Southland Hot Spot: Converting Co-Ops to Condos

While much of the Southland’s real estate market has ground to a halt, one segment of the marketplace is speeding along with appreciation rates upward of 20%--sometimes as high as 100%.

Long considered “white elephants” in terms of California’s skyrocketing sales and prices, the 10,000-plus stock cooperatives and community apartments (own-your-owns) in greater Los Angeles are among the hottest properties around, thanks to the trend of converting the properties to condominiums.

During the past 10 years, stock co-ops and own-your-owns have been difficult to finance and virtually impossible to sell. Values have dropped. When unable to sell or refinance original high interest rate loans, some owners have been forced into foreclosure.

Why the sudden turnaround? Converting co-ops and community apartments into condominiums offers many advantages. Financing is readily available. Eager first-time buyers snatch up these properties--still considered bargains in California’s high-priced market.

To date, in the Los Angeles and Orange County areas, more than 1,000 cooperative and community apartment units have been converted and 1,500 are in the process of converting. What exactly is the difference between co-ops, own-your-owns and condominiums?

In a stock cooperative, the corporation owns the whole project, including the real property and improvements. The owners are shareholders in the corporation and receive lease agreements that give them the right to occupy their units.

In an own-your-own, each owner receives a deed giving him or her an undivided interest in the common area of the project along with a right to occupy a unit, and an association is formed to manage and maintain the project.

With both the co-op and own-your-own, the homeowners do not actually own their individual units. In a condominium, the homeowners do own their individual units along with an undivided interest in the common area of the project.

Because a conversion to condominium must be undertaken for an entire building or project, the first step for interested owners is to take a preliminary poll to determine if sufficient interest exists to proceed.

Although most owners react positively to the possibility of converting, some raise a variety of concerns:

--Potential property tax increases. Persons who have owned their units for a number of years may be concerned that their property taxes will increase as a result of the conversion.

Property taxes typically are unaffected by the conversion, because it is simply a change in the form of ownership.

--Community control over property. Another concern of some owners is maintaining the same community atmosphere and control after the conversion. In practice, owners will have the same control; the same rules and regulations apply to the condominium as were applied before the conversion.

The new condominium association documents only modify those portions of the existing documents and rules and regulations as necessary to reflect the condominium form of ownership and to comply with current law and lender requirements.

--Income tax liability. A final, particularly significant concern is the effect of the conversion on individual owners’ income taxes.

While there is no effect for community apartments, some co-ops may be affected. For co-op owners who occupy their units, conversion is generally a tax-free transaction for federal and state income tax purposes.

But if a project contains a large number of rental units or second homes, the income tax results may be different.

After all individual concerns are addressed, the project may begin the conversion process. The three basic phases of the conversion are obtaining the necessary approvals, redefining the project as a condominium, and changing the legal documents and title for each owner.

--Required approvals. Generally, three approvals are required for the conversion--homeowner, local government and the California Department of Real Estate.

While we recommend that at least 75% of the owners approve the conversion, California law sometimes allows conversion with approval of only 51% of the owners. In many cases, the conversion of a co-op or community apartment to a condominium is exempt from the local government ordinances and it is not necessary to file a conversion application.

This removes a major obstacle to conversion by eliminating any physical requirements or modifications, such as additional parking or any other conditions which could be imposed by the city or county.

Finally, the California Department of Real Estate conducts an administrative review of the new condominium legal documents to ensure that they comply with current laws and regulations.

--Forming the condominium. The second phase, which overlaps the approval process, is redefining the project as a condominium project.

An engineer prepares the condominium plan, which is a diagrammatic plan of the project and each unit. This becomes the basis for the new legal description of the units as condominiums. The attorney prepares the new condominium management documents including the covenants, conditions and regulations (CC&Rs;), the bylaws and articles of incorporation. The attorney also prepares the documents that will be used to change the owners’ titles during the final phase of the conversion.

--Owning the condominium. The final phase of the conversion requires the services of both an escrow and title company. Basically, the owners exchange their co-op or community apartment unit for a grant deed to their unit as a condominium and receive a title insurance policy insuring that they have proper legal title to the unit as a condominium.

During this phase, the units can be converted independently one at a time.

The conversion process can be completed in six to eight months for a cost of $1,500-$2,500 a unit.

To begin the conversion process, the association needs to retain the necessary personnel. The association may choose to hire a single company to coordinate and provide all required services for one set fee. Alternatively, the association may choose to hire an experienced attorney who will assist the association in coordinating the conversion and hiring other personnel, such as the engineer, escrow company and title company.

Sometimes a board member or homeowner may wish to be the “conversion coordinator.” However, the board should be cautious about accepting a volunteer’s help because the conversion is a full-time job and issues which arise during the conversion are complicated. Those without sufficient expertise who attempt to manage a conversion could make the conversion more costly and lengthy than necessary.

The stock co-op and community apartment “white elephants” are on their way to extinction, but no one will miss them. By changing the legal definition of these properties to condominiums, thousands of owners are solving their financing and sales problems while creating new affordable housing for first-time buyers.