Work Out

It’s the nichiest of niche businesses. Unsold shares are not easily financed, and they are management-intensive. There’s a reason why this is called “patient money.”

Unsold shares. Those two innocent little words make up a lucrative niche in the city’s real estate market that can be a vexing headache to co-ops. That’s because unsold shares sometimes prevent co-ops from becoming what they’re supposed to be: corporations composed of shareholders who live in a building and work toward its long-term fiscal and physical well-being. Healthy co-ops, in other words, are built on owner occupancy. Unsold shares in co-ops are, as a rule, rent-controlled or rent-stabilized apartments, usually occupied by long-term renters. Owners and renters tend to be oil and water. And that’s the problem.

Muss Go

When a woman whom we will call Jane Smith moved into Donner Gardens, a 270-unit co-op in Jackson Heights, Queens, in 2001, she was dismayed to learn that the co-op’s sponsor, Muss Development, still owned nearly half of the shares some 15 years after the five-building property’s conversion from a rental to a co-op.

“When I got here, they hadn’t been living up to their end of the agreement – which was to sell units,” says Smith, a school administrator in the South Bronx, who got elected to the co-op’s board of directors in 2007. “We ended up taking legal action against the sponsor, and they told us they were thinking about selling all of their units.”

“The unsold shares were interfering with the co-op,” observes Abbey Goldstein, a partner at Goldstein & Greenlaw and the board’s attorney. “It was hard to sell units because there was a nine-member board and the sponsor represented four seats, so if they didn’t show up for a meeting, there wasn’t a quorum.”

Smith outlined other reasons why the board wanted Muss, a family-owned company based in Queens, to sell its unsold shares: “If a building is 100 percent owner-occupied, the people care more for the building, and you have more control over people who are not abiding by house rules. If you have to go through a sponsor, you have no control. We have no control over who rents a sponsor apartment, while we can control who buys shares. Also, mortgage rates depend on the level of owner occupancy.”

In addition, banks are less willing to offer mortgages to potential buyers, or refinance mortgages and approve home-equity loans for shareholders in co-ops with a high percentage of rental units. To top it off, buyers are wary of co-ops where sponsors or other investors hold significant blocks of shares.

Muss completed a bulk sale of its unsold shares in Donner Gardens – 120 apartments – in 2008, just before the city’s real estate market and the national economy took a nosedive. The buyer was another Queens-based company, Norcor Management, and while the board welcomed the sale, there were also moments of be-careful-what-you-wish-for anxiety. “We were very nervous,” Smith says. “Muss wasn’t horrible, and at least we knew who they were.”

The board’s anxiety proved groundless. As the economy and the city’s real estate market rebounded, Norcor did what the majority of investors in bulk sales do – as their rental apartments became available, Norcor put them up for sale at market prices, realizing a handsome profit. Harry Otterman, the president of Norcor, also helped the Donner Gardens board through some projects, large and small, including elevator and garage door repairs, replacement of all windows, and repairs to parapet walls and lintels.

“They brought a lot of knowledge and expertise,” Smith says, “and they’re very responsible about dealing with their tenants. We’ve developed a great relationship. They sell apartments for great prices, but they don’t flood the market, which would bring down the prices. They want to help the building keep value while making a profit for themselves.”

Otterman says that his company’s interests are in line with the interests of co-op shareholders. “The success of the co-ops we’ve converted and managed – that’s our success, too,” says Otterman. “As a marketer, the nicer a co-op looks, that’s to my advantage.”

Otterman says Norcor, which owns a total of 1,000 apartments and manages 20 buildings, mostly in Queens, has so far sold a dozen apartments at Donner Gardens – about 10 percent of its holdings – and it will continue to sell as long as the market remains healthy. “Our business plan is to sell apartments when the market is hot and hold onto them when it’s not,” he says. “The market controls what we do in general. Now the market is quite good.”

Purchasers of blocks of unsold shares are not looking to turn a fast buck. While they’ve historically been able to buy blocks for anywhere from 30 to 45 percent of their market value, it may be years before they are able to see a profit from sales of those apartments. There’s a term for what these investors bring to the table. It’s called “patient money.”

Spira Is Willing

Israel Spira needs an elaborate rack to hang all the various hats he wears. He’s senior property manager at Newport Management in Brooklyn, which makes bulk purchases of unsold shares and advises a small group of investors; he sits on some 20 co-op and condo boards; he manages 30 buildings; he owns apartments personally; and he serves as a consultant for sponsors.

“We mostly do bulk purchases, usually rent-stabilized or rent-controlled apartments,” Spira says. “The idea is to sell them individually. We’re a little unique in that sense. A lot of sponsors sell packages of apartments, and they’re not really involved in the day-to-day operation of the building. The reality is, if you take care of the lobby and other public spaces – if you improve the quality of life – the value of all the apartments goes up. I want to sell apartments even more than the co-op wants me to – because that’s where I make my profit. My interests and the co-op’s interests are aligned. At the end of the day, we’re partners.”

There are, however, a handful of investors who buy unsold shares with no intention of selling them – despite the landmark 2002 Court of Appeals decision in 511 West 232 Owners Corp. et al. v. Jennifer Realty Co. That ruling says that offering plans carry an implied obligation for sponsors to sell enough shares for the co-op to become “fully viable.” This refusal to sell might flout the law and infuriate shareholders in the co-op, but, says one broker, it “makes the investor’s grandchildren very, very happy.”

Susan Hewitt, president of The Cheshire Group, has been involved in the bulk sales of unsold co-op shares for the past quarter century – since the bad old days of sponsor defaults in the early 1990s. Back then, investors in these distressed properties were known as “white knights” – a bit of a misnomer since it implies altruism on the part of the investors, rarest of rare things in the sharp-elbow world of New York City real estate. Today, as back then, buyers of blocks of unsold shares are drawn by something much less lofty than altruism: the chance to make a handsome profit.

“It’s the nichiest of niche businesses,” says Hewitt, noting: “It’s not for everyone, and it’s definitely not for investors in quest of a quick score. These unsold shares are not easily financeable, so they’re liquid, and they’re management-intensive. They involve a complex relationship with the co-op board. You really have to be completely familiar with the city’s rent-regulation system and how co-op and condo boards work.”

It may be a niche market, but it’s one that broker Mark Zborovsky has been working since the late 1980s. Zborovsky’s first deal was a block of unsold shares representing 28 apartments in Bayside, Queens, worth $600,000. His third deal was shares for 695 apartments in three co-ops worth $16 million. Today, after a quarter century of working his chosen niche, Zborovsky is sometimes referred to in the press as “the king of blocks.”

In all those years, he says, the concept of his business has not changed much, regardless of the state of the real estate market. When a sponsor decides to sell a block of unsold shares, investors usually pay cash for those sharply discounted shares, even though the cash flow in those apartments is often negative – that is, rental income doesn’t cover maintenance and other costs. Then it becomes a waiting game.

“The investor waits for the renter to move out or die,” Zborovsky says, “and then it’s a free-market apartment.”

There are maybe a dozen bulk sales in the city every year. While Zborovsky’s biggest sale was a 665-unit block in the Bronx in 2013, some sales are as small as 9 apartments. Most blocks are between 20 and 100 apartments. He just brokered the sale of a block of 41 apartments in a 95-unit condo on the Upper West Side of Manhattan. The investor paid $37 million – about one-third of the apartments’ market value. It’s a chance for the investor to make a handsome profit. Eventually.

Investors Formerly Known as White Knights

Goldstein, the lawyer for Donner Gardens, advises boards that when a new investor buys a block of unsold shares from a sponsor, the board should view the transaction as both an opportunity and a cause for caution. The board is in a position to negotiate concessions from a new buyer, Goldstein says – “things like the investor’s membership on the board, procedures for subletting, and contributions from the investor for improvements to the common areas.”

The Donner Gardens board, for example, got Norcor to agree that it would hold two seats on a slimmed-down, seven-member board but could not cast votes on the other five seats. This short-circuited any prospect of the investor controlling the board.

The board’s leverage in these negotiations arises from its power to designate the investor as the “holder of unsold shares,” which carries the right to sublet apartments, and the right to sell apartments without board approval – rights coveted by most investors.

“I view this as a time for boards to be wary,” Goldstein says, “but also as an opportunity to obtain reasonable concessions from the investor.”

Put another way, boards need to remember that this is the world of New York City real estate, and there are no such things as white knights. Never have been, never will be.