A cooperative is an autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations though a jointly owned and democratically controlled enterprise. Residents purchase stock in a cooperative corporation that owns a structure: each stock holder is then entitled to live in a specific unit of the structure. Cooperatives are member- owned and democratically controlled ventures. From garden apartments and small cluster houses to large apartment buildings, housing cooperatives are multi-family residences whose owners have similar rights to real estate as condominium owners.
While condominium ownership is recognized in deed, ownership in cooperative housing is recognized through a proprietary lease and stock certificate. Cooperatives are owned collectively by resident members and established as corporations. The cooperative corporation is owned by tenant stockholders or members, who, though ownership of stock, shares, or membership certificates receive exclusive rights to occupy specific units. The cooperative corporation owns all the real property, including the land, separate units and all common areas. Purchase of these ownership interests and accompanying rights, if financed through cooperative share loans, is secured by an assignment of the occupancy agreement and pledge of corporate shares.
What are the benefits of cooperative ownership?
Cooperatives have greater power to regulate their members. This enables them to maintain a higher level of control and protection.
Cooperatives have the ability to borrow funds for repairs and capital improvements because of their corporate structure. Condominiums, on the other hand, are often forced to assess each individual owner when unexpected repairs are needed for the building. The interest paid on each cooperative member’s pro rata share of the corporation’s mortgage or loan is tax deductible – special assessments are not.
Co-ops are often cheaper to live in. Both cooperatives and condominiums charge fees to cover common costs of operating the building. In most cooperatives, however, these fees include most utilities and real estate tax. Many condominium units pay utilities individually and all condominium units pay their tax bill individually.
How is purchasing a co-op different from buying a condo or a house?
When you buy a house or a condominium, you are getting real property. When you buy a co-op you are not actually purchasing the physical apartment, but rather you are buying shares in the cooperative corporation which owns the building that the unit is located in. You will own the number of shares allocated for the unit based on its size and location. Instead of the deed you receive when you buy a house or condo, you instead get a stock certificate and a proprietary lease or occupancy agreement. The lease spells out the rights and obligations of the co-op and the shareholder for the use and occupancy of the unit. The shareholder becomes part owner of the building and has a proprietary lease on a specific unit.
How is a co-op mortgage different than a regular mortgage?
When you acquire a mortgage to buy a house or a condominium, the property is collateral for the mortgage. Since you are not buying real property when you buy a co-op, you are not getting a mortgage in the traditional meaning of the term. In essence, you are acquiring a loan to buy the shares and the proprietary lease to live in the co-op unit. Your shares in the co-op and the proprietary lease are collateral. Because the shares can’t be sold or disposed of as easily as a house or condo, they are not as valuable to the bank making the loan. The co-op’s board of directors may put conditions on the sale of its shares. It may also be difficult to sell the shares if the building is in poor physical or financial condition. Because of this, the loan rate may be higher than a standard single family mortgage rate.
Why should the financial condition of the building concern me when I am only buying the shares for one unit?
When you become a shareholder you share the assets and the liabilities of the whole building. For example, when you buy shares allocated to one 2- bedroom apartment in a 4-unit building with three other 2-bedroom apartments all owning the same number of shares, you are buying ¼ of that building (25% of its assets and 25% of its debt). If one of the other three cooperators defaults on the maintenance payments which help pay utilities, taxes, and the underlying mortgage on the building, you may have to increase your outlay before you can resolve the legal status of the defaulting cooperator.
The same scenario may apply to larger buildings, particularly if the sponsor owns a majority or a significant number of shares. While a sponsor may be one person, the percentage of shares held by the individual can be so high that a default could jeopardize every investor. That’s why lenders look at the level of owner occupancy and the ratio between occupant and sponsor-held shares. Generally, a lender may not consider granting a loan to a purchase co-op in a building which is less than 60% owner-occupied or in which the sponsor still holds the majority of shares after a significant amount of time has passed since the conversion plan was approved.
What are the common charges and how do they affect me as a cooperator?
The common charges are the costs associated with the upkeep of the building, as distinct from the costs of your apartment. These charges may include payments on the building’s underlying mortgage, real estate taxes, water and sewer fees, fuel costs, utilities for the common areas, salaries for building employees, insurance, and other expenses associated with the operation of the building. These costs are allocated to each shareholder as maintenance fees, usually payable to the corporation on a monthly basis. The corporation then pays the building’s bills.
What is a pro rata share and why is it important?
As a shareholder you are not only responsible for the maintenance and co-op loan on your apartment, you also have a share of the assets and liabilities of the building. The pro rata share is your apartment’s share of the building’s underlying mortgage. In most cases, that share is determined by dividing the amount of the underlying mortgage by the number of shares in the building and then multiplying the per share price amount by the number of shares for your apartment. The lower of either the appraised value or purchase price then divides that number. As a general rule, a lender may not consider approving a loan where the unit’s pro rata share exceeds 40% of the purchase price of the apartment. The reason for this is that the purchaser is assuming liability not only for the purchase price of the apartment shares but also for the additional pro rata share of the underlying mortgage.
If the building is over-financed, the pro rata share could exceed the appraised value of your apartment. If the co-op’s financial condition deteriorates and there is a default on the underlying mortgage caused by non-payment from other shareholders or the sponsor, you may be assessed additional charges to cover payments due on the underlying mortgage.
What is a reserve fund?
The reserve fund is a designated amount of money set aside and kept separate from the operating expenses of the building.
A co-op’s annual operating budget should include the adequate provision for ongoing maintenance. However, major capital improvements or unexpected repairs or replacements of building systems may need to be funded from the building’s reserve fund. If the fund is large enough there may be no need for increased maintenance fees, assessments of new loans. If not, the shareholders may have to absorb maintenance increases to cover the cost of the installation or to pay the principal and interest on the loan. Some co-op boards pass on the expense to shareholders through assessments rather than maintenance fee increases. This can take the form of a one time set amount or can be an addition to the monthly maintenance fee for a period of time or in any manner decided by the board.
In general, the lender looks for a reserve fund that is adequate to cover any major capital improvements. Typically a lender would like to see a reserve fund of at least $1,000 per unit with a minimum of $25,000 per building.
What information should I find out about the building’s underlying mortgage and why should I know about this?
Before buying you should ask for the terms of the underlying mortgage. What is the amount of mortgage? What is the term? Is it paid off in installments or is it a “balloon” mortgage, the entire principal becoming due at one time? What is that date?
As a shareholder, you pay your pro rata share of the underlying mortgage and interest in your monthly maintenance and your annual federal tax deduction is related to the mortgage interest payment. If the mortgage on the building is long term and at a favorable rate of interest, then you and the lender to whom you have applied for a loan can be more comfortable with your ability to make your loan and maintenance payments for the term of your co-op loan.
If the terms of the mortgage call for full payment in four or five years, the co-op board of directors will have to secure new financing without assurance that they can get favorable rates. If the building’s payments are fixed for an extended period, there is greater certainty that your maintenance payments will not increase and therefore you will probably be able to make your agreed cooperative loan payments.
Are there any tax benefits associated with being a co-op shareholder?
Just as it is with any home or condo owner, real estate and mortgage interest on primary residences are usually deductibles on your federal income tax return. As a co-op owner, the real estate taxes and interest in the underlying mortgage allocated to your shares may be deductible. The co-op annually notifies shareholders of the dollar amounts of these allocations. The value of the deduction is dependent on, among other things, your income tax bracket and whether you itemize deductions. It is advisable to consult a tax professional to discuss your particular situation.
For more info, please contact Jackie Leone Pleasant, Windermere/CH at 206-321-2897, or jackiep@windermere.com.
