Cooperatives and Condominiums

The decision to buy an apartment is complicated by the different forms of ownership. Developments, whether they are high rise buildings or comprised of individual structures, can be either a cooperative (co-op) or a condominium (condo). For the purpose of this discussion we will categorize Planned Unit Developments (puds) as condos, since, from the buyer’s prospective there isn’t enough of a difference to impact this comparison. In fact, many owners don’t realize they own a pud and not a condo. When the times comes to sell or refinance, their attorney informs them that what they always thought was a condo is in fact a pud. 

When purchasing a condo, the buyer takes title; that is, the purchaser’s name appears on a deed to the particular unit he is purchasing. The purchaser also owns a percentage of the common elements of the property. This percentage was determined when the condominium was originally formed. It was based on the relative size and location of the unit. The purchaser is billed for his property tax directly from the local municipality. The condominium will bill him for his common charges. 

These charges are based on the maintenance expenses for the property, labor costs, hazard insurance for the development and any other expenses the association of unit owners incurs as a group. For example, there may be a swimming pool on the property or an exercise room, both of which would require maintenance. The association may have other forms of revenue, such as parking fees, laundry room charges, etc. These revenue flows are used to keep the cost of the common charges down.

The board of directors makes decisions for the association. The board is made up of unit owners that are elected to the board by all owners. The board decides how money is spent, how much should be set aside for reserves, sets the common charges as well as all other fees (parking, pool fees, etc). The board also has the ability to assess each unit owner as needs arise.  The condominium may be faced with a non-recurring expense. For example, a tree falls due to a storm and damages one of the buildings. The board may feel that the best way to pay for the repairs is to assess each unit owner a one-time fee, based on their ownership percentage in the common areas. Each unit owner would then be obligated to make payment.

When you purchase a condo, you own your space as well as a share of all the common areas. You pay your own property tax and are responsible to make payments of common charges and assessments to the condominium association. An elected board of directors runs the association. When the time comes to sell your unit, you are responsible to market it and find a buyer. Typically, the association does not have the authority to approve whom you sell to or to set any limitations as to the sale price. The only power the association has is the right of first refusal. That is, if the association feels that your sale is not in the best interests of the remaining owners, it can match your agreed-upon price and purchase the unit from you. Few associations have the financial strength to exercise this power.

Why does the association have this power? In order to protect everyone’s investment. Let’s look at some examples. The local real estate market takes a rapid downturn. One, or several, of the unit owners must sell for whatever reason. The association may feel it is in their best interests to buy these units as a method to support the prices of the other units. A similar situation would occur if a bank forecloses on a unit. The association may elect to purchase the unit to protect the owners from a speculator buying into the development.

Since you are actually buying real estate, the closing costs associated with the purchase of a condo are the same as they would be if you were buying a home. Special, high leverage mortgage programs and typically, most first-time homebuyer programs will not be allowed on condos. The minimum down payment most lenders will require will be 10%. At times, some lenders will consider a 5% down payment but this would be rare.

Purchasing a co-op is completely different from purchasing a condo. You are not taking title to the unit, you are buying shares of the corporation and are given a lease to live in your unit. This seems like a strange arrangement, but as you read on, you will understand why it’s done this way and the benefits of this arrangement.

In a condo, each unit owner owns a percentage of the common areas. The ownership percentage is based on the size and location of the designated unit.  In a co-op, a similar analysis is done. The corporation has title to the development, all units and common areas. The corporation is made up of a specific number of shares. Each unit, based on its size, location, etc, is assigned a specific number of these shares. The sum of all the unit shares will equal the total number of shares in the corporation.  

What makes a cooperative corporation different from any other corporation is that each shareholder not only owns shares, but also has a right to use a particular space to either live in or rent out. This right to use the space is authorized through a document called a Proprietary Lease. When you purchase a co-op, you receive a stock certificate and a proprietary lease. This makes you an owner in the corporation as well as a lessee of the corporation.

As in all corporations, the day-to-day operating decisions are made by the board of directors. This board is voted in by the shareholders and is given the power to run the corporation. Although it is not mandatory, the directors are usually made of unit shareholders of the corporation.

In a co-op, each shareholder is billed for his share of the “maintenance”. The maintenance fee in a co-op covers more than the name implies. Besides including the cost to actually maintain the buildings, common areas, insurance costs, etc, it also includes the shareholder’s share of the property tax on the property. Remember, title is held in the corporate name. Taxes are billed to the corporation and the cost is passed through to each unit owner through the maintenance charge. The final component of the maintenance is the mortgage payment on the underlying mortgage.

When the corporation took title to the property, it probably financed it, just like any other purchaser. This financing requires monthly payments, payments paid for by the corporation and passed through to each shareholder through the maintenance payment. This ability of the corporation to arrange for financing based on its ownership of the property gives the co-op an alternative to assessment or maintenance increases to pay for major capital improvements. The corporation can simply arrange for bank financing and have the cost of the improvements spread over a long period of time. This will minimize the financial impact to the shareholders.

There are numerous other advantages to this form of ownership. All stock transfers need to be approved by the board of directors. The board has the authority to ask a potential purchaser to prove they have the financial capability to afford the purchase. The board can restrict a shareholder from subletting the apartment. The board has the right to reject a purchaser’s application for any reason as long as it doesn’t violate any discrimination laws. The added step of obtaining board approval for the sale, does make a co-op purchase move more slowly that that of a condo, but it is this approval process that gives a co-op more influence over its own destiny.

The big advantage to purchasing a co-op is that a buyer needs less cash to close the transaction than if he was purchasing a condo. We’ll use an example to illustrate this. We have 2 identical buildings next door to each other. Building “A” is a condo, with a sales price of $100,000 and common charges of $200.00 per month. Building “B” is a co-op, has a sales price of $50,000 and a maintenance of  $600.00 per month. To simplify the discussion, neither building pays property tax.

A purchaser on building “A” putting 10% down would need $10,000 for the down payment plus approximately $4,500 for closing costs. This brings his cash requirement to $14,500 and he would be carrying a $90,000 mortgage. A purchaser on building “B” putting 10% down would need $5,000 for the down payment plus approximately $2,000 for closing costs. This purchaser would need only $7,000 to invest and end up with a $40,000 mortgage.

Total monthly payments in both purchases would be similar. In building “A” we have a smaller common charge number, but a higher mortgage payment. In building “B” we are writing the larger check in maintenance fees and the smaller check for the mortgage.  What we are seeing here is that a portion of the sales price of the co-op is in the debt that the corporation has, that unit’s share of the underlying mortgage.

In purchasing a co-op you are not taking title to property. This reduces the closing costs dramatically from that of a condo. The closing costs for any co-op, prior to paying any points on your mortgage, will be less than $2,000. The closing costs on a condo, prior to paying any points, will be approximately 5% of the mortgage amount. As in condos, special high leverage loans and most first time homebuyer programs will not be allowed in the financing of a co-op. Although lenders today have the ability to finance co-op purchases with as little as 5% down, it would be extremely rare to find a corporation that would be willing to approve a purchase with such a small down payment. Most corporations have a minimum down payment requirement, some properties may not permit any amount of financing. The approval guidelines are unique to each property so if you are considering the purchase of a co-op you such see the guidelines for that particular corporation prior to entering into a purchase contract.

The individual needs of a purchaser will determine which form of ownership is better. Someone looking to purchase for the purpose of renting out the unit will probably be better off with a condo. Someone with a large amount of cash to invest and limited with his monthly income would probably be better off in a condo. A retiree who is downsizing from a house and is now going to be on a fixed income would be an example of this. However, a first-time buyer who has recently started his career with a strong salary but lacks a sizable cash position would be better suited for a co-op.

A development can be built as condo or a co-op. An existing rental development can be converted to a condo or co-op. From the buyer’s prospective a conversion needs to be looked at more closely. In a conversion, the landlord goes through the process of carving up his buildings into individual units. He will set the proportion of common areas to each unit, in the case of a condo. Set up the share value for each unit, in the case of a co-op. Repairs and upgrades will be done as needed, a budget will be written and then prices will be set for each unit. The actual conversion plan will be approved by the State and then the units will be marketed. 

The property will then officially be declared a condo or co-op once a certain percentage of sales are made. The landlord, who became the sponsor of the conversion, probably didn’t sell every one of the units. He has maintained ownership of some part of the development. The size of his involvement is a major consideration. The larger his percentage of ownership is, the more dependent the development is on one person for its financial survival. Generally  you want the sponsor to have less than a 50% interest in the development.

In choosing a unit, whether a condo or co-op, there are other things to consider besides its physical condition and location. You will also need to consider the financial condition of the development.

In a condo, you want to consider the following:

1. What percentage of the units does the sponsor retain?

2. What percentage of the units are owned by investors?

3. What percentage of the units are second homes?

4. How many units in the development?

5. Does any one investor own more than 10% of the total units in the project?

6. Are all units, common areas and amenities 100% complete?

7. Has voting control of the board of directors been turned over from the sponsor or builder?

8. What has been the history of the common charge for the last few years?

9. Have there been any special assessments over the last few years?

10. What is the size of the reserve fund, and has it changed over the last few years?

11. How many owners are delinquent more than 30 days in their unit common charges?

12. Are there any units in the property designated for commercial use?

In a co-op you should consider:

1. What percentage of the units does the sponsor retain?

2. What percentage of the units are owned by investors?

3. What percentage of the units are second homes?

4. How many units in the development?

5. Total project shares?

6. Total unit shares?

7. What is the expiration of the proprietary lease?

8. Does any one investor own more than 10% of the total units in the project?

9. Is there a ground lease (an arrangement where the co-op does not own the land it is built on but rents it from another entity) that the co-op is subject to?

10. How many shareholders are delinquent more than 30 days in their maintenance fees?

11. Does the co-op impose a stock transfer fee or flip tax (charges imposed on the seller of the stock)? If so, how is it calculated?

12. Has voting control of the board of directors been turned over from the sponsor?

13. What is the sponsor’s monthly rental income?

14. What is the sponsor’s monthly maintenance cost?

15. Does the sponsor have his shares pledged (does he have a loan against those shares)? If so, what are the terms of that pledge (loan)?

16. Is the sponsor delinquent on any financial obligations relating to this project or any other project in which he has a 10% or greater interest in?

17. Who is the mortgagee on the underlying mortgage?

18. What are all the terms of that mortgage?

19. Are the mortgage payments current?

Once you have these questions answered, your mortgage broker or attorney can then give you his opinion on the soundness of the purchase. You don’t need to become an expert yourself, you just want to have the necessary data so your advisors can give you sound advice.