Wednesday, March 11, 2015
Understanding the difference between Co-ops and condos
- Ownership structure where apartment "owners" don't actually own the apartment, but own shares in the "cooperative" corporation that correspond to the apartment that you will inhabit as well as your share of common elements. As part of your ownership of shares you are entitled to a "proprietary lease" to the apartment that you are "purchasing".
- Monthly carrying costs called "maintenance" include your portion of the costs to run the building and the monthly real estate taxes associated with your unit. Because taxes are included maintenance is quoted as one gross figure, but a certain percentage, typically between 35% and 60% is "tax deductible."
- Co-ops determine the minimum amount of down payment for buyers of the property. Minimum down payment in co-ops are usually 20% or 25%, but can be 50% or even higher in the most desirable, high-end buildings (think Prime Park Avenue, or Lower Fifth Avenue for example).
- Each co-op has a different set of requirements for acceptance to the building. Co-ops require extensive documentation of income, net worth, and references. A "board package" is the collection of these documents that the board reviews, and if they meet their criteria they will likely ask you to meet them for an interview before granting final approval.
- Co-ops institute policies that can restrict how often and for how long you may rent out your apartment.
- Co-ops tend to have lower closing costs because they are not subject to the 1.8%-1.925% mortgage recording tax.
- Positives to co-ops include that they are generally less expensive than condos, high down payments lessen the risk of your neighbors defaulting, and there is tighter control over who is moving in and out of the building. Co-ops also represent the majority of apartments for sale in NYC.
- Unlike co-ops, you physically own your apartment.
- Unlike co-ops, your monthly charges are divided into two payments called "common charges" and "real estate tax", rather than being lumped into one payment.
- Condos have more flexible financing terms. That means in essence, there is no minimum down payment required by the condo board. That might sound great, but, be mindful, most banks are looking for 15%-20% at a minimum to finance any property nowadays.
- Condos also require a "board package", however, the barrier to entry is far lower. Condo boards can only block approval by "right of first refusal". In other words, they can only deny a buyer if they are willing to do the transaction at the same terms that you are offering a buyer. This rarely happens.
- Condos are far less restrictive in regards to renting out your apartment. Generally, there are no limits outside of "right of first refusal."
- Condos tend to have higher closing costs because they are subject to mortgage recording tax of 1.8%-1.925%, unlike co-ops. If you are buying a new condo from the sponsor you are also typically responsible for the Transfer Tax of 1.825% (units over $500k, otherwise 1.425% under $500k).
So, there are big differences between co-op and condos, and the increased flexibility that condos offer are the primary reason that condos trade for higher prices than co-ops.
Now that we have established the difference between the two ownership types, we can move on to preparation.
Step 1- How much can I afford?
Buying an apartment sounds like a great idea. It is, but sometimes reality can clash with the concept. There are three things to consider. How much can I afford monthly? How much can I afford up front? How much will the condo or co-op (and bank if financing) consider appropriate for the first two questions?
Housing costs are generally the single largest expense in anyone's monthly budget. As a rule of thumb banks and co-op boards would prefer that your total debt (and real estate taxes) should not exceed 25% of your total income (“debt” would also include additional mortgage you may have and installment items like student loans, car loans, alimony, and the like). I use the word "ideal", because in certain circumstances this can be stretched a little. If a co-op board is more lenient, or if it is evident that you are just coming into your peak income years, you may be able to go to 30%. The same can be said for a condo, so long as your bank indicates that they would approve.
This brings us to the next big question- how much will this cost me up front? To generalize, and this varies, you should be prepared to have at least 25% of the purchase price available liquid in cash or easily converted securities for the down payment and closing costs. And, I hate to add an and here, but you should also have at least 2 years of monthly housing expenses in the bank. Closing cost vary from as little as 1.5% to as much as 6% or a tad more depending on what type of unit you are buying and whether or not it is a resale. Again, there is some stretch, especially in condos. In a condo resale, you may be able to get away with a 10% or 15% down payment and closing costs around 2%, but you also have to convince the bank that they have enough collateral and get them to approve.
Finally, there is the question of how much a co-op or condo deems appropriate for your down payment, debt to income ratio, and post-closing liquidity. For co-ops, each building has a minimum down payment. That number is usually 25%, but if you are looking at very affluent buildings, say on Park Avenue, that number can be 50% or even higher. For the average co-op the minimum down for the building, plus a debt income ratio at or below 25%, and 2 years of post-closing liquidity (mortgage + maintenance) should suffice. Every co-op is different, so, you should ask the listing agent and your agent to gather more information on what the board is looking for before you proceed, especially if you are cutting it close.
Step 2- Assemble your team
There are three critical people that you want to have lined up before you start looking for an apartment- a broker, a banker, and a lawyer.
Real Estate Professionals (I am one) are a critical piece of the team that you assemble. Most importantly, you should look for an experienced agent that works for a reputable firm and has a solid track record. You may have a friend or relative that is new to the business, or moonlight, the best advice there is avoid! A difficult transaction with an unexperienced representative can end a friendship, or make Thanksgiving dinner extraordinarily uncomfortable. Go with a pro! Experience cannot be overstated. As a buyer, you may never have purchased an apartment in NYC, or maybe it has been a while. It is a competitive market, and an experience broker offers many things- understanding of the market and pricing, negotiating tactics and strategy, package preparation and presentation, and working as a buffer between parties that can be very valuable. Remember, buying an apartment in NYC is one of the most complicated real estate transactions in the country. In NYC, the seller traditionally pays the commission making the decision to use a broker one that will have no effect on your finances. Brokers can also be a great resource for the other components of your team- a banker and a lawyer.
If you plan on purchasing and getting a mortgage, you are going nowhere without a good banker. My best advice is to ask around and figure out who is active in the local market. More precisely, if there is a specific building that you are interested in, ask your broker to find out who is writing mortgages in that specific building. It is a great help to work with a bank that is familiar with the building and already has it on its approved list. When you locate a banker, get yourself pre-approved for a mortgage. While a pre-approval letter is far from a guarantee that you will qualify for a mortgage, it is helpful to get an idea of what a bank thinks that you can afford and how much they will consider approving you for. When it comes time to bid for an apartment, having a pre-approval to present with your offer will show that you are more serious than someone without and give you a competitive advantage. Also, in preparation, you should run your credit. If there are blemishes you should address them immediately. Usually if there are a couple of dings, you can have them ironed out over a couple of months, qualify for a lower rate, and stand a better chance with a board.
Finally, you need to find a lawyer. Again, I will warn against what I call using "my cousin Vinny". You may have a friend or relative that is a lawyer, but it is crucial to hire a NYC based lawyer with extensive experience in co-op and condo closings. Your "cousin Vinny" might be a great guy, but if he does not understand the complexities of this specific field, he can blow up your deal pretty quickly. Your real estate attorney is responsible for doing due diligence, reading the board notes and financials, negotiating the contract, and representing you at closing.
Next up, Part Two: The Search...