Wednesday, March 1, 2023

Where Old Condos Go To Die

Will you still need me, will you still feed me,

When I'm sixty-four?

…The Beatles


            In 2005 we published a treatise entitled "The Uncertain Future of Common Interest Developments." We worried about the inability of condominium boards to fund reserves for future repairs and maintenance. In addition, political pressure from individual owners was keeping assessments artificially low. While this pleased the then-owners, it underfunded reserves and robbed future owners of the resources for long-term maintenance.


            In the following years, we noticed and added another factor to the under-funding equation—damage unseen during routine inspections, which eventually required unexpected and unfunded repairs. At first, these problems—rot in wall cavities hidden for years, gradual soil problems, slow deterioration of framing elements—required spot repairs but often led to large-scale reconstruction later. Unfortunately, some of that hidden damage eventually caused catastrophic failures of building parts or entire buildings and loss of life.


            After studying this phenomenon for several decades, we have concluded that these failures and the lack of funding that leads to them result from a fundamental flaw in the condominium business model. Allowing critical funding decisions to be made by a majority vote of owners with disparate interests invariably defeats most fund-raising efforts by the board of directors. This makes funding voluntary. Condominium repair and maintenance are determined not by experts but by laypeople whose interests in the project are mostly short-term. But the managing corporation's interests are long-term. Thus, an inherent conflict.


            The consequences of voluntary funding are seen in the gradual deterioration of many older condominium buildings. Newer owners resent that they have been saddled with the cost of decades of deferred maintenance while past owners escaped unharmed. Repairs or restoration that the association could have done inexpensively twenty years earlier, if found in time, now require six-figure special assessments or bank loans, again the responsibility of current owners. Reserve funds were kept artificially low by past votes against higher assessments, did not keep up with the rate of deterioration, and promoted increasing reserve deficits.


            So, what's the end game? What happens when current owners either balk at paying for reconstruction to keep a building watertight and safe or lack the financial capability to address these problems? State and local entities have learned of the potential for injury or death from failed building components due to poor maintenance. They can and will condemn buildings considered unsafe or uninhabitable. Insurance companies that provide liability or property damage coverage are also aware of these conditions and, for now, have raised premiums to account for it. But they may deny coverage altogether. Boards of directors have been sued by current owners who reject the idea that they should bear responsibility for many decades of deterioration. And then, there is the possibility that all or a part of the building will fail due to inadequate maintenance, construction defects, or natural disasters.

If any of these factors are present, the project may be at the end of its service life. That's not what a community association's governing documents intend, but that's the reality. Buildings destroyed, unsafe, or cannot be adequately maintained for habitability can no longer function as planned, and the owners must consider an "end of life" outcome. Some outcomes can be chosen, but some cannot be addressed in time to save the project. Here are a few.



Redevelopment is one of the few outcomes within the owners' control. When condos reach the end of their service lives, owners become desperate to find a way out. In cities like Chicago, where many older apartment buildings were converted to condos decades ago and were among the first to reach the end of their service lives, owners have turned to "de-conversion" to realize their equity. But it hasn't been easy. Writer Henry Grabar reports in Slate that Chicago requires an 85% owner vote to achieve de-conversion. Regardless, the process gives rise to infighting among owners and boards of directors with many views on dealing with an obsolete project.


In California, existing condominium buildings do not provide enough housing to meet demand, and open land suitable for new projects is scarce. But low-density condominiums built many years ago often sit on parcels not fully utilized under today's zoning laws. For example, if the zoning permits, a project of low-rise buildings with surface parking could increase its density by two or three times on the same site. These sites are often close to downtown and transit. The state or local entity could incentivize developers to buy these properties, demolish the existing buildings, and build needed new housing. The increased density would raise the site's value, allowing the present owners to receive more than the units are worth in their current condition. The developer could create and sell enough new units to be profitable. Affordable housing and mixed-use projects also fit this profile.  




Other than catastrophic loss, this is the least attractive outcome for obvious reasons. If a condominium building is condemned for safety or habitability reasons, the owners must vacate and have little leverage to obtain their equity from the project. A developer may pay salvage value for the property and redevelop it, but the former owners have little to show for their ownership. The trick here is not to wait until the building department is forced to condemn. As a project deteriorates without meaningful maintenance, it gradually loses market value. Projects allowed to deteriorate to the point of condemnation will have abandoned or foreclosed units, red-tagged buildings, and a general state of disrepair. This will leave the owners and their lenders with few options but take what they can get for the property.


A well-executed end-of-life strategy should not wait until a building's serviceability ends. For example, redevelopment should be considered an alternative to an expensive rehab that the owners can barely afford and which may not raise property values enough to justify the expense. A knowledgeable appraiser can provide a before and after valuation while a major rehab project is considered. This evaluation will give the owners another data point to help their decision. They may find that the dollars invested in reconstruction will not result in a proportional increase in market value, and they should consider other options. Waiting until the building is uninhabitable deprives the owners of options that may preserve a more significant percentage of whatever equity they have left.


Catastrophic Loss


Buildings can be lost to many natural or other causes. For example, wildfires, earthquakes, hurricanes, and other weather-related threats cause billions of dollars of damage to infrastructure every year. In addition, building deterioration from a lack of proper inspections and maintenance can lead to the collapse of all or parts of a building. The worst examples recently were the Champlain Towers South collapse in Surfside, Florida, which claimed 98 lives in 2021, and the loss of life sustained when a balcony collapsed on a building in Berkeley, California, in 2015. 




Insurance may cover some or all the costs to restore the structure and compensate victims. But coverage is often inadequate or disputed by insurance carriers. For example, property damage policies may pay to repair the "common areas" but may not fix the units' interiors. As a result, owners must carry insurance for their separate interests. Fire loss is usually covered. Insurance may also cover wind damage from falling trees. But losses due to flooding won't be covered by the typical condo policy and requires a separate flood policy. The same applies to earthquake insurance; owners must carry a separate unit policy.


A failure due to decades of deferred maintenance or hidden damage may not be covered, depending on how the damage occurs. A "sudden" collapse may find coverage, but the carrier will likely dispute the claim when damage has happened gradually. The limits may not adequately compensate the owners even if coverage is available. Liability coverage for the association and board members sued for their role in the catastrophe may be available but will often require months or years of litigation to resolve. In all these cases, what is usually left beyond insurance is the value of the remaining property. But there will be other claimants beyond the owners—lenders, insurance carriers looking for subrogation, and the estates of deceased owners—which usually means recovery will not be adequate for anyone. 




Legal considerations and the condition of the building(s) will determine what course is available to the owners. Some state statutes outline when a condominium property can be sold in its entirety. A sale to a developer at market value requires an active board of directors with the full support of the owners behind the proposal and building conditions good enough to leave the owners with some leverage—like the ability to sell individual units instead of a sale of the entire project. The governing documents or state law will dictate what percentage of owners must approve a sale of the whole property for redevelopment. The rules must be carefully researched as they will vary considerably.




Condominium buildings do not last forever. Maintenance is highly variable among projects, but it does not meet long-term requirements on average. But maintenance isn't everything. The owners' wealth, whether the location or the building has intrinsic value, the type of construction, and the evolution of the surrounding neighborhood will all play a part in determining a building's service life. But when deterioration or calamity brings that end close, and if they still have options, the owners must consider how best to extract their equity. A delay in making that decision could be costly.

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