Published: Summer 1996

THE IMPACT OF RENTAL ISSUES
ON COOPERATIVES & CONDOMINIUMS

The ideal housing cooperative is a self-run community, with each unit owned by a resident homeowner who takes part in the tasks of managing the building. Unfortunately, this profile doesn't fit every New York cooperative today.

It often takes many years before a building completes its conversion from rental status to a full cooperative. During this period, a significant percentage of units may be occupied by renters, and these renters themselves have diverse statuses.

CNYC presented a seminar at its 15th annual Cooperative Housing Conference on the Impact of Rental Issues on New York Cooperatives and Condominiums. Richard Nardi of the Mortgage Bankers' Association joined former DHCR Commissioner Donald Halperin, journalist Lois Weiss and CNYC Board Chairman Stuart M. Saft for a far-ranging discussion identifying and commenting upon a variety of renter's issues that affect cooperatives and condominiums.

NON-EVICTION CONVERSIONS CREATE MIXED BUILDINGS

Since most conversions are "non-eviction" conversions, many rent controlled or rent stabilized tenants frequently live on in the building as tenants of the sponsor or of investors. The law protects the rights of these renters and assures that they will receive many services from the owner of their units. See Our Members Write detailing the similar experiences of a Queens cooperative.

In addition to the rent-regulated units, apartments may also be rented at market rates. This occurs for a variety of reasons. In recent years, with the market down and lenders reluctant to make loans for the purchase of units in certain buildings, subletting has become more and more prevalent as owners ready to move elsewhere find that they can't easily sell their units. Similarly, sponsors securing vacancies as their rent-regulated tenants left chose to rent their units rather than sell them at low prices.

"DECONVERSION"
Finally, a very small number of cooperatives have failed. Their mortgages have been foreclosed, and they have been "deconverted", turned back into rental units. The courts have determined that the former shareholders of these buildings are entitled to rent stabilized rents, and that these rents are to be established by the New York State Division of Housing and Community Renewal (DHCR). Although only a minuscule portion of the population is directly affected, the repercussions of this situation are said to be far-reaching.

The formula that DHCR establishes as the basis for post-deconversion rent could limit the willingness of banks to make mortgage loans, because they are required by regulators to reserve sufficient funds to protect each loan from the worst-case risk. If rents were set too low for a building to be operated profitably upon deconversion, lenders claim that this would force them to make smaller loans at higher rates.

"When the DHCR sets rents, those rent levels will be used in all future appraisals of cooperatives. This will have a very big impact on the amount of financing available to co-ops," said Mr. Nardi. "This affects Park Avenue co-ops as much as any other co-op out there."

Mr. Nardi has been trying to convince DHCR of the need for a fair system of post-foreclosure rents. "We want to have it set at fair market rents, but the real point we have tried to get across is for the DHCR to go slowly, to listen to as many people as they can, because this potentially can hurt all co-ops."

CNYC acknowledges the need for a reasonable rent that reflects the cost of operating the unit. CNYC has therefore recommended that the post-deconversion rent be set at maintenance (with appropriate adjustments for situations where buildings artificially reduced maintenance prior to deconversion). Maintenance is the unit's proportional share of the cost of operating the building at break-even. If, as lenders ask, the deconversion rents are set at market rates, CNYC contends that this could become an incentive for lenders -- particularly private lenders -- to foreclose, and for sponsors to strategize schemes of vacancy decontrol.

Some have suggested that DHCR opt for a complex formula that takes the stabilized or controlled rent of the unit at the time that it was purchased and increases that rent by the percentages permitted in the intervening years. Since rent stabilized rents bear no relationship to the cost of operating an apartment, but are rather a reflection of how long a person has lived in the unit and how many times the unit turned over prior to that tenant's occupancy, the resulting rents will be diverse.

We continue to await the determination of the DHCR on these issues, and, as we wait, we note with some relief that foreclosures are very few, and that lenders tend to cooperate as much as they possibly can in working out impossible situations and enabling the cooperatives to recover and then to thrive. When foreclosures do occur, the DHCR is advising that reasonable rents be fairly negotiated to enable former shareholders to remain in place.

SUBLET ISSUES
A far more common impact of rental issues on cooperatives and condominiums, the panel agreed, was that of a subletting situation. In recent years, many cooperatives have had to cope with problems associated with having too many sublets. Many lenders refuse to finance units or refinance the underlying mortgages in cooperatives whose sublets exceed a predetermined percentage of the units. Subletting is also seen as "the antithesis of the whole idea of a cooperative, which is to create a small community where you have a say," said Mr. Nardi. As a result, many cooperatives enact stringent sublet policies to dissuade shareholders from, in effect, turning their buildings back into rentals.

Yet Mr. Saft admonished that taking an unyielding stance on sublets is sometimes the wrong thing to do. "In a typical cooperative, each shareholder has a right under the bylaws and the proprietary lease to sublet his apartment," he said. "In a building where people cannot sell and cannot remain in an apartment that they have outgrown, too rigid a sublet policy will invite a revolution against the board." He mentioned a West Side cooperative that enacted a stringent sublet policy because 50 percent of the building was already rented. The non-resident shareholders organized a proxy fight to unseat the board, eventually forcing the board to back down.

FLEXIBILITY ADVISED
The solution for most boards is to remain flexible. "If you have a static sublet policy, you need to re-evaluate it based on the building's needs," said Mr. Nardi. Added Mr. Saft: "You're better off implementing restrictions on time -- only allowing sublets for two of every five years of ownership -- rather than putting a cap on the percentage of sublets you're going to allow in the building. The cap cuts some people out, and that's just another way to create trouble."

"HOLDERS OF UNSOLD SHARES"
Holders of unsold shares also present several points of confusion for many cooperatives. "If the sponsor sells the apartment to a non-occupant and confers upon them the status of holder of unsold shares, then the shares on the apartment continue to be unsold shares," said Mr. Saft. "In that case, the sponsor is still responsible for any default made by the new owner. If the shares are not sold as unsold shares -- to an owner-occupant -- then the new owner has responsibility in case of a default."

REDUCTION IN SERVICES
Another important question is whether cooperatives can reduce services -- for example, no longer provide 24-hour doorman service -- when there are rent-regulated tenants in the building. "It's not black and white," said Mr. Saft. "The board has the right to reduce services unless it says otherwise in the operating plan. If you reduce services, rent-regulated tenants have to go ahead and apply [to the DHCR] for rent reductions, which means that the sponsor has to deal with the decreased income. Thus, in buildings where the sponsor maintains control of the board, reducing services may be difficult. But if you control the board, you can do what you want. The sponsor is still your shareholder, and, like all other shareholders, he must continue to pay you his monthly maintenance." See Our Members Write.

OUTLOOK HOPEFUL
Once homeowners own and occupy, say, 60% to 65% of the units in a cooperative or condominium, it is no longer seriously hampered by the presence of rental tenants. Several factors now combine to bring promise of improvement in this area. The recent upturn in the market are providing an incentive for sponsors and sublessors to sell their units. The new property tax abatement which is available only to homeowners in cooperatives and condominiums who own no more than three units (see Tax Reform Law Passed) may also help tip the balance from renting to selling when an apartment becomes available.

For its part, the Council of New York Cooperatives & Condominiums is committed to seeking legislation or state regulations that will require that sponsors continue to sell units at least until the cooperative or condominium has a sufficient percentage of homeowners to be viable and loan worthy. The Newsletter and this Web site will continue to report on any progress.