CO-OPS 101

Last month's feature dove into the intricate New York City rental market, and this month, we explore homebuying. As expected, New York City defies tradition and has a vocabulary all its own when it comes to buying your dream home.

In New York City, the typical homebuyer will be faced with 3 property types:

1. Co-op (short for Cooperative)
2. Condo
3. Townhouse

This month, we'll explore Co-ops, as they are the most misunderstood -- yet pervasive (75% of NYC properties!) -- of the three.

What Is a Co-Op?
Unlike traditional real estate, where each house or parcel of land or apartment is an independent piece of real property with a corresponding deed, a co-op is a collection of shareholders who each owns a portion of the corporation that owns the apartment building. When you buy into a co-op, you are not buying real property or the apartment itself; instead, you are buying stock in that corporation. You don't receive a mortgage; you receive a loan to purchase the shares (though for tax purposes, this loan is treated the same as a mortgage, and the interest can still be deducted). You don't receive a deed; you receive a stock certificate for the number of shares allocated to your apartment based on its size, location, and other factors. And you receive a proprietary lease, which entitles you to occupy your apartment.

Once you've bought into a co-op, you'll have to pay monthly maintenance fees. These fees include:

1. Standard building upkeep and maintenance (staff salaries, utilities, etc.)
2. Real estate taxes
3. Interest on the building's underlying mortgage

(note: a condo, which we'll discuss in a later blog, does not include numbers 2 & 3 in its monthly maintenance; these are unique to a co-op). 

As a shareholder, you own your proportionate share of the building's assets and liabilities, and you are part of the community that is responsible for the building's mortgage, utilities, and real estate taxes ultimately being paid. If another shareholder defaults on his payments, the rest of the shareholders may have to cover the shortfall. This is one of the reason's a co-op is so selective about who can buy into the community, and where the Board of Directors comes in.

A co-op's Board of Directors is (generally) a group of elected shareholders responsible for the oversight of the building's finances, house rules, maintenance, and selection of potential new shareholders. 

What Are They Looking For?
Given that a co-op is a community of shareholders, Boards are generally looking for financially sound prospects who will add to (or at least not detract from) that community. While every Board is different, here's what they will want to see to assess your candidacy:

1. A full financial statement breaking out your assets and liabilities.
2. Here's where things get invasive. They'll need to see bank statements, tax returns, and any other documents to support the numbers on your financial statement. No one will take your information at face value, so you'll need to provide proof for every claim.
3. Debt-to-income Ratio: Boards want to ensure that you're financially sound and will not be a burden to the cooperative, so they look at how much of your monthly income will be consumed by your mortgage and maintenance. This is referred to as your debt-to-income ratio and is calculated by dividing your monthly mortgage and maintenance by your monthly income. An ideal debt-to-income ratio is <25%, but more liberal boards may approve up to 30%. Beyond 30% is a red flag for many boards.
   1. Example: You are buying a $500,000 apartment with 20% down ($100,000) and a $400,000 mortgage @ 4%. Your monthly mortgage payments would be $1,910; assume maintenance is $1,500 each month, for a total monthly payment of $3,410. For a debt-to-income ratio of 25%, you'd need to make at least $13,640/month ($3,410 / $13,640 = 0.25 or 25%), or $163,680/year.
4. Post Closing Liquidity: How much in liquid assets will you have after making your down payment and paying closing costs? Most Boards require at least 6 months of post-closing liquidity, while others require as much as two years' worth. 
   • Example: You have $150,000 in the bank and are buying the same apartment as above. Assume closing costs are 2% of purchase price, or $10,000. That'll leave you with $40,000 in liquid assets after closing ($150,000 starting - $100,000 down payment - $10,000 closing costs). Your total monthly payments are $3,410, so you'd need to have at least $20,460 in liquid assets available after closing for 6 months of coverage and up to $81,840 for a full two years. Your $40,000 in post-closing liquidity may not be sufficient!
5. Reference letters, both professional and personal. Boards want to make sure you're an upstanding person who will not disrupt the co-op community, so these letters are very important. Pick your references wisely, and review the letters with your broker before submission to ensure they don't include any red flags or innocent comments that could be misinterpreted.

Your broker will help you compile your board package and ensure it is neatly organized, bound, and indexed for presentation to the Board. Your broker should also validate all your financial information and references, and they should calculate your ratios to ensure there will not be any surprises.

Once all this information has been submitted to the Board, they will make a determination as to whether they want to bring you in for an interview. Take this interview very seriously. Your broker will work with you to prepare you for the interview, and always show up dressed as you would for any job interview. This is where the board can ask you about anything and assess who you are as a person. Remember, you are buying into a community, and the Board wants to ensure you will be an upstanding addition. They may ask how you'll be using the apartment (e.g. will you be practicing cello at 5am?). They may ask you to clarify information on your financials. Be sure to prep with your broker beforehand​ so you know what to expect.

If you are rejected by a Board, they do not need to share the reason (though they cannot violate Fair Housing Laws and reject prospects based on protected classes).

This All Sounds So Complicated. Why Would I Ever Buy into a Co-Op?
While the process of applying to and ultimately purchasing a co-op in onerous, there are some very rewarding benefits.
​
Tax Benefits
When you own a co-op, you get to write-off not only the interest on your own loan, but also your prorata share of the building's property taxes and of the interest on its underlying mortgage.

Know Your Neighbors
The same process that makes buying into a co-op such a pain also is what makes ultimately living in one so great. Because the Board can be so selective, co-ops tends to feel more community oriented, and because sublet policies tend to be pretty strict (see the Cons section below), co-ops tend to be more owner-occupied than other types of buildings, meaning less transience. With more owners actually living in the building, there also tends to be more commitment to maintaining the building and more investment by residents in its goings-on.

Refinancing and Maintenance Savings
Unlike in a condo, most co-ops have an underlying mortgage on the building. This not only provides a tax benefits to shareholders (as discussed above), but it can also help mitigate maintenance increases. For example, when it comes time for capital improvements in the building, or the reserve fund is not enough to cover necessary expenses, the underlying mortgage can be refinanced, and any savings realized can be used to offset maintenace cost increases that would otherwise need to be enacted.

Lower Closing Costs
Because a co-op is not real property, and you don't actually receive a mortgage, you avoid paying the upwards of 2% mortgage tax that condo buyers incur. On a $500,000 apartment example, that's $10,000 in savings!

Lower Purchase Price
On average, co-ops command 10%-20% less than condos.

Well Now This Sounds Pretty Great! What Are the Downsides?

More Restrictive
As we've discussed, a co-op is meant to be a housing community, and thus Boards tend to create rules -- a lot of them -- to dictate how shareholders can use their space. These rules can include how to document guests, what financing is allowed, how big your pets can be, and whether or not you can sublet your space. Many co-ops restrict subletting (if they allow it at all), sometimes imposing steep fees and requiring that a shareholder live in the unit for a specified period of time before being allowed to sublet. Also, subletters are required to go through the same application and interview process as the shareholder himself!

No Investment Properties
Because of the limitations on subletting, a co-op generally cannot be purchased as an investment property.

Higher Downpayment Requirements (sometimes)

Flip Taxes
Some co-ops impose a flip tax, which is a fee that (usually) the seller pays upon sale. It can be a fixed dollar amount, per share cost, or percentage of the sales price. This can make co-ops harder to sell, and it restricts a shareholder's ultimate profits.

Next month, we'll dive into Condos.

If you're ready to make the jump into home ownership, I'm always available to help with your search. Please reach out any time!

Matt Martin
Licensed Real Estate Salesperson
831 Broadway, New York, NY 10003
O: 212.521.5704 | C: 323.790.6288
Website  |  Facebook  |  Twitter  |  Instagram  |  LinkedIn
[email protected]  |  Halstead Property, LLC