Co-ops and condos can be a good option for first-time homebuyers. They are also attractive alternatives for people who own a house but want to downsize because they don't need the space anymore. But while co-ops and condos generally cost less than free-standing houses and require less upkeep, there are still some potential pitfalls.
First, some definitions: When you buy a condominium, you get a deed and title to an apartment and contribute funds for the upkeep of common property such as the grounds, building exterior, lobby and elevators. Condo owners pay real estate taxes and in general can rent or sell as they wish.
With a co-op, you are buying stock in the company that owns a building. You don't actually own any real property, but the stock entitles you to a lease for a unit in the building. As with a condo, you contribute funds for the upkeep of common grounds, but your monthly fees also cover the real estate taxes and insurance for the building, among other things. Co-op boards also can restrict your ability to sublet your unit.
In either case, you are living at close quarters with other people in the building and may be subject to rules and policies you don't like, such as no pets or mandatory carpeting. Just as important, you will be co-mingling your finances with everyone else in the building, since co-op and condo owners may have to foot the bill if their neighbors fail to pay their monthly fees. It can also be harder for you to sell your unit if others in the building default on their mortgages.
For this reason, lenders take a close look at the ownership structures and finances of co-ops and condos -- and you should, too.
Ed Fusco, an attorney based in the Park Slope section of Brooklyn, N.Y., says, "Banks ... want evidence that the sponsor doesn't have a controlling interest and also that the building is owner-occupied. Often, in a new conversion, the units aren't completely sold and banks will put restrictions of loans."
For example, he says, a bank would be reluctant to finance the purchase of an apartment in a 25-unit building if only two units are sold and the rest are in the hands of the sponsor, since these remaining units might eventually be rented, rather than sold.
Fusco says this dates back to the last real estate downturn in the 1980s. Back then, sponsors who owned too many units and got into financial trouble often stopped paying the maintenance, causing the building to default on the underlying mortgage. When the underlying mortgage gets foreclosed, then everyone in the building stands to lose his or her apartment, including the banks that have those apartments as collateral.
These days, in many new conversions, the sponsor will approach banks and make deals upfront. Many times applicants can get a mortgage anywhere they want but must at least apply for one with the lender specified in the building's offering plan.
If you're buying a co-op, getting a mortgage is just the first step; you may also need to be approved by the co-op board. Even in today's market, when many banks are tightening their lending criteria, getting past the co-op board can be much tougher.
Barbara Fox, a Manhattan-based real estate broker, cautions, "Buying an apartment, and in particular a co-op in New York, is a cumbersome and personally invasive process. Your net worth and investments are stripped down to almost the penny."
Fox says that while other cities have co-ops, New York instituted a system that is "similar to joining a private club. Early on, when the co-op concept came into focus, the people who were living in these very expensive apartments wanted to be able to know that they could control who was living next door to them."
But another reason for the scrutiny is that "the board needs to know that a buyer will be a constructive entity; most important to the board is the status of your finances."
Jonathan Raboy, real estate agent at Citi-Habitats, tell the story of a client who was unable to buy an apartment on Manhattan's West Side because the co-op board -- not the bank -- felt his finances didn't pass muster. "The board there required an extremely low debt-to-income ratio, and although my client was a professional and had a good ratio, it at the time was more than this board would have liked to see," he says. Before his client could satisfy the board, another prospective buyer came along and outbid him.
Although board approval is waived for an apartment owned by the building's sponsor, the downside is that, in New York at least, the buyer has to pay the seller's transfer tax and certain other fees.
Ideally, you should know as much about a buildings finances as the board knows about yours. "You need to be comfortable with the financials of the co-op," says Steven B. Schnall, the president of New York Mortgage Co. "And you need your realtor and attorney to help you assess that. If the building is only 20% owner-occupied, it still could be a sound building financially."
In an older building, one thing to look for is the reserve fund. "An older building will need repairs sooner than a new building will," Schnall says. "You need to be sure the building is reserving for future capital improvements."
Some other things to be aware of: An older co-op that has paid down its underlying mortgage significantly might have lower maintenance. On the other hand, Schnall says many new condos have tax abatements, which can keep your real estate taxes down for a certain number of years.