Saturday, February 28, 2009

Co-ops create new conundrums

By Candace Taylor
February, 28, 2009

After a few years in the shadow of the glitzy condos that have been transforming the Manhattan skyline, co-ops may be emerging as a more financially stable and attractive option, but they are still facing a unique set of challenges.

Manhattan co-op boards — already known for their demanding requirements — have in many cases reacted to the economic crisis by becoming stricter than ever before. As a result, some real estate observers say board members are lowering the value of their own homes.

Brokers and market analysts say in an effort to preserve their property values, many co-op boards are rejecting buyers because the prices that they're offering on their target apartments are too low. However, these rejections, combined with a smaller pool of qualified buyers, are ironically putting additional downward pressure on co-op prices. In response, experts are encouraging boards to loosen up some of their restrictions, for their own sake.

"I'm finding co-op boards to be even further behind the market than sellers," said Jonathan Miller, president of appraisal firm Miller Samuel. "That's going to be a continuing problem during this period."

The most recent crackdown by co-op boards comes at a time when co-ops could actually be luring buyers who, while wary of the market in general, might be more comfortable with the secure financial footing that co-ops offer. Co-ops are not only cheaper than condos; experts say they're also holding their value better as the economic downturn grips Manhattan.

In the fourth quarter of 2008, the median price of a Manhattan co-op was $675,000, down 2 percent from the previous quarter, according to Prudential Douglas Elliman's quarterly market report, prepared by Miller. By contrast, the median sale price of a condo in the fourth quarter was $1.12 million, down 8.2 percent from the previous quarter.

"For the past 10 years, people thought 'why would anyone want a co-op?" said Kathy Braddock, co-founder of Charles Rutenberg Realty. Now, "co-ops are being looked at in a healthy way again."

Saving grace

Co-ops, which first began popping up in New York City in the 1920s, account for some 75 percent of the housing stock in Manhattan, according to Miller.

Their more restrictive policies mean they generally sell for 20 to 30 percent less than condos, said Aaron Shmulewitz, a partner at the real estate law firm Belkin Burden Wenig & Goldman. That's one of the primary reasons why nearly all new residential developments are condos, he said.

Yet the high percentage of co-ops in Manhattan is being viewed as a saving grace, and one of the key reasons the borough has largely avoided the same kind of fallout from the subprime mortgage crisis that many other places have seen.

For one thing, co-op owners are often required to put more money down and are thus less vulnerable to default. Moreover, when the owner of a co-op goes into foreclosure, the bank must step in and pay the maintenance charges, Shmulewitz said.

Finally, many banks now require 50 to 70 percent of units in a building to be sold in order for buyers in the building to obtain mortgages, making new condo developments — which once sold like hotcakes — a hard sell.

As a result, while co-ops risk devaluing their buildings, they will see fewer foreclosures and hold their value better than condos as the city heads into a downturn, Miller said.

"You're going to see less volatility with co-ops," he said. "They did a much better job of vetting the qualifications of buyers."

Amelia Gewirtz, an executive vice president at Halstead Property, agreed. "It's easier to get a deal going in resale than new development. That's totally flip-flopped," she said.

Threatening value

While co-ops may be holding up better than condos, the danger they face is real, experts say.

The practice of rejecting buyers because of their proposed low purchase prices occurred frequently in the recession of the early 1990s and continued sporadically as home prices in New York skyrocketed. Now, it's becoming more common as prices begin to dip again, Miller said. "Boards are turning down deals that are selling too low," he said.

The idea behind the practice is simple. "Co-op boards want to protect the value of each shareholder's investment in the building by keeping prices as high as possible," said Shmulewitz.

In better times, that practice often worked in shareholders' favor, with boards acting as a safety net to ensure properties were selling for fair market value.

Richard Hamilton, a senior vice president at Halstead Property, said he recently saw a board reject the sale of an apartment, part of an estate sale, because it was "ridiculously underpriced." The board felt it hadn't been marketed correctly, since it was sold to a colleague of the listing broker who planned to flip it.

"They knew the person who was buying the apartment was already showing it to other buyers before it was sold," Hamilton recalled, adding that the board did the seller "a favor."

However, now that the real estate prices are declining, the tactic ultimately hurts resale values by making it harder for shareholders to sell their homes.

"For them to kill a transaction because it's priced too low is counterproductive for them," Miller said. "It has the effect of damaging the collateral they're trying to protect. By constraining the market, they hurt the values in their building."

Agents avoid buildings with overly strict boards, Hamilton said. "There are buildings that agents don't want to show because they reject buyers for ridiculous reasons," he said.

While most co-ops are reasonable, "the ones that aren't are the ones that are going to be sorry" if they continue strict practices in the current down market.

Luckily, some boards already seem to be getting the message, said Gewirtz.

In a recent sale at Lincoln Towers on West End Avenue, she warned the buyer that the co-op board might think the sale price was too low.

"We said to her, 'If you take this price we can't promise you will pass the board," Gewirtz recalled. "They may reject you because it's just a drop in value from the last sale."

Surprisingly, the buyer was approved. "I was pleasantly surprised," she said, concluding: "Co-op boards are aware of what's going on in the world."

Rejections rising

Price isn't the only reason boards are rejecting buyers. As The Real Deal and other publications have reported, many are now stricter when it comes to financial requirements, and look askance at buyers who work on Wall Street.

Shmulewitz said he's seeing more rejections now than he did before the slowdown. He also said the number of conditional acceptances — where buyers are accepted only if they set aside a year or two years of maintenance fees in escrow — has now grown from 5 percent to 10 to 15 percent.

Since there are fewer buyers in the first place and financing is difficult to come by, co-ops should think twice before rejecting potential purchasers, brokers say.

"Boards need to get real," Halstead's Hamilton said. "They need to realize that this market is different and they need to be flexible."

Some co-ops "are being overly conservative," said Louise Phillips Forbes, an executive vice president at Halstead Property, who sometimes advises boards to resist the temptation to reject qualified buyers because they feel prices are too low.

"I caution boards that their role is to quantify if an individual is able to afford the maintenance," she said. "It isn't about trying to manipulate the market."

And of course, many boards have additional rules about pets, subleasing or certain renovations. Now that the market is declining and buyers are scarce, these rules, too, can depress the value of apartments.

Deanna Kory, a senior vice president at the Corcoran Group, said she recently sold an apartment to a buyer who planned to combine it with another apartment in the building. The board, which has strict rules about such changes, turned the buyer down. "We got a great price and the board turned the people down," she said. "Now it's on the market at a much lower price."

Sensing the change in the air, some boards are beginning to relax their rules, particularly when it comes to renting. "Managing agents are advising boards that their rental policies are going to have to loosen up," Forbes said.

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