Two definitions of Condop, and confusion about them

Real Estate Weekly, June 14, 2000 by Neil Binder

An interesting wrinkle in the real estate scene, which began to appear approximately 10 years ago, is the Condop. The term itself has become a source of confusion because there are two definitions being used in the marketplace: a legal definition and a broker definition.

The legal definition of a Condop is a building, which has been partitioned into mixed-use segments; with each segment receiving a condominium unit deed. In turn, one of these segments is identified as a residential component that is owned by a cooperative corporation. This residential component is therefore referred to as a Condop since the cooperative corporation effectively owns a condominium unit deed rather than a fee simple interest in the land.

The initial motivation for creating Condops (as legally defined) was to avoid potential adverse consequences of violating section 216 of the Internal Revenue Code. Included within this provision is a requirement that a cooperative corporation cannot receive more than 20 percent of its income from sources other than tenant-shareholders in order to qualify for a tax deduction pass through of interest and real estate taxes to individuals. In addition, another motivating factor was that federal law created certain limitations on the ability of sponsors to enjoy the benefits derived from utilizing a master lease on the retail component of the property at a below market rent for an extended period of time.

The alternative definition of a Condop, used by real estate brokers, relates to cooperative apartment buildings that do not have board approval requirements or restrictions on rentals. These building are viewed as hybrids wherein the ownership form is a cooperative corporation but the procedural characteristics are similar to a condominium. The term Condop is being used to reflect this hybrid character.

In reviewing transactions in Condop buildings, using the broker definition, it clearly appears that the prices received by Condops are also hybrid. Our experience shows that the values associated with Condop apartments sell for a premium over cooperatives of 5 percent to 15 percent depending on the size of the apartment (with smaller apartments receiving a greater premium). However, it also appears that they sell at an equally sized discount when compared to condominiums since there is an underlying mortgage on the building (with the related debt payment included in the maintenance) and a slightly higher interest charge on unit financing from a bank.

It is apparent that the broker definition of Condop might become a useful feature in augmenting value to a building seeking to improve sales prices in that the elimination of approval requirements and restrictions on rentals clearly register a heightened level of desirability.

The legal definition of Condop may also be an appealing feature, particularly for new construction. The Condop form can permit the builder/sponsor to convert a construction-interim loan with a high interest rate to a long-term permanent mortgage with a lower rate immediately after building completion.

This feature can thereby accelerate receipt of cash by the developer since he/ she does not need to wait for apartment sales to close in order to gain access to these funds. Since these funds correlate to a permanent mortgage on the building the developer/sponsor need not be concerned about his/her repayment of these funds since they are fully assumed by the cooperative corporation. It is also conceivable that if a developer were to implement a strategy to utilize both the legal and broker definition of a Condop he/she could generate a higher economic return. This is because it appears that the revenue generated by the Condop apartment sales coupled with the funds obtained from the underlying building mortgage should provide a similar return to that offered by selling condominium units while the Condop form provides an extra benefit