By Stuart M. Saft, Partner, Holland & Knight LLP
Two of the most common questions that I’m asked are: why there are cooperatives when condominiums seem to be such a popular form of ownership and, since condos sell at a premium over co-ops, why haven’t all the co-ops converted to condominiums? Part of the answer is historical because condominiums are a creature of statute and New York didn’t enact a Condominium Act until 1964 whereas New York has had cooperatives for over a century.
Before going into the reasons why few of the approximately 6,500 cooperative housing corporations have converted to condominiums, I must clear up a misunderstanding regarding the popularity of condominiums. There’s an assumption that a cooperative is a building where an all-powerful board of directors has an absolute right to reject purchasers, subleases, financing and alterations, and a condominium is a building where a weak board of managers has no right to do what a co-op board can do. But that assumption is wrong. The right of a co-op’s board to reject purchasers only exists because the proprietary lease grants the board the right to do so; absent that provision, the board could do nothing to stop a transfer of shares. The absence of a right by a Condominium Board to reject purchasers exists because the right is not contained in its by-laws, but it could if the sponsor or a large majority of the unit owners wanted the right to exist. These rights which, to many New Yorkers define a co-op or a condominium, are not caused by the way in which the law is written, but rather are based on the way in which the sponsors wrote the documents.
New York only produced co-ops until the late 1980s, by which time there was an excess of 6,500 cooperative corporations and nary a condominium. Now there are over a thousand condominium buildings and a co-op offering plan is a rarity. At the present time, this distinction is largely driven by a belief that condominiums sell for at least 15 percent more than cooperatives. However, co-ops sell for less predominantly because of the belief that it’s easier to sell and lease in a condominium.
This has led to a great deal of interest in converting cooperative buildings into condominiums in order to magically increase the value of the apartments. The process to do so isn’t difficult or expensive and yet, almost none of the 6,500 cooperatives have done so. In order to convert a cooperative into a condominium, the corporation would have to take the following steps: the cooperative’s lawyer prepares a declaration and by-laws, which contain much of the material found in the cooperative’s proprietary lease and by-laws, and the cooperative’s architect draws maps indicating which parts of the building are units, common elements and limited common elements; the board should (but isn’t legally obligated to do so) prepare a Proxy statement explaining what is being done and its consequence; the board should allocate the percentages among the various units; the board should obtain a “No Action” letter from the attorney general because the city surveyor will not permit the declaration forming the condominium to be filed without a letter from the attorney general even though nothing is being sold to the public; a vote of the shareholders is taken which, based on the cooperative’s documents could require the affirmative vote of between two-thirds to all of the shareholders; and, the shareholders exchange their proprietary lease for their apartments and stock certificates for a deed to their unit. Sounds simple, doesn’t it? Then why isn’t it happening?
There are four reasons why few cooperators are taking advantage of the ability to increase the value of their homes by 15-20 percent. The first is the difficulty in getting the soon to be former shareholders to agree on the terms of the declaration and by-laws; the sponsor wrote the first set, so the shareholders inherited them but now they must agree as to what should be the condominium’s responsibility and the unit owners. The second is the need to pay off all the debt on the building, because there cannot be a mortgage on a condominium’s common elements, and the shareholders have to get their own lenders to agree to transfer their lien on the shares and proprietary lease to a mortgage on the unit. The third is that many cooperative shareholders like the fact that the board has control over who’s going to be living next to them or above or below them and a powerful board can protect the shareholders from all those quality of life issues that can be so rankling. However, the biggest factor is the fourth: the income tax consequences. The Internal Revenue Code treats the exchange of a co-op’s shares for a deed to the same condominium unit as a sale of the co-op apartment and the purchase of the condominium unit. Therefore, the former shareholder has to be taxed on the phantom gain he or she would have realized based on the profit that would have been made if the apartment was sold at the present time for its fair market value.
Correcting this obvious mistake in the Internal Revenue Code would require changing about a dozen words, which I have been attempting to accomplish for two decades, but no one in Washington cares about what’s considered a purely New York issue. Not even New York’s senators or representatives, even though it would produce more profit for sellers and more revenue for the government.
Stuart Saft
Holland & Knight
31 W 52nd St., 12th Fl.
New York, NY 10019
212-513-3308
Stuart.saft@hklaw.com
