By LISA SELIN DAVIS
When it comes to combining dwelling units, two really are better than one. But expect higher fees and more paperwork.
Mortgages for connecting two condos or co-ops, or converting a multifamily to a single-family house, can be complicated. “It’s not the kind of thing that you take off the shelf,” says Mike McPartland, head of investment finance for North America at Citi Private Bank.
If a buyer owns one unit and is buying an adjacent one, lenders may do a condominium or co-op combination cash-out refinance: The borrower pays off the balance of the first mortgage and gets a new one. “They’re going to spread the mortgage on both units,” says Marc H. Sanders, a real-estate lawyer with New York-based Hafif & Associates.
In other cases, lenders may issue two simultaneous loans—a first mortgage and a construction loan.
“The marketplace for this product is still developing; you’re going to get a lot of diversification in terms of what lenders will do,” says Jason Auerbach, division head of New Jersey-based First Choice Loan Services Inc. First Choice and its subsidiaries handled more than $25 million in loans for combining co-ops and condos, or multifamily houses to single-family houses, in 2013.
About half of their combination loans were jumbos, Mr. Auerbach said. Of those, the average loan was well over $1 million. (Jumbo loans exceed $417,000 in most markets, and $625,500 in pricey housing markets such as New York and San Francisco.)
In the past year, Mr. Auerbach has seen a number of lenders enter this marketplace, due to factors such as the reduced demand for refinancing.
While combinations can be hard to track, data show that New York City saw steady demand last year for projects in which multiunit properties were turned into single-family homes. In 2013, there were 139 such conversions in the city, up from 134 in 2012, according to the real-estate data website Property Shark. (These projects could include a townhouse with several apartments turned into a home for one family.)
Buyers usually hire an architect to draw up plans for the combination; the loan amount is based on the appraisal, which estimates the value of the finished product using those floor plans, comparable properties and the current value of the separate units as guides. “We’re saying if this were combined right now and completed, what would it be worth,” says Jonathan Miller, president and CEO of Miller Samuel, a real-estate appraisal and consulting firm.
In a market like New York City, where space is at a premium and residents hunger for family-size apartments, combined units are considered more valuable than separate ones. “In our market one-plus-one equals 2.5,” says Mr. Miller.
But the idea that combined properties are worth more than two singles doesn’t mean loans are always as big as customers want. “We need to be comfortable that the borrower isn’t going to over-improve the property,” says Mr. McPartland, meaning borrowers shouldn’t put more money into renovating it than it will be worth afterward. “We don’t want to lend $3 million on a $500,000 apartment, where the value of the apartment will never equal the amount of money put in.”
Most banks hold some of the loan in escrow, to protect against potential construction troubles. “The minute you start taking a sledgehammer to the property, that collateral is now worth less,” says Mr. McPartland. “You have to underwrite the risk of the construction.”
For a recent combination mortgage-and-construction loan for two condominiums purchased concurrently, First Choice approved the buyers for up to 65% of the estimated $3.9 million future value of the combined units, with a one-year interest-only loan. At closing, they borrowed $1.45 million for the purchase, while another $800,000 stayed in escrow for construction costs. Only when they drew down on that $800,000 did they have to pay interest on it. And it could only be accessed after the work was inspected.
“The client completes some work, an inspector verifies the work is complete and we pay the invoice to the vendor,” says Mr. Auerbach. “The inspector makes sure that HVAC really did get installed and not that they just put a big box on top of the building; the inspector really matches up the budget with the work.”
If they don’t match up, says Mr. Miller, “We adjust the value, and that can impact their leverage, or how much they’re able to finance.” But, he adds, those examples are exceedingly rare—only a handful in his 28 years of experience.
Here are some other issues to consider:
• Higher loan costs: These loans might be more expensive. Fixed rates could range between 5% and 6%, with higher fees. “You should expect it to be close to two points, or 2% of the loan, for typical jumbo combination mortgages,” says Mr. Auerbach.
• Approvals: To combine two units in a condo or co-op, you’ll likely need approval from the management, homeowners’ association or board. For multifamily conversions, you’ll need to check zoning.
• Certificate of Occupancy: A combined property may be assessed differently due to state laws governing assessments.
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