Co-op conversions are no temptation

Real Estate Weekly, Dec 27, 2000 by Neil Binder

There has been discussion in the industry recently on the advantages of converting an existing cooperative apartment building to condominium ownership. Driven by the apparent disparity in prices between apartments in otherwise similar cooperative and condominium buildings, the theory behind conversions is that condominiums sell quicker and for higher prices than coops. Promoters of the strategy also note investors prefer to buy condominiums, leading to inherently higher demand for these properties.

In reality the arguments behind co-op to condo conversions are very weak and there are few cases in which I believe such a move makes sense. Let's dissect the argument and find out the truth of the matter.

The most significant actual differences between cooperative and condominium ownership fall into two categories: ease of transfer and the right to rent. Many co-op boards do in fact limit residents' rights to freely rent and transfer their apartments. However, these restrictions are not inherent to cooperative ownership, and co-op boards can easily remove them if they so desire. In this manner, a cooperative apartment building would alter its rules to permit the same rights of transferability and rental normally enjoyed in condominiums.

In fact, there are a number of landlords and developers who have pursued this route to boosting values in their properties. Their buildings, though cooperatives, are marketed with slogans such as "No Board Approval" and "Renting Allowed." Brokers frequently refer to these buildings as "condops" to differentiate them from co-ops with more restrictive rules. In sales, these buildings seem to achieve the price levels generally obtained only by condominium apartments, when the cooperative building's underlying mortgage is factored in.

Another frequently used argument for condominium conversions points to the fact that residents of many cooperative buildings pay maintenance charges that are well above average monthly charges at condominium buildings. It is often assumed that by converting a building to condominium ownership, its maintenance charges can be dramatically reduced. Lower maintenance charges would make apartments in that building much more salable in any market.

In truth, there is no easy way to simply erase high maintenance charges. In almost every case, the reason for the high monthly fees is excessive mortgage financing on the underlying property. Nearly every cooperative building carries an underlying mortgage, in addition to the mortgages carried by individual residents.

In certain buildings, the costs of carrying that mortgage have been allowed to balloon to an excessive size. In turn, that inflates residents' monthly maintenance costs.

Conversion to condominium cannot eliminate this excessive underlying mortgage. It can only transfer the obligation from the shoulders of the general building to the backs of each apartment's owner. A mortgage will not simply disappear. The cash to pay it off in the case of a condominium conversion must come from somewhere. In fact, it must come from the owners of units in the building. And there is seldom any financial advantage for residents to take on their share of this cost directly, rather than shouldering it through their monthly maintenance costs.

For investors, condominiums offer little advantage over cooperatives. Investor financing is readily available for both types of units at similar terms. Plus, the rights deductibility and profit recognition are the same for both. Both qualify for 1031 like kind exchange treatment. And in the case of depreciation they too are similar, since the amount of underlying mortgage on the cooperative can be added to the purchase price of the stock determining depreciable basis.

In short, with no market advantages and no financial advantages, there is little reason to consider the condominium conversion of cooperative apartment buildings.

The only parties that are guaranteed to benefit from a conversion are the attorneys performing the legal work and the brokers gaining marketing fees. Boards of cooperative buildings would better spend their resources reviving their rules on renting and transfers and refinancing high-priced loans.