Should We Sell the Stairs?

Just as magicians pull rabbits out of hats, some boards can pull profit from adversity.

Consider this: several years ago one of our co-ops discovered that its building’s foundation was settling. Large areas of the property, including a swath of stairwell space covering the entire height of the tower, required bracing and shoring in order to stabilize the edifice. One of these stairwell shafts abutted the ten A-line apartments’ kitchens and the D-line’s master bedrooms. During the course of massive structural repair to the stairwell area, the board realized that the space could be finished and partitioned with walls, floors, and ceilings and then leased to A- and D-line shareholders for use as extra pantry and closet space. The board also realized that once the cellar space situated at the base of the stairwell was shored up it could also be finished and converted into storage rooms and bicycle racks that could be rented out to all the tenants.

Given New Yorkers’ unquenchable thirst for additional storage or recreational space of any kind, and boards’ insatiable appetite for revenue, the concept of turning what had been an idle fallow area into income-producing, quality-of-life-enhancing property proved to be a win-win arrangement for the entire building. Shareholders benefited, not only from the instantaneous enjoyment of additional usable space but also from the enhanced value of their apartments. The 48-unit Brooklyn Heights cooperative obtained an instant cash windfall of roughly $85,000 plus an annual additional $6,600 maintenance stream from the sale of the stairwell space to A- and D-line shareholders. It is also deriving about $9,000 per year in newly found income from the basement storage space. The entire process of converting and selling, including construction, took roughly nine months.

A Universal Concept

This concept can just as easily be applied to the sale or licensing of roof, garden, or hallway space within a building. All that is necessary for such an application is the existence of extra space that would be useful to individual shareholders or unit-owners and has not been allocated to particular apartments under the terms of the building’s offering plan.

The first step in the process for any co-op board seeking to raise revenues this way is to decide whether, in effect, to sell the space to its shareholder by issuing additional stock and having the new area become part of what is covered by the purchaser’s proprietary lease or rent the space by issuing a revocable license agreement. When the space is sold, it is automatically passed on to successor shareholders. When the space is rented through a license agreement, the right of use reverts back to the co-op at the time the arrangement is terminated. Thus, while the co-op retains some control over the future use of its space, it loses its enhanced revenue stream when the license ends.

Co-op boards typically elect to sell rather than rent their extraneous space because they can more easily justify charging a large upfront payment when they are transferring ownership of space, thereby adding permanent value to the apartment.

In condominiums but not cooperatives, the board does not own any of the common space. Instead, each unit-owner owns a portion of all common space as a tenant-in-common with every other unit-owner. Since condominium boards cannot sell what they do not own, the only way they can dispose of extraneous common space is through a revocable license agreement.

The second step in the process is to appraise the space. Condo and co-op boards issuing license agreements need to determine the fair rental value. For one thing, co-ops must decide on the appropriate share allocation for the area being sold. IRS regulations require that each share allocation in a building be “reasonably related” to every other share allocation. If you don’t do this, every shareholder could lose his or her tax deduction for mortgage interest and real estate taxes. Thus, for the protection of the shareholders an appraiser’s opinion letter attesting to the “reasonableness” of the share allocation he/she has assigned to the subject space is necessary. The additional monthly maintenance to be paid by the acquiring shareholder is a function of this share allocation.

The appraisal is necessary to determine the fair market value of the subject space for purposes of its “sale” to the shareholder. The appraiser’s fees and all other costs (including the board’s legal fees) associated with a sale or rental of extra common space are typically borne by the acquiring shareholder or unit-owner. Since license agreements do not involve the sale of square footage or stock, co-op.condo boards that rent rather than sell may proceed with the negotiation and execution of their license agreements once they get the appraisal.

The “No Action” Action

The next step in the process for co-op boards seeking to sell common space is obtaining a “no action letter” from the attorney general’s office. Broadly speaking, New York State securities laws provide that whenever newly minted shares of stock in a corporation are to be offered for sale, they must be accompanied by a prospectus.

However, recognizing that preparation of that document is an extremely cumbersome process for very small offerings of cooperative stock, the attorney general created a streamlined procedure for complying. Basically, when you file an application describing the nature of the stock offering and provide detailed background information about the cooperative corporation and a corporate resolution authorizing additional shares, the attorney general will typically produce a letter assuring the board that its office will take “no action” against the corporation by reason of its offering of shares without the legally mandated accompanying prospectus. The board is then free to proceed with its stock sale.

Following receipt of such a letter, the board adopts corporate resolutions setting the price per share of the newly issued stock and authorizing execution of a sales contract with the acquiring shareholder. Following execution of the contract, the parties proceed with the closing. That’s where the shareholder receives a new stock certificate and proprietary lease combining the newly issued shares with the shareholder’s existing shares. After that, the acquiring shareholder is billed for maintenance and assessments based on his/her new share allocation.

Boards, of course, need not wait for disaster to strike before locating available extraneous common space and tapping into such hidden assets. Architects can be commissioned to review building plans and spatial configurations with an eye towards identifying areas as fertile ground for the board’s cultivation of new revenues.