Transforming Into A Condo

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Three decades ago, a wave of rental conversions transformed New York City into the nation’s capital of cooperative housing. Today, as some of those co-ops survey a changed real estate landscape – from interest rates to property values to the stagnant economy – a movement has begun to stir.

A small number of co-ops are converting into condos. Is this the beginning of a new trend in the city’s ever-evolving housing market? Or is it just a flash in the pan?

Song of the Condo

Two buildings – one in the Bensonhurst section of Brooklyn, the other in Rego Park, Queens – are among the handful of co-ops that have made the switch to the condominium camp in recent years. Their primary reasons: greater value and increased unit-owner control of the apartments.

Value was important to Sofya Golkhovaya, a native of the Ukraine, who moved into the 1930s-vintage Bensonhurst co-op in 1993 and has served on the 59-unit building’s board for many years. Currently president, she felt that her cooperative apartment was not a good investment anymore: the maintenance was high and much of that went to pay interest on the co-op’s $2.4 million underlying mortgage. Meanwhile, she says the value of her shares remained flat or had declined.

Over in Queens, The Delmar, a 36-unit co-op, also was concerned about declining value. Board president Connie Sokol, who was renting her apartment when the building converted in 1987, says shareholders began to get edgy even before the economy tanked in 2008.

Although the sponsor owns just five units, Sokol and other board members feared that even a few foreclosures on shareholders could be disastrous. “We’d heard of some co-ops in Queens where the board made bad decisions and the corporation went bankrupt and the building went back to a rental,” says Sokol. “We thought that with our underlying mortgage of $500,000, the bank would auction off the building and the sponsor could pick it up and turn the building back into a rental. That shook us up.”

Both boards had heard positive things about condominiums. “The big advantage is that [in a condominium] I own my own unit,” Sokol says, in the kind of “I me mine” attitude that is antithetical to co-op philosophy. “If everyone in the building loses their jobs or we get an idiot board, my investment is safe.”

The Bensonhurst board had heard a great deal about the higher prices condos could apparently command in the market, as well as the greater freedom individual owners had in dealing with their apartments – no board telling them what to do regarding sublets – and the absence of an underlying mortgage.

Hurdles

But there were also serious hurdles. “There are many roadblocks, not the least of which is the repayment of the building’s underlying mortgage. And that might include huge prepayment penalties,” explains Arthur Weinstein, an attorney in private practice who specializes in co-op and condo law but who was not involved with these conversions. In fact, says the attorney, a former shareholder will probably end up paying more because of the need to take out a new, larger loan than the one currently in place, simply to pay off that former shareholder’s portion of the co-op’s underlying mortgage.

There are lawyers’ fees, filing fees with city agencies, approvals needed from the state attorney general’s office – it is an expensive and complex process, and many lawyers say the headaches outweigh the benefits.

Unless, of course, you want to pay a conversion specialist fees in the $250,000 range to do all that work for you, acting as a kind of one-stop shop. Both boards found such an entity in ROA Hutton, a New Jersey-based company that has converted more than 3,000 cooperatives into condominiums nationwide, mostly in New Jersey and New York State. (Significantly, there are fewer properties making the switch in New York City.)

After checking with two satisfied buildings in Queens that ROA Hutton had helped convert several years ago, the five Bensonhurst board members invited Jack Boyajian, the president of ROA Hutton, to meet them in March 2010. Boyajian laid out what is required to convert from a co-op to a condo. The steps to take involved: Getting shareholder approval

. The Bensonhurst co-op needed the approval of at least 67 percent of the shareholders to proceed with the conversion (the percentage, spelled out in the bylaws, varies from building to building). Paying off the underlying mortgage

. The co-op had to pay off its underlying mortgage, and shareholders who carried personal mortgages would have to arrange their own financing for a condo unit. Drafting new governing documents

. A new declaration of the condominium and new bylaws would have to be written to replace the old proprietary lease and bylaws. Coping with tax obligation

s. Instead of owning shares in a corporation that owns real estate, owners of condos own a piece of real estate directly. “The tax consequences [of the exchange] are quite tricky,” says Weinstein. “If you’re surrendering your co-op stock and getting a condominium apartment in exchange, you are getting valuable consideration in exchange for your stock. And that’s a taxable event.”

If an apartment’s value has increased at the time of conversion, shareholders who used the apartment as their principal residence and meet certain other requirements can declare an “exclusion of gain” up to $250,000 ($500,000 on a joint return). If the rise in value is larger, however, even such an owner of the new condo might have to pay some income tax, according to Joel E. Miller, a partner at the law firm Miller & Miller.

“As to a shareholder who is holding the apartment for an income-producing purpose (as, for example, by renting it out), different rules would apply,” Miller says. “In such a case, the shareholder would very likely have to report no gain at the time of the exchange, no matter how much the apartment had appreciated, but what was the shareholder’s tax basis in the shares would become the tax basis of the condo unit.”

The corporation could also face taxes. When a corporation transfers property to a shareholder in redemption of his shares – which is essentially what happens during a co-op-to-condo conversion – the corporation is taxed as though it had sold the property at its then-fair market value, except if the apartment is the “principal residence” of the shareholder at the time of the exchange.

Wary Is the Watchword

Many co-op boards are wary of giving up controls that are built into the cooperative system – over who buys in, how to keep the quality of life high for every resident (through house rules and other protections), and how to keep the property financially sound.

Attorneys argue that boards’ wariness of condo conversions is not groundless. Most of them immediately point to the issue of collecting money from a resident who falls into arrears on monthly charges.

“In an economy that’s down and [with] the likelihood of default higher than it was a few years ago, that’s when the ugly underbelly of the condo comes up – the inability of the condo to collect money,” says attorney Seth Sahr, a partner with Novitt, Sahr & Snow who was hired by the Bensonhurst building after its conversion to a condo. “A co-op, on the other hand, can go into nonjudicial foreclosure and auction off the shares that are in arrears.”

“In a co-op, you’re not going to get burned by someone who doesn’t pay his maintenance,” adds Weinstein. “The co-op has first lien” – i.e., first claim on money collected if there is a foreclosure action and the board takes over and sells the apartment. In a condominium, the bank holds the first lien and, in a foreclosure, the condo may ultimately see nothing from the defaulting owner – and have to eat the cost of the unpaid arrears.

But nothing about the conversion seemed to trouble the two boards, whose responses to such warnings, say experts, are alarmingly glib and naive. “We did give up the chance to interview potential buyers, but we have the right of first refusal [to buy an apartment if a potential buyer is deemed undesirable],” says Sokol, either unaware or unconcerned about the fact that, as Sahr points out, “Condos rarely exercise that right of first refusal, usually because they don’t have the cash to buy an apartment. Beyond that, the condo has almost no ability to control who comes into the building, whereas a co-op board’s only limitation is that they can’t discriminate against any protected classes. The courts have ruled that the co-op board has broad authority to turn down a proposed occupant. If they see something they don’t like, they can say no.”

Sahr argues that this quality-of-life issue is frequently overlooked. “There are always problem people,” he says. “A co-op has the benefit of being able to control people – a noisy neighbor, say – through the proprietary lease, bylaws, and house rules. They can also take such people to landlord-tenant court, which is a streamlined process. With a condo, if your bylaws permit it, the only recourse is to go to state supreme court and go through an ‘ejectment’ proceeding. That’s more cumbersome, lengthy, and more expensive – and your likelihood of success is lower.”

The inability of a condo to check out the financials of prospective buyers is also dismissed by Sokol with the comment: “That’s not a big deal because a buyer is going to have to be financially sound to get approval for a mortgage. Not only that, our management company gives us a ‘tenant data verification,’ kind of like a background check, on potential buyers. At least we know who’s coming in.”

Weinstein argues that one reason banks had more trouble than New York City co-ops in the 2008 financial meltdown was precisely because the boards were more conservative than the banks in approving buyers. And, he adds, banks have less incentive to be as scrupulous as they should be in condo approvals since they have the first lien on the unit.

The residents at The Delmar and at the Bensonhurst property apparently listened to all these arguments, then decided to give up a co-op’s controls in favor of the condo’s benefits of homeownership and enhanced value. For now, no one’s having second thoughts.

“People in the building are thrilled,” says Golkhovaya, who lives in a 1,300-square-foot, two-bedroom apartment with high ceilings, oak parquet floors, and a spacious kitchen. She claims the value has gone from $260,000 as a co-op to at least $360,000 as a condo. The building-wide change in values has brought a change in attitude among many residents. "In the beginning,” she says, “people were hostile and scared. Now they’ve talked to people in the neighborhood, relatives and accountants, and they get the impression this makes sense.”

Sokol, too, likes what she sees. She says apartments in The Delmar that were worth between $140,000 and $160,000 before the conversion have seen their value jump by as much as $100,000 since the conversion.

All aboard?
Why would you convert your building from a co-op to condo?
Watch the video: http://bit.ly/coop2condo.