Published on: March 27, 2019
By Mark Einhorn
Reading the real estate section of the New York Times recently, I was struck by the number of ads featuring condominiums for sale. There would be nothing remarkable about this in the Boston Globe, but condominiums historically have been relatively rare in New York, where cooperatives have long been the primary form of common interest ownership.
In Massachusetts (and in New England generally), it is cooperatives that are the exception. There are some cooperative developments (Jamaicaway Tower and the Residences at Copley Place, to name a couple of large ones in Boston) ─ not many, perhaps, but enough to make it worthwhile to discuss what makes cooperatives different.
The primary difference between condos and coops is their ownership structure. In a condominium, each unit is a separate real estate parcel. Buyers own their units individually, as they would own a single-family home, and have an undivided percentage interest in the common areas, which means they share ownership of the common areas with other members of the community.
In a cooperative, the buildings, including the units in them, are owned by a corporation. Buyers don’t purchase their units – they don’t purchase real estate at all. They purchase shares in the corporation, entitling them to occupy their unit as a tenant. Despite that important distinction, coop buyers enjoy the benefits of homeownership, including the ability to deduct the interest paid on the loan they obtain to purchase shares in a cooperative community.
Unlike a mortgage on a condominium loan, which is secured by the condominium unit, a cooperative share loan, as the name suggests, is secured by shares in the corporation. If there is an outstanding mortgage on the cooperative building(s), as is often the case, coop buyers must also pay a portion of the interest on that blanket loan, and that interest, too, is deductible.
Condo and coop loans are both subject to IRS caps on the deductibility of mortgage interest. An additional restriction applies to share loans, interest on which is deductible only if 80 percent of the corporation’s income is derived from shareholders and 80 percent of the space in the building is available to them.
Property taxes are deductible on both condo and cooperative loans, but they are assessed differently. Condo units are assessed individually; owners receive and pay those bills directly. A cooperative building is assessed as a whole; the corporation receives the bill and members pay their proportionate share of it. Because the sum of the parts (individual units) in a condominium often exceeds the whole, the assessed value of a cooperative building is often lower than the combined assessed value of individual units in a comparable condominium, resulting in lower property tax bills for coop shareholders.
Common Area Fees
Condo owners and coop shareholders both pay monthly fees covering their share of the cost of the community’s maintenance and operating expenses. In a condominium, owners usually (though not always) pay for water and utilities separately; in a cooperative, owners’ shares of those costs are typically included in their monthly fee, along with their share of the property tax and interest on a blanket mortgage. While condo owners can’t deduct any portion of their common area fee, coop owners can deduct the portion attributable to property taxes and mortgage interest, but only those portions of the fee are deductible.
The governance infrastructure of condos and coops differs in several key respects. A condominium is structured as a trust (or an incorporated or unincorporated association) typically created through a declaration, a master deed and bylaws recorded with the Registry of Deeds. A cooperative is a corporation, created through articles of incorporation and bylaws filed with the secretary of state, and governed by a proprietary lease that applies to all shareholders and building tenants. There is no equivalent of a proprietary lease in a condominium. Amending the governing documents in both condos and coops typically requires the approval of a supermajority of owners or shareholders.
Condo owners and coop shareholders elect a representative board to govern the community, with the authority to adopt and enforce rules and regulations. A condominium board’s authority to govern behavior typically extends only to common areas; it stops at the threshold of an owner’s unit. Coop boards generally have more independent authority than their condominium counterparts to restrict activities within a unit, because the cooperative actually owns the building, making the board’s relationship with owners closer to that of landlords and tenants. That said, we advise coop boards that want to restrict the uses of a unit – by prohibiting smoking, for example – to do so by having owners amend the governing documents rather than by adopting regulations approved only by the board. This reduces the risk of litigation challenging the enforceability of those restrictions.
Picking and Choosing
Probably the most important distinction between condos and coops lies in the ability of coop shareholders to restrict who lives in the community. The rationale: If an owner defaults on a condominium loan, the lender will foreclose on that owner’s unit. But coop shareholders are responsible not only for their individual share loans, but also for a portion of any mortgage on the building, putting the entire building potentially at risk of foreclosure if even a few owners default on that obligation. Coop shareholders, thus, have a legitimate interest in ensuring that their neighbors have the financial wherewithal to make their payments and a credit history reflecting the likelihood that they will do so.
It isn’t unusual for coops to require down payments on share loans that are larger than lenders demand. Some require buyers to pay cash – or to demonstrate the ability to do so; many restrict the size of secondary loans secured by coop shares and some prohibit those loans entirely. Possibly because coops scrutinize buyers more carefully and impose more rigorous underwriting requirements than lenders typically impose on condominium buyers, most coops did not experience the financial problems that battered many condominium communities during the financial meltdown.
Cooperatives don’t just consider the financial capacity of potential shareholders; they also consider whether these prospective neighbors will be a “good fit” for the community. Coops can’t discriminate illegally based on any protected class, but they can consider character and lifestyle issues. One New York cooperative famously rejected Richard Nixon, and many have rejected musicians (because of concern about noise) and celebrities who might attract attention that would disturb other residents.
Rentals and Tenants
Cooperatives tightly control rentals and often prohibit them entirely. Those that permit shareholders to sublet their units usually insist on approving the tenants. This will sound unusual to condo board members who have heard their attorneys (including me) caution them not to participate in any way in the rental of owners’ units, other than to enforce any covenants restricting or prohibiting rentals in their community.
In a condominium, tenant selection, lease terms, rent collection and evictions (if necessary) should be left entirely to the unit owners/landlords. Condo boards have no reason to insert themselves in that process and many reasons not to – primary among them, avoiding potential liability for discriminating against tenants or interfering in a business relationship.
If a condo owner’s tenant doesn’t pay the rent, that’s the owner’s problem. In a cooperative, however, a tenant’s failure to pay the rent could jeopardize the ability of shareholders to meet their financial obligations, creating a more direct risk for the community as a whole and a reason for coop boards to vet prospective tenants. Additionally, cooperative boards concerned about the character and “fit” of shareholders would be equally concerned about the character and fit of tenants subletting their units. Presumably, Richard Nixon would have been no more welcome as a tenant in that New York cooperative than he was as potential shareholder.
The vetting process for tenants and shareholders that distinguishes cooperatives from condominiums also creates significant liability exposure for cooperative boards and managers, because of the heightened risk of violating Fair Housing laws. For that reason, coop boards should create a clear and objective process for evaluating applicants. You don’t want to make this up as you go along ─ that’s a recipe for disaster.
The best practice is to assess financial capacity first; this reduces the risk that a board will be perceived to have rejected a shareholder or a tenant for improper (discriminatory) reasons. Once applicants pass the financial test, boards can interview them to assess compatibility, hobbies, and other issues. Interview questions should be open-ended, designed to determine what kind of neighbors they would be and their willingness to follow rules, but steering clear of sexual orientation, children, religion and other Fair Housing land mines.
Because cooperatives have the ability to select their neighbors, they have acquired a reputation for sometimes being somewhat snobby. This no doubt appeals to some prospective buyers while repelling others. The shareholder vetting process itself, along with the other restrictions and requirements coops impose ─ higher down payments, restrictions on secondary loans, and restrictions on rentals, for example ─ discourages many from considering a coop. Lack of familiarity also tends to limit the pool of prospective coop buyers outside of New York. As a result, cooperatives are usually less expensive than condominiums; buyers will generally pay less per square foot for a coop than for a comparable condominium unit. But coop shareholders may also experience the down side of that comparison when they sell to buyers who expect to pay less than they would for a condominium unit.
On the other hand, for a variety of reasons, coops tend to attract buyers with an ownership horizon longer than the three-to-five-year average that is typical in condominiums. Because coop owners establish deeper roots in their communities, they are also, as a general rule, more actively involved in them. Coops aren’t the equivalent of communes, by any means, but they often have a more “communal” spirit than condominiums, which struggle regularly to find volunteers or even to attract a quorum for annual meetings.
The differences between cooperatives and condominiums make the two forms of ownership more or less appealing to some people than to others. There is no question that coops aren’t for everyone. But then, neither are condominiums.