A lot of people, especially those who live outside New York City, have only a vague notion what a co-op building is and isn’t. Sure, they know it’s some sort of apartment, but the details and particularities of a co-op’s structure are often hazy at best. We’ve even heard of people confusing co-ops buildings with co-op farms! What should you know when you’re considering buying a co-op versus buying a condo?
Table of Contents:
What is a co-op in New York City?
What are the disadvantages of owning a co-op?
What are the advantages of owning a co-op?
What does a co-op’s maintenance fee cover?
What is a co-op assessment?
What are the financial requirements for a co-op?
How do I make an offer on a co-op?
What paperwork is required for the co-op board application?
What is involved in a co-op board interview?
Why are co-op buyers typically rejected?
Should I use a buyer’s real estate broker to purchase a co-op?
Co-op is short for “cooperative”. When you buy a co-op apartment, you are actually buying shares in a corporation, not the actual apartment. That might sound strange given a co-op listing advertises a specific apartment (just like a condo listing) but technically, a buyer purchases shares in the co-op which owns and manages the building. This compares to condos where you’re buying the actual apartment. In legal terms, a co-op is “personal property” while a condo is “real property”. We’ll get into the details later but this is actually an important distinction when it comes to closing costs.
Don’t worry - if you buy a co-op, your fellow co-op owners won’t have keys to your apartment.
Each co-op shareholder is granted the right to occupy a specific apartment in the building. This is also called the “proprietary lease” for that apartment. Think of the proprietary lease and shares as a package deal. You’re buying shares in the overall building plus the right to live in a specific unit within the building.
It’s very important for NYC buyers to understand what a co-op is as the New York City real estate market has the largest concentration of co-ops in the U.S. In fact, about 75% of New York apartment buildings are co-ops.
Most people in NYC are quick to hate on co-ops. It’s important to note that every co-op is different. There are co-ops that behave like condos and condos that behave like co-ops. Yoreevo’s first deal was in a condo with a flip tax - a fee typically associated only with co-ops. So while there are general guidelines, make sure to get specifics for any building you’re considering - co-op or condo.
Let’s explore some of the clear and widely known negatives when it comes to co-ops:
Board Approval Process
On your way into a co-op, prepare for a particularly invasive board approval process. The board can ask for pretty much anything and you can either comply or take your business elsewhere - there is no negotiating. We’ll address some common components of a board application later but for now, suffice it to say, co-op applications are more complex and take longer than those of condos.
Limited Subletting (ability to rent out a co-op)
Subletting (a co-op’s term for renting) tends to be more restrictive in co-ops as you need to follow the building’s sublet policy and get board approval for each sublet. Sublet policies can vary from sublets being outright forbidden to no restrictions whatsoever. Again, it depends on the specific co-op. Usually a co-op will require a shareholder to live in the unit for a period of time and/or restrict how often they can sublet their unit.
As mentioned prior, flip taxes are not unique to co-ops but they are dramatically more common. A flip tax technically isn’t a tax as it’s paid into the co-op’s reserve fund. Having a flip tax isn’t even necessarily a bad thing for a buyer. If you plan on owning the apartment for a long time, you should love a flip tax as sellers subsidize your maintenance.
Like any other rule in a co-op, the co-op’s shareholders decide if they want to have a flip tax or not. It’s usually a simple percentage of the purchase price (most often 1%) but we have seen flip taxes that depend on how long the property was owned or how much the seller is making on the sale.
Smaller Buyer Pool
We’ll get into the details below but co-ops’ financial requirements are more conservative of those required by the bank so all else equal, fewer buyers can qualify to purchase a co-op. Co-ops also generally don’t allow foreign buyers in the building as the co-ops typically want owner occupied units. The smaller buyer pool isn’t really a negative as it’s a positive on the way in but still something to consider.
Co-ops Cost Less
For all the reasons mentioned above, all else equal, co-ops will cost less than a condo. In very broad terms, we would say 20% to 30% less. This is without a doubt the #1 reason most co-op buyers end up purchasing a co-op over a condo.
Co-op Closing Costs Are Lower
Closing costs are much lower on a co-op versus condo because personal property is being exchanged (shares and the proprietary lease) rather than real property. This important distinction allows co-op buyers to avoid the mortgage recording tax which is only charged on mortgages placed on real property. Co-ops also don’t require title insurance as the co-op knows exactly who owns each unit at any given time.
After you get into a co-op, the application process works in your favor. Putting aside the sometimes arbitrary whims of a board, there are clear benefits to residents of the building. Recently a real estate attorney we’ve worked with was at a co-op law convention (those exist!) and someone made a point that resonated with him. As part of their free wheeling allure, most condo applications do not include a background check while co-ops generally do require them. As a result, you can be pretty sure your co-op neighbors are going to be squeaky clean.
As we mentioned, co-ops often, maybe always, have financial requirements that are stricter than those of banks. Buyers will be required to put at least 20% down and have a debt to income ratio of below 30% and often below 25%. These elevated financial requirements are part of the reason NYC did not see a housing crisis as bad as the rest of the country in 2008. Co-ops basically did not allow banks to lend as aggressively as they did in the rest of the country. While condos did drag down the overall market, there were far fewer foreclosures on co-ops.
This is a significant positive as the last thing you want in your building is a forced seller. When someone needs to sell, especially in a bad market, it will usually be at a low price. A forced sale in the building can reset pricing for the entire building as the transaction will be part of the “comps” going forward.
Co-ops combine the two monthly charges in condos - property taxes and common charges - into one monthly maintenance payment. You don’t pay your unit’s property taxes directly because remember - you don’t actually own the apartment - you own shares in a building which has to pay property taxes. While the percentage of maintenance that goes to property taxes versus common charges varies from building to building, a very rough rule is 50% goes to each.
The common charge component of maintenance goes to everything required to run the building - cleaning the hallways, taking out the garbage, the water bill etc. The maintenance can also cover planned capital improvements to the building like painting the common areas or a new entryway. If a co-op has doormen and elevators, those will increase the cost of running the building substantially.
All co-ops have a reserve fund - you can think of this as a checking account. Out of the reserve fund, bills are paid like the super’s salary and the utility bill for common areas. There also is some cushion in case of an unexpected expense but sometimes there’s not enough cushion.
For example, if there’s a leak in the roof that could potentially bring gallons of rain water cascading into the apartments below, this would have to be addressed and paid for immediately. Such a repair would be very costly. When expenses like this occur, each shareholder will be assessed a fee to pay for the repair in addition to their monthly maintenance fee.
Assessments can also be voluntary. A co-op’s shareholders may elect to redo the entryway without enough money in the reserve fund and therefore implement an assessment for the cost.
Assessments are usually apportioned by the number of shares a co-op owner has (which are themselves roughly apportioned by the size of each apartment). The amount and duration of the assessment will also be determined at the outset.
As mentioned above, most, if not all co-ops require at least 20% down. We have not come across a resale co-op unit that did not require 20% down. 20% is a minimum however and often a co-op will require 25%, 30% or even 50% down for some of the more exclusive co-ops.
But cash is not enough. In order to assess a buyer’s ability to service their mortgage and any other debt they carry, the co-op board will look at their debt to income ratio or DTI. A DTI is calculated by looking at all required monthly payments a buyer would have if they were to purchase the apartment. Often that will simply be the sum of their mortgage and maintenance payments but if they have a mortgage on another property, a car lease, student debt payments, etc, that will all be included. The total is then divided by the applicant’s monthly income. Most co-ops want that number below 30% or even 25%.
Depending on the individual building, sometimes you can buy despite a high DTI by putting a year or two of maintenance in escrow at closing. That can be a solution for a retiree or someone else with a lot of assets and not much income.
The last metric that comes up is “post closing liquidity”. The board will look at that same monthly payment used in the DTI calculation and see how many months of payments you will have in liquid assets after closing. Liquid assets are any that you could easily use to pay bills so think cash and stocks. Retirement accounts are sometimes considered but don’t count on it. Real estate is obviously not considered as it is hard to sell. Most buildings want to see 12 or 24 months of post closing liquidity.
Why do co-ops have these financial requirements? Basically to avoid the negative implications of a forced sale. If a buyer stretches to purchase the most expensive apartment they can possibly buy and loses their job the day after closing, that’s very disruptive for the building. It’s also a pain for the board. While buyers hate the application process, there are people spending their time to review applications on the other side of the table as well.
Since the listing agent needs to have confidence you’ll satisfy the board’s financial requirements, making an offer on a co-op requires more financial information. On top of the actual offer and a mortgage pre-approval, be prepared for some additional questions about your finances. If you own another property, you’ll need to provide information about property taxes and any mortgage as those will be included in your DTI calculation.
We had a client get annoyed with a listing agent because the agent wanted to know why the client had such a high income but limited assets. We understood where both parties were coming from - the client found the question invasive but the listing agent knew the board was going to ask and wanted to make sure the answer would be satisfactory. Simply put, the co-op application process is not for everyone.
Keep in mind that any information asked in this stage will be included (with supporting documentation) in the full board application which the listing agent will review.
After getting an offer accepted and signing the contract, work begins on the co-op application. While each building’s or management company’s application is different, most will require:
It’s important to note one important difference in co-ops versus condos at this point. Most buyers think buying a condo is automatic but there is still an application process. Often the paperwork required for a condo application is just as intense as that of a co-op. Provided you have the cash or financing for the purchase, condo boards cannot prevent the purchase but they can prevent you from purchasing by exercising their right of first refusal. Condo boards have the right to purchase any unit instead of the buyer so while that’s extremely rare, it can and has happened. As part of the condo approval process, the condo will issue a statement saying they are waiving their right of first refusal and allow the applicant to purchase the apartment.
Co-op board interviews have a bad rap and while you should be prepared for a full on, job-like interview, most of the time, the interview is more of a welcome to the building. The board may ask you about yourself or a few questions about your application but if there were any significant issues, they likely would have been addressed before the board interview was scheduled. The board members do not want to waste their time any more than you want to waste yours so getting to the board interview is a very encouraging step in the co-op purchasing process.
When a board rejects an applicant, they don’t have to (and typically don’t) give any reason whatsoever, even to the selling shareholder. While we don’t have data to back this up, our experience tells us the majority of rejections are for financial reasons. Particularly if the price is good, the seller may gamble and hope an applicant with a 32% DTI ratio is approved by the building that typically requires a 30% DTI.
Boards also want to see good reference letters - both personal and professional. If one or two board members are rubbed the wrong way, they’re going to be hesitant to accept the applicant. An agent once told us she had an applicant rejected and the only thing she could point to was a personal reference letter that stated the applicant loved cooking a particularly pungent type of cuisine.
Sometimes the board will reject an applicant because they are getting too good of a deal. If the seller doesn’t care about money (and NYC has a few people like that!) and just wants to be done with the process, they might offer the apartment to their buddy or a neighbor for a low price. Since this affects the value of other units in the building as much as a forced sale, the board will often reject these “below market value” transactions.
Many buyers think they can save a bundle if they forgo the use of a buyer’s real estate broker. It’s a fair assumption but even without a buyer’s broker, the seller still pays the same commission. Most listing agreements are structured as the seller pays the listing broker 5% or 6% and then if the buyer has a broker the commission will be split 50/50. Listing brokers love unrepresented buyers because they keep the entire commission for themselves.
For this reason, there’s no reason not to have a real estate broker. It assures you have someone looking out for your best interests and only your best interests, negotiating on your behalf and making sure relevant questions are being asked. Even better, whether you’re considering a co-op or condo, you can get a buyer’s broker that provides full service representation and commission rebates (like Yoreevo!). With a commission rebate, your broker gets half of the commission (usually 2.5% or 3%) and gives part of that back to you. Most Yoreevo clients receive a commission rebate for 1.5% to 2% of the purchase price which often covers more than the buyer’s closing costs!