A newly constructed condominium or a conversion of a building from a rental apartment building into cooperative ownership or a condominium is handled by an entity called a sponsor (also known as a developer). The sponsor most follow very strict regulations governed by the New York State Attorney General Office when offering apartments for sale. Accordingly, all sponsor sales are offered through a fairly complicated and lengthy book called an offering plan or prospectus. It is very important to have an attorney review the plan carefully and advise the purchaser of the issues and risks when purchasing a sponsor apartment.
Most new construction will be a Condominium building rather than a cooperative apartment. Sometimes the building will be an existing rental building that that is converted to a condo but on most occasions the building will be newly constructed.
One of the key benefits of purchasing a sponsor apartment is that there generally is no board approval or application process. This of course is very appealing to investors and foreigners or those who do not want to disclose their financial information. In addition, usually the sponsor apartment will be newly constructed or renovated with new appliances and fixtures. However, the good things come with some disadvantages and risks: The closing costs can be significantly higher than the purchase of a condominium apartment from a third party as well as many more other closing concerns which are outlined below.
1. CLOSING COSTS
Unlike a transaction where the purchaser buys an apartment from a third party seller, when buying an apartment form a sponsor, the purchaser’s closing costs can be much higher.
- Transfer Taxes –In most offering plans, the New York State Attorney General allows the sponsor to pass on the New York City and New York State transfer taxes to the purchaser when purchasing the apartment. Normally, these taxes are paid by the Seller. Payment of such tax may be negotiable depending upon the market. Whenever a purchaser pays the transfer taxes, the City and the State take the position that the purchase price should be increased or “grossed up” by the amount of the transfer tax. Accordingly, the transfer taxes are added back into the purchase price and then the taxes are calculated again. The purchaser will also be required to pay these taxes again when selling the Apartment. NYC Transfer Tax is presently 1.0% of the purchase price if the sale is $500,000 and under and 1.425% of the purchase price if the sales price is over $500,000. The NYS Transfer Tax is presently .40% of the sales price. Furthermore, if the purchase price is over $1 million, the purchaser will be required to pay the New York State “mansion tax” presently equal to 1% of the purchase price at the closing. If the “grossed up” purchase price exceeds $1M, the purchaser will pay the mansion tax even if the original purchase price was under $1 million. For example, If the sales price is $990,000 and the purchaser pays the transfer taxes ($18.067.50), when the price is grossed up to $1,008,067.50, it triggers the mansion tax. In addition, if the purchaser buys two or more units simultaneously, the New York City transfer tax increases to 2.625%. As a note, there is no city transfer tax in Nassau, Suffolk or Westchester counties.
- Reserve Funds and Working Capital Funds – Most offering plans require a purchaser to deposit one or two months of common charges (or maintenance) into a working capital fund for new construction buildings. The working capital fund is established to develop an account for future repairs. This is not a fee that can be recouped when the property is sold. Most new construction offering plans do not require the sponsor to create a reserve fund. However, if the property is a conversion from an existing building, most sponsors will create a reserve fund separate and apart from the working capital fund. It is important for a purchaser to determine if the sponsor has elected to provide for a reserve fund to be used for capital improvements or repairs to the building. Most lenders will require newly constructed buildings to have a minimum of 10% of the annual common charges in a reserve fund before they make a loan to a purchaser of an apartment in the building.
- Sponsor’s Legal Fee – The Sponsor will normally require the purchaser to pay for the sponsor’s legal fee. This fee can range between $750 to $3,000.
- Superintendent’s Apartment – Many new construction offering plans require a purchaser to pay the pro-rata portion of the superintendant’s apartment. This can be a very expensive addition to the closing costs. This expense is generally not recoupable when the apartment is sold.
- Other Fees – There may be other hidden costs and fees set forth in the offering plan (ex. Fees to reimburse the sponsor for its expense to secure the tax abatement or the first year of condominium insurance). The purchaser’s attorney must carefully read the section of the offering plan entitled “CLOSING COSTS and ADJUSTMENTS.”
2. CLOSING DATE AND PENALTIES
– Most offering plans provide that the closing date will be set upon 30 days written notice by the sponsor to the purchaser. If a purchaser fails to close on the closing date, the purchaser may be subject to a serious penalty unless a grace period has been negotiated. The penalty can range from an amount equal to 0.03% to 0.05% of the purchase price for each day starting from the original scheduled close date as well as all adjustments from the original scheduled close date for each day the close date is postponed by the purchaser. Since it is difficult to determine the actual closing date with new construction, most sponsors, if requested, will grant a 1 or 2 week grace period to the purchaser in the event he or she is not available on the scheduled closing date. As a note, closings cannot occur until the sponsor has obtained a temporary certificate of occupancy (TCO) and if a condominium, the condominium declaration has been filed with the appropriate municipal office. The procurement of the TCO and the filing of the declaration are out of the sponsor’s control and there can be delays in securing these documents from the city.
3. COMMON CHARGES/MAINTENANCE AND REAL ESTATE TAXES
– Every purchaser should understand what the projected monthly common charges/maintenance charges for the apartment will be as well as the projected real estate taxes pursuant to the plan. The purchaser should determine if there will be any tax abatements on the apartment and when they phase out and expire. This can have a major financial impact on a purchaser at a future date. If the taxes are fully abated at the time of the closing, the taxes can be almost nothing. But over time, the taxes can increase dramatically (As a note, 421-a tax abatements usually are in effect for a 10 to 15 year period). This may not be an issue at the time of closing but it is important to understand when you sign a contract to purchase a sponsor apartment since it could impact a sale at a later date when the taxes are much higher.
Also, sometimes the real estate taxes quoted in the offering plan do no not take into account what the taxes may be when the building is fully constructed and re-assessed. For example, the taxes for the year of operation may be quoted in the plan as $5,000 a year but may increase to $10,000 a year after the building is fully constructed and fully assessed by the city.
4. OTHER CONCERNS
- Sales and Sublets Most condominium offering plans provide that unit owners may sell or sublet their apartment without right of restriction, subject to the condominium’s right of first refusal. Some offering plans may limit the time period for leasing or subletting the apartment. It is important to read the by-laws regarding sales and leasing of apartments.
- Repairs – A purchaser must know the condition of the building when purchasing under an offering plan. Some plans include an engineer report. If the property is newly constructed, the offering plan will usually include an architect’s report which details the plans and specifications for the fixtures and build out of the apartment. If the building will be new, no repairs will be required. However, if the building is a conversion from a rental into a co-op or condo, it is advisable to review the engineer’s report in the offering plan and determine how much the sponsor is willing to contribute to the repairs or improvements of the building. Each purchaser will generally be given a right to inspect the property before closing and sign a “punch list” which lists the work that remains uncorrected by the sponsor. In addition, once the sponsor obtains a temporary certificate of occupancy, the sponsor can require you to close even if all minor work in the apartment has not been completed. The offering plan will generally require a purchaser to close if minor punch list items have been uncorrected by the time of closing. The sponsor will not agree to hold monies in escrow pending the repairs but they will agree to sign a “survival” agreement acknowledging that the sponsor will correct the items post closing.
- Unsold Apartments – A determination must be made as to how many units are under contract or have closed in the building. Generally, lenders will not provide financing to purchasers if there are more than 50% unsold apartments in the building (At the time of publication, many lenders require 70% of the apartments to be sold before they will make a loan).
- Sponsor Control – The sponsor usually maintains control of the board of directors until a certain number of years have passed or after a certain percentage of the units have closed. During the time the sponsor has control of the condominium, it will have control of the maintenance, facilities and services to be provided to the unit owners and shall determine the common charges to be paid by the apartment owners.
- Budget – The projected budget for the first year of operation in the plan must be reviewed to see if the building will be receiving sufficient income to pay for its expenses.
- Alterations – All structural alterations to the apartment can only be made with the prior written approval of the board of managers of the condominium. If the sponsor has not yet received the final certificate of occupancy at the time of the closing, then the purchaser may not be able to complete alterations or renovations in the apartment until the final certificate of occupancy has been obtained (which can be up to two years after the first closing).
- Superintendent – Many offering plans provide that there will be an on site superintendent. However, it is important to confirm this. In addition, if the super does live in the building, most plans provide that the condominium will purchase the apartment from the sponsor and pay the sponsor back over a period of time pursuant to the terms of a loan. The purchaser should make sure that the loan payments, real estate taxes, maintenance and common charges, where applicable, are included in the budget of the building. In the event the condominium does not purchase or own the superintendant’s apartment, the sponsor may rent an apartment to the condominium. If this is the case, it is important to see how long the lease is and what the terms are. A purchaser should be aware what happens when the lease ends and where the super will live.
- Build-Out – Most offering plans provide that the common areas may not be completed and services may not be available for up to one year after the first closing.
- Sponsor Experience – The purchaser should determine if the sponsor, or its principals, have developed any other condominiums. If the sponsor does not have prior experience, this could have an adverse impact in the initial operation of the building.
- Financing – Most offering plans provide that the contract of sale is not contingent upon the purchaser securing financing. Accordingly, if the purchaser does not obtain a loan, he or she must find alternative financing or the purchaser may not receive a refund of the down payment.
- Advertising – Most offering plans provide that purchasers cannot advertise the sale of the apartment before the closing and sometimes up to a year after the closing.
- Commercial Space – It is very important to try to determine who will occupy the commercial space, if any. The commercial unit is usually retained by the sponsor and it may have the right to lease it to a bar or restaurant which maybe noisy.
- Deposits – Most offering plans provide that a purchaser will be required to make a down payment between ten and fifteen percent of the purchase price when signing the contract. However, many offering plans provide that the purchaser must also make an additional down payment (usually an additional 10 to 15%) within certain time periods. If the purchaser fails to make the second installment on time, it may result in a default of the initial down payment.
- Lot Line Windows – Lot line windows are windows located directly on edge of the building’s property line. Lot line windows can be a headache because they can devalue a property and need to adhere to strict guidelines. Whenever a wall of a building is flush against the property line, the windows on that wall will most likely be deemed lot line windows by the Department of Buildings. If the adjacent property ever builds up to the height of the window, the window must be permanently boarded up, usually at the owner’s expense.
- Foreign Investors – There are certain considerations a foreign buyer must consider and understand before purchasing an apartment.
There are two taxes that will need to be paid by a foreign seller if they are not United States citizens or a New York State resident. While this will not be a concern when purchasing the property, it will be have a financial impact when the property is sold. A foreigner seller will be subject to Federal withholding tax and New York State Estimated Gains Tax when the apartment is sold.
In 1984, the Internal Revenue Service passed the Foreign Investor Real Property Transfer Act (FIRPTA). FIRPTA’s objective is to force non-resident aliens to file U.S. income tax returns and pay the appropriate tax on U.S. source profits. The IRS concern was that a foreigner would sell U.S. real estate, make a profit and fail to file a U.S. income tax return and pay any taxes associated therewith. FIRPTA prevents this by requiring a withholding of 10% of the sales price, regardless of the amount of the profit from the transaction. FIRPTA applies to individuals as well as entities such as foreign corporations and partnerships. It applies to the transfer of all U.S. real property interests including the sale of cooperative apartments. The required payment of ten percent is a deposit on any tax liability owed by the property owner. The deposit is not lost; it is merely a deposit on the tax owed and once a determination has been made by the Internal Revenue Service how much is owed, excess funds are refunded to the seller. However, an exemption from the full withholding tax (ten percent of the sales price) is available if the seller’s true tax can be proven to be less than the withholding amount.
Similarly, if the Seller is not a New York State resident, the seller must pay to New York State at closing estimated New York State capital gains tax based on the profit made on the sale of the property. The approximate gains tax at the time of this article was 9%.
Conclusion. While there are many attractive aspects of purchasing a property from a sponsor/developer, the purchaser must examine all of the considerations when buying a newly constructed apartment.
*DISCLAIMER. Nothing herein is offered as legal advice. All information in this article is for informational purposes only. Please consult with an attorney before taking any legal actions.