I'll Be Back

With the economy going sour, insurance costs rising, and people leaving New York City before of the recent terrorist attacks, some boards are asking, "Will subletting be necessary? Is it time to review our subleasing policies?"

Good questions. To many owners in a bind, the sublessee has often proved a lifesaver. Unable to sell their units because of a bad economy, shareholders who had moved on to larger digs rented their apartments, which then provided a source of income while they waited out the recession.

To boards and those owners who didn't sublet, however, the sublettor was more problematic. When seeking refinancing, boards found that lenders were reluctant to loan money to buildings that consisted of more than 20 or 25 percent of resident non-owners (investors, sponsor-controlled units, and sublessees). The high ratio of non-owner-occupied apartments was seen as a sign of instability.

In addition, sublettors were seen as part of a transient population, not as committed to or caring for the building as owner-occupants. "Renters don't take as keen an interest in the building," observes Ann Bially, a former board member at 227 Ocean Parkway, a 76-unit co-op in Brooklyn. "You also have less of a pool of owners to get board members from."

Bially, who attempted to sell her apartment in 1991, was unable to do so because mortgages at the building were unavailable. The majority of units were, and still are, subleased. Citibank eventually agreed to finance 20 percent of the units, but the subleasing issues haven't gone away.

The end result of all this was that many boards adopted subletting policies that restricted the length of a sublessee's term or which required a sublet fee, among other things. Some boards denied subletting entirely. These steps, along with a strong economy, lessened the subleasing dilemma.

But, now, some boards may be finding themselves wondering what the market is going to do to the economics of running their building. Many experts say that, as the financial picture darkens, subletting will become an issue again.

"Always, when there is a downturn in the economy, people look to subletting to ride it out," observes attorney Bruce Cholst, a partner with Rosen & Livingston. "Three issues will arise because of it: To what extent should a board allow subletting as an accommodation to the owner? Will refinancing become a problem if the owner-occupancy ratio is affected? And will the building become less attractive to owners or potential purchasers if there is a transient population? Pressure will increase on boards to sublet and they need to decide what to do before it does."

Boards should review their sublet policies. Folio House, a 41-unit co-op on Fifth Avenue, for example, has a sublet surcharge of 10 percent for the first year and 15 percent the second year. (Under unusual circumstances, the board allowed one sublet to continue into a third year and charged 20 percent.) The idea is to discourage prolonged subleasing.

"We also have an unwritten rule that we would not allow more than 10 percent — four units — to be sublet in the building," says board president Mike Hussey. "Right now we have one: last year we had two. We have averaged no more than one or two for the last ten years…[but] there is so much room for negotiation that we do not expect sublets to become an issue."
When it comes to ways to limit the number of sublettors there are a few technique that a board that expects problems or is having problems can apply.

The Progressive Method.Rather than immediately booting the sublettors onto the street, boards can phase the numbers down over a few years, setting smaller percentage goals to be reached over a five- or ten-year period. For example, a building with 25 percent subletting can set a goal of decreasing sublets from three to five percent each year.

Fee-Fi-Fo-Fum. As Folio House has done, a co-op can charge increasing subletting fees from one year to the next. Also, by placing a limit of no more than two to three years of consecutive subletting, the financial gains of subletting can be restricted and the push made towards sale. (Other properties have calculated fees at $1 a share.) If you decide to do this, though, avoid generalities. For instance, one co-op said in its bylaws that any subletting fee would be 30 percent of the annual maintenance, but then added the caveat that it would bear "a reasonable relationship to actual expenses of the transaction." The addition of that statement created the question of what was "reasonable." The board ended up in court having to defend and explain. "Even where imposition of sublet fees is permitted, the fee structure selected by the board may not violate any express restrictions which appear in the governing documents," explains Cholst. "Authorization for imposition of a sublet fee must be grounded in the co-op's governing documents." Having the authorization clear and in place now can prevent back-peddling later. Checking the language with your attorney is a must.

Meet the Neighbors. A co-op has the right to interview potential sublettors. The tenant should be interviewed before the sublet begins and, again, at the completion of the first year or term, to determine whether the sublease should be renewed.

Nix It. Some boards have opted to disallow subletting entirely, regardless of economic hardships that owners may be experiencing. As tough as this sounds, when seen in the light of a business decision, for many boards this makes sense. They want to keep the property as attractive as possible to purchasers and owners and subletting can tarnish that image.

Whatever a board decides, the decision is not dependent on getting all the shareholders to agree. That said, the time to make the policies is before the issue becomes a problem. According to Paul J. Herman, managing director of Rose Associates, it is probably too early to tell what changes the economy will cause. He expects that it will be at least a year before boards see a shift one way or the other. "Buildings have had it good economically the last few years," he notes. "If they've kept maintenance at a fair market level, there should not be a big problem."

Still, some minor fluctuations have already occurred. Sales activity slowed toward the end of last year, say many in the industry, and rentals have dropped as well. In some cases drastically. For example, Madison Green, a 425-unit condominium in Manhattan, has seen a drop in rents in one-bedrooms from $3,000 a month to $2,500.

Regulating subletting in condos is not a major issue, of course, since part of the appeal of condominiums is that units can be rented without board approval. "Subletting has added a lot of value to our building. We don't put rules out that make it hard," observes Nathan Willensky, president of the Madison Green board. "People buy as investments and we want to make sure their investment is good." Half of the units in the condo are either rented or subleased.

Still, such a situation can affect the quality of life. What the Madison Green board has done to prevent the "I don't care, I'm just renting" attitude is to institute policies that make for a safer environment. For instance, messengers or delivery people are not allowed beyond the lobby. "A lot of renters love to have stuff delivered," he observes, "and some who didn't understand the ins and outs of tipping were giving 50 cents to deliverymen. They would get upset and graffiti our elevators."

Clearly, subletting has its benefits to some properties and the arguments for and against it haven't changed much in the ten years since its heyday. The major issues are still the renter attitude, financing, and safety. A smart board will deal with each of these and have its rules ready to answer the call of the sublettor.