Co-ops

Work in progress

This page is still a work in progress. I haven’t finished writing everything I want to write, and the structure needs to be redone to suit the intended audience.

I live in a cooperative apartment building (a co-op), an uncommon form of homeownership in most parts of the country. Unlike most people, who would get a mortgage to purchase a condominium in a building governed by a homeowners’ association (HOA), I purchased shares in a corporation that owns the entire apartment building. These shares grant me the right to a perpetual lease for a specific apartment within the building.

When I began the process of buying into my co-op, it was difficult to find factually accurate information about what it really meant to live in a co-op instead of a condo because they are so uncommon. Most of the information I found was specific to co-ops in New York City (where they were most common) or limited-equity co-ops (a form of affordable housing). Further, most of the stated distinctions between co-ops and condos are broad generalizations which don’t even apply to my co-op. In the interests of speaking in definite terms, I’ll describe how my co-op works through the experience I had buying and living in it.

Ownership and day-to-day

By all external appearances, I live in a condo that I bought through the standard process: I had a real estate agent, I got a loan, and I bought a specific apartment from its previous owner.

In reality though, I didn’t buy a condo; I bought shares in a corporation from the previous owner of those shares. That corporation owns the entire building and all apartments within it. And by virtue of the fact that I bought a 2% stake in the corporation, I own about 2% of the building and everything in it.¹ Pedantically, I am a shareholder rather than a homeowner because I don’t actually own the apartment in which I live.

What makes my apartment mine is the proprietary lease that is inextricably tied to the shares that I own. Like renting an apartment from a landlord, I rent my apartment from the corporation. But unlike a regular apartment rental, my proprietary lease has a ~30 year term which renews in perpetuity as long as I own my shares. And because I am a 2% owner of the corporation, I am also renting 2% of my apartment to myself. But my 49 other neighbors are also renting their 2% of my apartment to me, and I am renting my 2% of their apartments to all of them.

In reality, this distinction never manifests in day-to-day life. We all have locks to our own apartment doors, and we all treat the interiors of our apartments as if we own them—we paint, renovate, and tailor them to suit our lives. Probably the most noticeable difference in day-to-day life is just in the vernacular that we use:

• We refer to each other as shareholders rather than owners.
• We refer to the corporation and the board rather than the HOA.
• Most people use the term regular assessments instead of HOA dues. They’re the same thing as HOA dues though, and some people do say “HOA dues” colloquially.

Most other things are the same too; we are subject to the same laws as HOAs in terms of governance and procedure, for example. However, we are incorporated as a for-profit corporation instead of the typical nonprofit mutual benefit corporation, so there are subtle tax differences between how an HOA would pay taxes and how the co-op pays taxes.

The big difference: buying

The biggest difference between being a cooperative instead of a condo appears during the buying process.

Share loans instead of mortgages

Foremost, because buyers don’t buy real estate as they were buying a condo, you cannot get a mortgage when buying into a co-op. Rather, you have to get a share loan which, as it sounds, is a loan to buy shares in our corporation. Many traditional mortgage lenders do not offer share loans because these loans are not backed by real estate. Instead, share loans are collateralized by the shareholder’s shares in the corporation and the associated proprietary lease. If a shareholder goes bankrupt, the bank cannot foreclose on physical property to recover the loan. Additionally, most co-ops have a right of first refusal on the shares. This means the corporation can reclaim the shares in cases like bankruptcy, leaving the lender with nothing to sell. As a result, many lenders see share loans higher-risk and not worth dealing with.

In reality, co-ops and share loan providers have agreements and loan terms that plug these holes so that the loan is collateralized just as a mortgage on a condo would have been. However, many lenders are unwilling to figure this out due to the rarity of co-ops, so there aren’t always a lot of options when getting a share loan to buy into a co-op. When I bought into mine, I had to rely on the co-op to provide a list of lenders because my mortgage broker wouldn’t touch a share loan.

Financial screenings

The other hurdle in buying into a co-op is the amount of scrutiny the co-op subjects prospective buyers. When I bought into my co-op, there was a buyer application package that I had to submit which included proof that:

1. I had at least a couple hundred thousand dollars in assets after the close of the sale. This meant submitting account statements from my banks and brokerages to the co-op that showed how much money I had, where it was, and what form it took.
2. I was providing a minimum 20% down payment - that is, my debt-to-value (DTV) ratio was no higher than 80%. Buyers whose loan terms have a smaller down payment (perhaps through private mortgage insurance) would be forbidden from buying.
3. I met a maximum debt-to-income ratio, including the cost of all my loans and the regular assessment (the HOA dues). That is, I had to have a certain minimum monthly income.
4. I had good credit. This meant submitting credit reports to the co-op with my full credit history.
5. My finances were stable year-over-year. This meant submitting two years of past federal tax returns in their entirety.
6. Personal references. These were people that could vouch that I was a decent person.

And bear in mind, I was submitting this to the co-op, not a bank or a lender, and not the person from whom I was buying the apartment. This felt very invasive, because it was. And if I did not meet any of the above criteria, my application would be rejected and the apartment sale would be terminated.

If this was a condo purchase, many of the above requirements would probably be grounds for a lawsuit because a homeowners association has no basis to forbid an individual from selling their condo to whomever they want. Whether a buyer can actually afford to buy a condo is up to either the buyer and the seller or the buyer and their lender. The HOA exists only to manage the shared interests of all the condo owners.

So why can co-ops block sales on the basis of a prospective buyer’s finances?

Remember that the sale is for shares in the corporation, not for real estate. The corporation owns the real estate, and by extension, is responsible for all of its liabilities—including property taxes and any mortgage the corporation took out to build the building. If the corporation cannot make its tax or mortgage payments, the whole apartment building could be foreclosed on or have a tax lien placed on it. Even if individual shareholders can afford their part of these payments (in their regular assessments, or “HOA dues”), they cannot prevent foreclosure or a tax lien on their apartment.

By comparison, condo owners are directly responsible for the liabilities of their real estate. If they can’t make their mortgage or tax payments, the condo can be foreclosed on or have a tax lien placed on it, but other condo owners are unaffected. Their HOA dues might effectively increase so that the HOA’s bills can get paid, but there’s no legal basis for the bank to take their homes just because their neighbor went bankrupt.

Given the collective financial responsibility and shared fate of all shareholders in a co-op, co-ops have an obligation to make sure that new shareholders don’t put all other shareholders at risk. This is why new buyers have to open their books to the co-op when they want to buy.

What’s not actually different

A lot of online descriptions of co-ops state differences like:

• Regular assessments (HOA fees) are usually higher because property taxes and utilities are paid for by the corporation directly, and these costs are recovered through regular assessments.
• Rules are more restrictive about what you can change inside your apartment since you don’t own it.
• Rules are more restrictive about whether you can rent your apartment or not.
• You will be interviewed by existing shareholders as part of the buyer application process.

None of these are strictly true; case-in-point is that none of these are true in my co-op.

Property taxes and utilities are not shared

About thirty years after my co-op was incorporated, it divided its apartments out into separate property tax lots so that individual shareholders were directly accountable for the property taxes their apartments. As a result, I pay my property taxes directly to the city, and the co-op has no say in when I do this. If I fail to pay my property taxes, the corporation is also not liable, which dramatically reduces the risk to other shareholders if I fall on hard times. Thus, this aspect of living in my co-op is effectively the same as living in a condo.

The way our utilities work is completely independent of the fact that we are incorporated as a co-op as well. While the building does have a single meter for water, electricity, and gas, we separately bill out the utility costs as separate line items on the monthly dues. Ideally we would be able to individually meter every apartment’s consumption of water, gas, and electricity, but we only have individual submeters for electricity. The corporation pays a single electric bill for the whole building every month, and it then bills me for the electricity that my apartment consumed based on my submeter. Our gas and water do not have submeters, so we each pay our 2% share of those bills to the corporation each month just as any condo building without submeters would do.

Apartment renovations aren’t onerous

Our corporation’s bylaws do not dictate what modifications we can make inside our apartments any more than a condo association’s CC&Rs would. Renovations do have to be approved by a committee, but this is to ensure that changes will meet local building code and will not affect the structural integrity of the building.

Perhaps the only unusual aspect of this is the requirement that every contractor who works in our building must be fully licensed and insured. This is a result of the legal liability the corporation has; if a worker is injured inside a shareholder’s apartment, the corporation is liable since it owns the apartment. Once in a while this catches people by surprise if they try to use an unlicensed contractor or plumber.

Renting or subletting is more restrictive

In California, co-ops are subject to the same housing laws that condos are, and California Civil Code § 4741 requires that an HOA allow at least 25% of its units to be rentals. As a result, unless more than 25% of the apartments in my building are already rented or sublet, shareholders can rent their apartments out. It’s simply untrue that co-ops are different from condos in this way in California.

If a shareholder wants to rent out their apartment, there still is an application that requires approval from the co-op’s board of directors. But there aren’t many legal ways for the board to deny these requests, so it’s become a formality.

Buying in requires interviews

While the law allows co-ops to scrutinize prospective buyers more than a condo HOA can, it doesn’t allow co-ops to discriminate against buyers for reasons beyond financial risk. This means that there isn’t much reason for co-ops to interview prospective buyers since they already have to submit their financial records. In the worst case, the prospective buyer is revealed to be a jerk in the interview—but so what? The corporation cannot deny the buyer application on that basis; doing so might expose the corporation to a housing discrimination lawsuit.

When I bought into my co-op, the board president offered to talk to us during the buying process to answer any questions we had, but it was not an interview. We took her up on the offer simply to get a better understanding of the community and the way the cooperative worked.

Footnotes

1. I bought 2% of the shares because there are about 50 apartments in my building. 100% of the shares divided amongst 50 apartments comes out to 2% of all shares being tied to each apartment. ↩