Answer:
The short answer, unfortunately, is “yes, and very little,” says Jeffrey Rendin, a real estate lawyer and partner at the firm Wagner Berkow. “A sponsor who retains ownership of several—or sometimes even an outright majority—of the apartments in a building can create significant operational issues for the building and sometimes financial hardship for individual owners like yourself. But purchasers in any building that was constructed or converted in the past 15 years are generally presumed to have accepted these risks.”
That is because sponsors almost always reserve right to rent rather than sell their apartments, and make no secret about it. You will find a warning about this on the cover of any offering plan written since 2003—in boldface, all-capitalized text—and repeated many times throughout.
Although New York’s highest court has held that sponsors have an implicit duty to sell enough apartments to make the co-op (or condo) viable as an owner-occupied building, that decision is of little effect today. “It applies to offering plans where sponsors don’t discuss the possibility that they might cease selling apartments and rent them instead,” says Rendin.
Back in the 1980s and 1990s, most offering plans didn’t disclose the risks associated with a sponsor maintaining majority ownership. It was a rude awakening to many individual owners when they discovered that their building might, effectively, be under the sponsor’s operational control indefinitely. That’s not what these purchasers agreed to when they bought their apartments, the court ruled.
Since that decision, sponsors almost uniformly disclose in their offering plans that they might stop selling their apartments at any time, or sell to investor-purchasers who intend to rent out the apartments they buy. And because this is so prominently disclosed, right on the cover of the offering plan and repeated throughout, purchasers are deemed to be aware of, and accept, this risk.
The problem with renters
In a condo building that has a lot of rental units, lenders are often hesitant to extend financing to buyers until there is a critical mass of apartments sold. That can impact your unit's resale value, so some lenders won’t finance the initial purchase, while some will at a higher cost to the borrower.
It’s often hard to predict which new buildings are going to sell out right away and which aren’t, says Rendin. One way of evaluating the risk that a sponsor might not sell all the apartments is to investigate what they’ve done in the past. A skilled lawyer may be needed to piece this information together, since so many new condo offerings are sold through shell companies and LLCs.
Mitigating the risk
If you have your heart set on a condo in a brand-new development in a trendy neighborhood, you are assuming the most risk, Rendin says.
Others see the value in purchasing an apartment in a building that has been in operation for at least a few years and where the owner-renter mix isn't a complete open question. Your lawyer can review an existing building’s governance provisions, current operations, and finances to inform your purchase decision.
That was one of the first things Rendin himself looked into when he bought his co-op.
“I wanted to know how long the building was in existence, whether the individual unit owners controlled the board, and the care with which they were exercising their fiduciary duties," he says. "I knew right away I would avoid a building where a sponsor or successor sponsor held a substantial number of units, or audited financials were unavailable, or the building was involved in some intractable litigation. What rational homeowner wants to buy problems?”
The governance provisions of a building is crucial, as some sponsors put “really onerous provisions into an offering plan that has the effect of letting them exercise control beyond reasonable expectations,” Rendin says. Another important consideration is whether the sponsor is meeting all its financial obligations with respect to its unsold units. A sponsor in arrears on maintenance or in mortgage foreclosure can have spillover effects on the building’s finances.
Condos sold to investors
On the flip side, there are many people who want to buy an investment apartment to rent out. Condo buildings permit this, and generally command higher prices than many co-ops because they capture demand from investor-purchasers as well as homebuyers.
“Sponsors will write into the offering plans that they’re making sales to both classes of purchasers, and condo boards do not have the same power to reject future potential purchasers that are a feature of co-ops,” Rendin says.
So while condo owners can never be assured that their building will achieve 100 percent owner-occupancy, the silver lining is there is greater resale demand for condos, which is generally reflected in higher resale prices.
Wagner, Berkow & Brandt, LLP is a NYC-based law firm concentrating in real estate, corporate, commercial litigation, and cooperative and condominium law. Founding members Steve Wagner and Bonnie Berkow have been recognized for their real estate expertise for more than 30 years. To submit a question for this column, click here. To ask about a legal consultation, send an email or call (646) 780-7272.
