On the Money: Co-op Loans and the Proprietary Lease Problem

Co-op owners and would-be purchasers could be affected in the same way, thanks to an obscure federal policy put forward in the guidelines by Fannie Mae.

The Project Standard Office within Fannie Mae enforces guidelines by which the largest packager of American home loans determines whether borrowers get approved. One of its many rules specifically and critically applies to co-ops.

Since co-ops do not give their shareholders actual title to the apartments they live in, but rather a proprietary lease on their unit, the office requires banks selling loans to them to arrange for proper assurance that the units remain in the hands of the purchasers throughout the term of their loans.

That's where the trouble appears. All proprietary leases have an expiration date, and while the majority of them extend at least 50 years, they do so from the date the term started. If a co-op doesn’t pay attention to the term, it will cause problems for purchasers or those refinancing a mortgage.

A decade ago, says Niemeier, if the term of proprietary lease wasn’t long enough, a co-op board could simply supply a “letter of intent” stating their intention to renew the proprietary lease. Today, if the term falls short of 30 years (plus a five year cushion) to cover a 30-year purchaser loan, a board has to supply a “statement letter” indicating the exact date the proprietary lease will be renewed.

Experts say the conflict could possibly affect nearly one out of five co-ops in the New York area.

If a bank can’t obtain a waiver for the borrower from Fannie Mae or its smaller rival, Freddie Mac, what the would-be borrower can do is go to a bank willing to make a portfolio loan — that is one from its own balance sheet — or borrow for a shorter term that falls within the length of the lease. Of course, the borrower can also simply walk away from the purchase.

Niemeier notes that with the enforcement of the guidelines, waivers are no longer free-flowing. Banks are choosing not to make loans in buildings with 30-year leases. Boards should take note of the expiration dates of their proprietary lease, now, and plan for its renewal. And because this action requires shareholder approval, a board might as well dig in and update all the old language to legal practices that will actually protect you and your board today. 

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