DECIDING TO PURCHASE A CONDOMINIUM OR COOPERATIVE APARTMENT
Before purchasing a condo or co-op apartment, it is imperative that the Purchaser understand the significant differences between the two types of ownership. There are numerous legal and financial differences.
A co-op is a multi-unit apartment building where each resident has an interest in the entire building, and a lease (or contract or share of stock) enabling the owner to occupy a particular apartment unit there. When a building is converted to cooperative ownership, title to the building is transferred to a corporation (commonly referenced to as an “apartment corporation”) which is formed to take ownership of the property and building.
Unit owners do not actually purchase their apartments. They buy shares of stock in the apartment corporation allocated to a particular apartment. Unit owners are frequently referred to as (“shareholders”). The shareholders live in the apartment pursuant to the terms of a proprietary lease (the landlord is apartment corporation and the shareholder is tenant). The proprietary lease is a lengthy agreement which defines the shareholders right and obligations regarding the occupancy of the apartment (similar to a rental apartment lease but much more detailed).
The apartment corporation owns the entire building. Accordingly, there is usually one tax lot issued to the building. Real estate taxes are paid by the apartment corporation. Most co-ops have an underlying mortgage when the building is converted to a co-op. The underlying mortgage is a commercial mortgage taken out and payable by the apartment corporation.
The monthly maintenance paid by shareholder will pay for the underlying mortgage, the real estate taxes and the general operating expenses of the building (i.e., fuel, insurance, payroll, supplies, etc.). Maintenance charges are based on the number of shares in the apartment corporation.
The number of shares allocated to each apartment must be fair and reasonable based on number of rooms and location and size of each unit. Maintenance charges can be increased periodically if taxes rise, if debt services increase or the cost of services increase.
Shareholders in a co-op have certain tax advantages if the co-op meets certain requirements of federal tax laws. If such requirements are met, the shareholders can deduct the portion of the maintenance used to pay interest on the underlying mortgage and the real estate taxes which are paid by the apartment corporation. This rule is known as the “80/20 Rule” whereby co-ops must derive 80% of the income from maintenance in order for the co-op to qualify as a co-op under the IRS regulations. In addition, the shareholders may deduct the interest (but not the principal) that is paid on a loan to finance the purchase of the shares allocated to the apartment.
A shareholder can obtain a co-op loan to finance the purchase of the apartment. The stock certificate and proprietary lease are pledged (given) to the lender to hold as collateral for the repayment of the co-op loan. When the loan is paid off, the stock and lease are returned to the co-op shareholder. Since co-ops are not real property, the lender files a UCC-1 financing statement rather than a mortgage to secure its interest on the apartment.
An apartment corporation is run by a board of directors. Each year, the apartment corporation has an annual shareholder meeting at which the directors are elected by the shareholders. The powers and responsibilities of a co-op board are detailed in the by-laws. A copy of the by-laws and proprietary lease can be found in the offering plan.
Total monthly carrying charges consist of maintenance and payments on the shareholders loan. There is no public record of purchasers, sellers and sales prices (a deed is not recorded).
Generally, co-ops do not allowed subletting and restrict the right to sell on apartment without the consent of the board of directors. Many co-ops do not allow ownership of the shares to be in the name of an entity like a trust, corporation or LLC. In the event a purchaser desires to take title in the name of a trust or entity, the purchaser (or his or her lawyer) should check with the managing agent to see if such ownership is permitted.
Many apartment corporations hire a managing agent (an outside company) to operate the building. The managing agent collects maintenance charges from shareholders, pays the expenses and supervises staff. The managing agent can also handle the transfer of the stock and lease to a new owner. The apartment corporation pays a fee to the managing agent for these services.
Typically, the attorney for the purchaser will order a lien search rather than a title report (since co-ops are not real property, searches are made against the seller, purchaser and co-op corporation).
The cost of the lien search is much cheaper than a title report. In addition, co-ops sale prices are usually quite lower than condominiums because of the fact there is no free transferability.
When a building is converted to condominium ownership, the purchaser takes title to the apartment by a deed rather than shares and a proprietary lease. And owns a percentage of the common areas (called “common elements”). The deed is filed (recorded) in the appropriate municipal office where the property is located (in Manhattan, it is the New York City Register’s office).
When a purchaser buys a condominium apartment, the purchaser also buys with the other unit owners, an undivided interest in the common elements of the building. Common elements include the public areas of the building (hallways, roof, lobby, electrical, mechanical, heating and air conditioning systems that service the building) as well as the land. A common element is a percentage of the purchaser’s ownership based on the size and location of the apartment.
The condominium is formed by filing a condominium declaration in the appropriate municipal office. The declaration contains a complete description of the of the land building and units and the percentage of ownership of each unit
Condominium unit owners pay “common charges” (not “maintenance” as in co-ops). Like a co-op, common charges pay for the generally operating expenses of the building (fuel, insurance, payroll, supplies, etc.). However, each unit owner is responsible for paying his or her own real estate taxes because each condo unit is designed its own tax lot. There generally is no underlying mortgage on the building. Unit owners can finance the purchase of an apartment with a mortgage. Accordingly, unit owners may only deduct real estate taxes and interest on their mortgage annually.
The condominium is governed by a “board of managers” (as opposed to a “board of directors” in a co-op). The managers are elected annually at a meeting of the unit owners. The manager’s authority to operate the building is detailed in documents called the condominium declaration and by-laws (both found in the offering plan). These documents provide rules and procedures for conducting the affairs of the condominium and define the right and obligations of unit owners.
Similar to a co-op, a condominium hires a managing agent to run the day to day operations of the building, a condominium managing agent is not necessary to transfer an apartment because new shares and a lease is not applicable. The transfer documents are prepared by the Seller’s attorney.
A co-op corporation is formed by filing a certificate of incorporation with the Department of State (this process takes approximately one week). A condominium is formed by filing the condominium declaration with the county registers office (this process can take one to six months).
One of the major differences between a cooperative and a condominium is that condominiums allow free transferability or leasing of apartments generally without an interview and approval process in a co-op. However, most condominiums require that an apartment owner give the condominium the right of first refusal to purchase or rent the unit when an owner is selling or leasing an apartment. Although it is rare that a condominium will exercise its right of first refusal, a closing cannot occur without it. Because of its free transferability, a condominium is desirable for investors because apartments can be rented without the constraints set forth in cooperative documents.
Finally, a major difference between co-ops and condominium is the closing costs associated with an apartment sale. Because a co-op is not deemed to be real property, the co-op purchaser avoids substantial closing costs. A purchaser of a condominium must pay for title insurance and must pay a tax called “mortgage recording tax.” These major expenses are not required in a co-op apartment purchase. Typically, the attorney for the purchaser will order a title report rather than a lien search (since condos are real property, title is actually searched at the municipal office). The cost of the title charges is much higher than a lien search. In addition, condo sale prices are usually quite higher than co-ops because of the fact there is free transferability.