For years now, NYC has been grappling with a severely overbuilt luxury condo market. Even before the COVID pandemic arrived on the scene, analysts predicted that it would take six years to clear all the unsold units in Manhattan. As of now (early 2021), our best estimates say that there are over 7,000 unsold new development units in the borough, almost 6,000 of those remaining unlisted. This “shadow inventory” has created a severe weight on the market and left many developers in despair that they’ll ever see a return on their investments. Some are already considering alternative business plans for the year ahead. These plans include bulk purchasers, bringing new partners into the capital stack, and refinancing their existing debt. How well these plans will work depends on each developer’s particular situation and that of their project.
So, what does all this mean for savvy investors looking to make their next big purchase? It means that major discounts of 10% -20% could be on the way. The real problem for these developers is that they’re beholden to their banks and lenders. They can’t just set any price they want. They have to negotiate, and whichever buildings come down first on the price will have an advantage.
But buying one of these distressed properties isn’t like a regular purchase. There are considerations that you need to be mindful of before going down this path. Our aim with this guide is to walk you through those considerations to be ready in the year ahead.
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What sort of investment opportunities are available in distressed condominiums?What sort of investment opportunities are available in distressed condominiums?
There are two avenues open to you for any investor looking to get involved in this area of the market.
The first is the option to purchase multiple units as part of a “bulk sale.” This is when you purchase ten or more units or at least 20% of the building’s condos. This threshold determines whether the buyer is subject to regulatory oversight by the New York State attorney general and is deemed a “sponsor” or “successor-sponsor.”
The other option is to purchase an equity interest in the development and become a new sponsor entity member. As part of this recapitalization, the buyer acquires an indirect ownership interest in all of the building’s unsold properties.
What is involved in the offering plan?What is involved in the offering plan?
In the case of a bulk sale, the buildings offering plan must be amended to disclose that the buyer is a successor-sponsor of the units they purchased. This means the buyer has all the rights, obligations, and liabilities of a sponsor, though only concerning the units they own on or after closing day. The amended offering plan will also disclose that the original sponsor remains responsible for the purchased units until closing day. If they hold any other units besides those purchased in the bulk sale, they will continue to be liable.
Additionally, a bulk purchaser must also designate at least one individual as the “principle” of the successor-sponsor. This is usually a director, shareholder, or another individual interested in the offering plan. Their task is to submit a certification as to the truthfulness and completeness of the offering plan.
As for the recapitalization route, the transaction’s specific details will determine whether any changes have to be made to the offering plan. This will be worked out between the original sponsor and the investor.
Whether going for a bulk sale or recapitalization, the principle’s identity will be a critical component of the transaction. There’s a lot of nuance here and questions of liability that an investor will have to consider when choosing a principle carefully. The addition or removal of principals is a factor the attorney general considers when looking at existing purchasers and whether they have a right to rescind their contracts.
What future rights will the investor have over the condominium?What future rights will the investor have over the condominium?
In bulk sales, the investor has all the rights of a sponsor over their units. They are free to modify prices, renovate some or all of the units, determine how they be released on the market, change to renting instead of selling, and, depending on zoning restrictions, change the use of unsold units. The bulk purchaser does not have to own all unsold units, and their rights will be restricted to only the units they own. Typically, any bulk purchase will involve negotiating and planning between the investor and the original sponsor. They will need to work out their relationship dynamic to coordinate offering plans, competing sales programs, shared control of the condominium board, and other decisions.
In a recapitalization, the investor’s rights and ability to control the project will be determined by their position within the entity. All of this will be worked out in the transaction to determine what rights the investor has over the setting of prices, how sales will be handled, and the condominium’s general running. The bigger the investment, the greater the control.
How does all this fit in with existing purchasers?How does all this fit in with existing purchasers?
Whether a bulk purchase or a recapitalization, the attorney general will determine whether the transaction has any adverse effects on existing purchasers. Each one will be considered on a case-by-case basis. If any are found to have suffered adverse effects, they will have the right to rescind their contracts. Key factors for the attorney general in deciding on each case will be the principal’s prior experience, reputation, and successor-sponsor.
Investors can reduce the risk of this by submitting the appropriate disclosures to the attorney general and public. Also, even if the transaction is deemed not to have any adverse effects, future events may still trigger a right of rescission. For investors, you must mitigate the chances of this by performing extensive due diligence.
What about maintenance and transfer tax considerations?What about maintenance and transfer tax considerations?
When closing on a bulk sale, transfer taxes must be paid to New York City and New York State. In this case, the transfer taxes are at the commercial rate, which is higher than those paid for an individual sale. There may also be a Mansion Tax that must be paid to New York State.
As with other considerations, the exact nature of transfer taxes in a recapitalization depends on the deal’s specific terms. In both cases, there are approaches you can take that will mitigate the amount of tax owed. All of this needs to be carefully worked out between the investor and their counsel during the underwriting process.
Final ThoughtsFinal Thoughts
The most important thing to take from all this is that there is no one-size-fits-all approach to buying distressed condominiums. How an investor approaches depends on their overall investment strategy and the condominium’s specific situation they’re buying in. Whether you’re looking for a bulk sale or a recapitalization, both can be advantageous when approached with care.
The key thing is due diligence and overall strategy. Focus on those and leave no stone unturned as you consider each deal. Your buyer’s agent and real estate attorney can provide invaluable counsel as you navigate this area of the market. Make sure they are experienced in this sector and prepared to give you honest answers. This is not the sort of market you want to walk into with a “Yes Man” at your side. Which, honestly, is not something you should ever want in a real estate deal.