Real Estate Investing 203 – Shifting Classes or Uses

Back in Real Estate Investing 101, I briefly mentioned “Shifting Classes” after the Buy & Hold strategy. There are a few different ways to shift classes and uses that can build value for investors.

Residential to Commercial

One of the most common ways to increase value while shifting classes or use is to have a property re-zoned from residential to commercial usage. A property that is located on a busy street would be a prime example. The busy street lowers the value for a residential property because of the noise and associated traffic. It is even more true of a corner lot. So, this busy location is a detriment.

However, for a commercial property, the traffic is an asset. If it is a corner lot with heavy traffic on multiple sides, that is even more of a bonus. A savvy investor might see the commercial potential of a property, possibly even years before having it re-zoned. In fact, it is preferable to buy the property well before it can be converted to commercial zoning and rent it out for residential purposes. The reason that one may choose to do it this way is that the property can be purchased for the best price, and then carried with the costs offset by a renter while the investor seeks to have the property re-zoned. Depending on local rules and nearby zoning, as well as future plans the city may have, it might take a year or more to get the property properly re-zoned. Meanwhile, because the property is located on a busy thoroughfare, advertising for renters is as easy as putting a sign on the property.

Keep in mind that frontage may be just as important for commercial property as acreage. That is another reason that corner lots are such a premium. They have as much as twice the frontage/acre as a lot on just one street. Obviously, lot dimensions will play into this, but in almost all cases the corner lot is the premium.

Low Density to High Density Residential

Another popular way to increase land value is to change it from a lower density residential to a higher density residential usage. Finding a single property or an assemblage of properties to re-zone to higher density can increase the attractiveness of the property to a developer.

Of course, as with most real estate, location is everything. A townhouse or condo development might not be in demand in a less densely populated area, but might support very high valuations in a sought after area. It might also be a great way to capitalize on a smaller parcel adjacent to a popular subdivision. For those familiar with the St. Marlo subdivision at the extreme southern end of Forsyth County out side of Atlanta, The Weston, which is next door is a great example.

Apartment to Condo Conversions

This is an often overlooked strategy that is similar to flipping, but on a huge scale. It is out of the realm of most investors, but purchasing an apartment complex and converting them to condo can be extremely profitable. This is especially true of a slightly older community. As the community ages, the demand for it may decrease. As demand drops, the rent may not keep up with fresher complexes. At the same time, the mechanical systems will be getting ready for an overhaul. If one can purchase the entire operation at a reasonable price, one might be able to flip it to individual ownership.

There are a few different strategies that can be employed depending on the needs of the investor as well as the needs of the community and subject property.

Starting at the lowest end of the economic scale, if the property is converted to condo, there might be reluctance from current residents. One way to overcome this is to build a pricing model that allows the majority to remain in place, increase the value of the community and more quickly sell the remaining units. Finding a financing solution that allows the tenant to be converted to a buyer means that one doesn’t need to market as many units. Offer to pay closing costs, finding sources of down payment assistance or 100% loans would also help to ease the transition. If there is a way to allow the current residents to buy in below the prices that the property will be marketed at, this is even better. This gives the current residents instant equity, and they will be more likely to be better neighbors since they now have a stake in the community. Occasionally, converting to low income housing may also carry tax benefits for the investors. Having single unit or multi-unit investors in line should there be residents that don’t wish to purchase is also an option, but not as attractive since there will be a lot of residents without a financial stake in the community.

The same strategies can be used with higher priced properties as well. But, financing is often easier to set up. Many of the residents may already to considering purchasing their next residence, and allowing them to buy in below market will be very attractive. Set up several programs that allow different pricing based on renovations to existing units. Offer a low price for un-renovated units (only to residents in those units), a mechanical only upgrade, and a full upgrade including fixtures, etc. For a full upgrade, one might offer a nearby similar unit to allow a faster transition.

This can also be done with vacated apartment complexes, but there will generally be much higher renovation costs. However, the profit margin may be significantly higher. While driving through New Orleans earlier this year, I couldn’t help but think that there were huge opportunities in renovating apartments.

Commercial to Condo

Loft conversions are hugely popular. Most of the conversions that are currently being done are very high end. However, this can be done at various price points. The primary difference will be in the level and quantity of finish for the units. Finding a building worth saving, that is convertible to residential space is the first challenge. It needs to be unique and have plenty of character.

If one is shooting for the lower end of the market, all that needs to be done is to provide the stubs for plumbing, and require the buyer build out kitchens and baths on their own. Set some sort of minimum standards, and be sure all work is permitted and done to local code.

Moving up, one may choose to put in baths and a kitchen, either fully finished or in some other state agreed by the buyer. One could also go as far as to have several private rooms, and fully outfit the space with high end finishes and fixtures. Additional amenities could be included ranging from pool and parking to high-speed, wireless internet access.

In all of the condo conversions, whether from apartments or commercial space, it is very important to set up some sort of Owner’s Association. This will help keep cohesion in the community as it is populated. This also provides a mechanism to care for common property and maintain amenities. Another issue that the OA will need to deal with is the level of renters for the community. The lower the percentage of renters v. owner-occupants, the lower the maintenance needs generally are. However, if there are no renters allowed, it might adversely affect resale values. There are a lot of different strategies for dealing with that particular situation.