Legal Considerations for Condominium Deconversions in Chicago
With the demand for apartments in Chicago rising, many real estate developers have discovered a previously untapped supply of potential acquisition targets — residential condominium buildings. This includes older condominium properties plagued by large deferred maintenance obligations and stagnating or declining unit sales prices.
While the process for converting condominium buildings into rental properties can be more time consuming and labor-intensive than acquiring an existing apartment building, patient investors often see hidden value opportunities. They are able to capitalize on the spread between a building’s higher value as a rental property versus its lower value as an owner-occupied condominium building.
Purchasing all of the condominium units in an existing building is not your typical real estate purchase. Because of the unique issues involved and the potential voluminous amount of documents involved, both the condominium association (the Association) and the buyer should be represented by experienced counsel with the bandwidth to handle the simultaneous closing of potentially hundreds of units. The counsel should also have a deep familiarity with condominium law, and in particular, Section 15 of the Illinois Condominium Property Act (the Act).
Deconversion is the term that has become widely used in the real estate industry to refer to the sales process that an Association goes through pursuant to Section 15 of the Act.
The Association must obtain at least 75 percent of the unit owners’ approval (with a few exceptions) to sell the entire condominium building to a single buyer, and then, pursuant to Section 16 of the Act, remove the property from governance under the Act.
The purchase, sales contract
To expedite the approval process and avoid protracted negotiation with the Association and its members, buyer’s counsel should present the Association with a reasonable purchase and sales contract that addresses unit owners’ basic concerns. The contract, however, must protect the buyer from assuming unknown Association and unit owner liabilities. The following are issues unique to condominium deconversions that a buyer must consider.
• Identifying the proper seller: Should the seller be the Association or all of the unit owners? The answer is both. While the Association technically does not own the real estate that is the subject of the sale, Section 15 of the Act provides that the Association may legally bind all of the unit owners to sell their units if the requisite percentage of unit owners approve the sale, but the Association will not want to make covenants and representations with respect to the condition of or leases affecting the individual units. These must come directly from the unit owners.
• Delays: Delays can arise for a number of reasons, including bankruptcy filings by unit owners, title issues and Section 15 appraisal disputes. Accordingly, the buyer will want the right to extend the original closing date in order to be in a position to close on 100 percent of the units in one mass closing.
• Objecting unit owners: If, pursuant to Section 15, a unit owner files a written objection to the sales price with the Association within 20 days of the date of the meeting at which the sale was approved, the contract should require that the Association resolve the dispute and pay all expenses relating to the dispute.
• Unit upgrades: One of the toughest issues to address, both practically and legally, is how to treat unit owners who believe they are entitled to a higher purchase price because of improvements made to their units. In order to gain unit owner approval, the prospective buyer must get creative.
One option may be for the buyer to allocate as much as 5 percent of the purchase price to pay those unit owners who have recently improved their units. These additional payments can be based on a fixed schedule of values for certain specified improvements.
• Leases: How can the buyer’s attorney protect its client from buying a building subject to unit leases of which the buyer is totally unaware? This information must be provided directly from the individual unit owners.
The buyer must also anticipate that many unit owners will insist on remaining in their units for some limited period of time after the closing and the contract should allow unit owners to lease back their unit.
In addition, deconversion buildings tend to have a high percentage of tenants residing in the units. Therefore, the buyer, which will be taking an assignment of these leases from the unit owner, must protect itself from tenant claims that the unit owner has breached the lease or has violated a particular law or ordinance, such as the Chicago Landlord Tenant Ordinance.
• Association issues: When a buyer buys all of the units, the buyer may inadvertently become the Association and therefore responsible for Association obligations and liabilities, such as union contracts covering the doormen, or pending lawsuits against the Association. To protect the buyer against these potential liabilities, special protections and remedies must be built into the contract, such as a cash holdback of Association funds.
The law with respect to deconversions is scant and still developing. As the law evolves, it will be important for associations and buyers to keep abreast of all developments and best practices.
— By Dan Bronson and Courtney Mayster, principals in the real estate practice at Much Shelist. This article originally appeared in the October 2018 issue of Heartland Real Estate Business magazine.