Condo owners can be caught up in market downturn

When the real estate market boomed between 1995 and 2005, speculation ran rampant. Property "flippers" were rolling over huge profits, selling their contracts for condos in new buildings before they were even built.

Just like the game of musical chairs, the music stopped and someone was going to get stuck.

All across the country new construction and conversions have been foreclosed by unpaid lenders because of slow sales, and early buyers are getting stuck with units in a building that cannot cover its overhead. Recent stories about owners vacuuming the hallways and shoveling the parking lots is only one small aspect of the possible crisis.

How about the hypothetical building with 90 units? Thirty sold to owner occupants, 30 to investors who have renters and 30 who own empty units. An active imagination can create a number of scenarios, such as bankruptcy, with a capital - ruptcy.

According to law in Illinois, when a written contract is entered into for the purchase of real estate, that purchaser becomes the "equitable" owner of the property. The developer or seller maintains legal title. This is the legal doctrine of "equitable conversion;" the buyer then owns the "equitable title," the seller holds the "legal title." The rights of the legal titleholder take precedence, such as in condominiums where the legal titleholder is treated as the owner unless he assigns the right to vote, or other rights to the buyer/equitable owner.

That is why with regard to "contract sales" - a/k/a installment contracts, a/k/a contracts for deed, under Section 18, (b) (11) of the Illinois Condominium Property Act - it is the buyer who counts towards quorum at meetings of the owners and the right to vote, unless reserved by the seller. (Developers however, are exempted here, but my point is to illustrate how the concept of equitable conversion works.)

When a new building is under construction, the developer has construction loans that are liens against the entire property, but they are not broken down into a mortgage lien over an individual buyer's interest in the property. The reason this is now topical is because of the recent mortgage crisis, subprime loan catastrophes and an avalanche of foreclosures (does this sounds like a recap of natural disaster?). Seller financing is once again becoming popular, especially in a "down" market.

When a buyer closes, they purchase title insurance that insures new construction liens/or loans showing up after closing. The people who have closed at least have the protection of title insurance, since the title company is supposed to review liens before they issue a commitment and ultimately a title policy. A buyer cannot get a personal mortgage loan if there was a developer's mortgage lien against an individual unit that is not insured. Liens filed or developer mortgages foreclosed after the fact are protected by American Land Title Association, or ALTA, which provides title insurance coverage for liens that show up after the closing.

When a developer becomes insolvent during construction, buyers who have not closed have a serious problem. Their earnest money may be at risk since they do not have title insurance protection. Unless the developer escrowed their deposit, which is doubtful, their total investment is at risk. They can record their contract to establish their rights, but it would be subordinate in all likelihood to a foreclosure by any lenders. That strategy only works in the event of an attempted conveyance of the unit before a foreclosure, such as a deed in lieu of foreclosure. Their only hope is that a successor developer purchases the property at the foreclosure sale and the successor builder would honor their contract, and that ultimately depends upon who purchases the property.

The condominium association comes into existence when the property is "submitted to the act," which is when the declaration and plats are recorded. Some developers hold off recording their documents until the first closing in order to avoid liability for assessments. In this instance, if the property is foreclosed before the documents are recorded, it is not yet a condominium, as there is no such thing as a "de facto" condominium, and the buyers would have the greatest risk because they technically do not own units, since units and common elements do not come into existence until the declaration is recorded.

If the declaration is recorded and the property is submitted to the act, there is a condominium association even if it is not operating, and those owners who have closed, do have the rights of owners. As a practical matter, if the developer or his successor retains ownership of a number of units and does not pay assessments or contribute to the operating expenses, the other buyers have to either make up the difference to pay their bills and go after the delinquent owner(s) or they may all be in default of their obligations and the property would have to either go into receivership or file bankruptcy. The association cannot be dissolved as a result of the foreclosure, unless the foreclosure purchaser buys out the buyer's interests and then dissolves the association as the only owner.

The horse is already out of the barn and the door is closed. These difficult times can remind people that nothing lasts forever, especially real estate and stock bubbles. The most important things you can do if your building is inundated with foreclosures, or people who walked away and left the keys, are the following:

Have A+ financials and stay on top of cash flow and expenses.

Work with anyone with a hardship and who cannot afford to stay unless they can catch a break.

Monitor your collections and mortgage foreclosures carefully.

Focus your priorities; if the building is new, rather than worry about too many renters, concentrate your energies on keeping the property solvent.

Condo talk appears alternate Saturdays in New Homes. Jordan Shifrin is an attorney with Kovitz Shifrin Nesbit in Buffalo Grove. Send questions for the column to him at jshifrin@ksnlaw.com. This column is not a substitute for consultation with legal counsel. Past columns can be read at www.ksnlaw.net.