes a hit, says Peter Zalewski, principal of CondoVultures Realty, a Miami-based consultancy. "All comparables will be compromised negatively," he says. "So if you're an individual trying to sell, the price is going to come down."

Among such funds known to be scanning the horizon for condo opportunities are Lubert-Adler Partners, Condo Capital Solutions and Skyvest Real Estate Opportunity Fund.

Instant Depreciation

Even if a buyer is interested in purchasing an individual condo at a price a seller can accept, Zalewski says, unless it's an all-cash transaction, the banks will probably nix it.

"When a vulture fund purchases a bulk of units," Zalewski says, "it creates some real challenges for existing owners looking to resell or refinance. Any financier who's going to lend money on a residential project where a bulk sale has occurred will require a condo questionnaire to gauge the health of the building.

"The fact that there's a bulk buyer in possession sends up a red flag to any lender that theoretically the building may be compromised, because if they for some reason can't continue to pay, the whole building will be in jeopardy. It can be a real dilemma for anyone trying to get financing."

Lenders are also less likely to grant a mortgage to your potential buyer if 30 percent or more of the residents in your building are renters, says Jack McCabe, principal of McCabe Research & Consulting in Deerfield Beach, Fla.

"Or if they do," he says, "it would be at a reduced loan-to-buyer amount, and that in effect could kill the deal." That means buyers would have to come up with a hefty down payment.

That's important, McCabe adds, because the strategy of most bulk buyers is to rent units at below market value while they wait for the economy to recover. "They're going to be a lot less pressed to cover their operating expenses than you are," he says.

Buyers who acquire one or two units with the same strategy in mind will find themselves undercut, McCabe says. "Because of their size and economies of scale, the vultures have the ability to rent at a lower rate than you can. They're therefore more likely to pull in tenants while your unit sits empty."

Zalewski says the vulture funds with which he consults expect to drop rents "well below market value, so that they'll be able to poach renters from a mature market to bring them to an overbuilt market. They hope they can then convert to higher rents or sales in the future."

Quality Of Life Impacted

The safety net designed by many condo associations that limits the number of units that can be inhabited by renters at any given time, McCabe says, motivates many bulk owners to try to acquire a controlling interest in the association.

"They don't have to buy a majority of units to do that," he says. "Many times a large number of individual unit-owners are absentee and don't show up to vote. So ownership of even a fourth of the total units may, in essence, give them control.

"In most cases they want control so they can change the association rules to be more amenable to their strategies. That means allowing more renters. Chances are that their renters are not of the same caliber in income and creditworthiness as past buyers. So resident owners may find themselves living with people who may not be trustworthy or take care of the property as well as an owner would."

Under these circumstances, McCabe adds, "daily rentals are a possibility, and you may see some condo documents rewritten to allow fractional sales."

One often-cited benefit of condo living is resort-style amenities. Yet pools, gyms, on-site business centers, spas and mini movie theaters are perks that create expenses a vulture landlord may not want on the balance sheet.

"Bulk buyers are looking to maximize returns," Zalewski says. "That means the elimination of many services. They'll run a skeleton operation."

"Their purchase price will dictate their operating procedures," McCabe says. "If they paid a price that will require them to continue to pay monthly expenditures -- or if their income from the property doesn't cover operating expenses -- they'll look to cut down on costs. It could be something as simple as lowering the hot-tub temperature from 104 to 98 degrees, but for someone looking to buy a particular lifestyle, there are obviously inherent risks."

What To Look For

Wilkas suggests individual buyers who think they have found a steal of a deal should ditch the rose-colored glasses and take a clear-eyed look at what they're getting into.

"Before you do anything," she says, "take a look at the minutes of the board, budgets and everything else you can get your hands on, going back at least a year -- two years is better. That'll give you a picture of what's going on in that complex. How well-run is the budget? Are they in good financial standing? Do they have a lot of short sales? That's an indicator of problems.

"It really is 'caveat emptor.' A buyer shouldn't attempt it without professional help.