Buying a NYC co-op as an investment property might be tempting because of how cheap co-ops are compared to condos. In fact, co-ops in NYC are anywhere from 10% to 40% less expensive than condos.
In theory, the lower purchase price of a co-op offers an investor a higher rental yield, assuming rental income potential is the same for both the condo and co-op under consideration. But despite the potential for a higher rental yield, are co-ops really a good investment in NYC? What are the risks of owning a co-op as an investment property?
Investors often consider co-ops because they’re less expensive than condos in New York City. This makes the rental yield on a co-op apartment higher compared to a condo, assuming the rental income potential is similar for both.
Many investors also consider co-ops because of the fact that there are more of them to choose from. The greater supply is partly why co-ops are cheaper than condos in NYC.
An investor constrained by a certain budget might also be forced to consider co-ops in order to have an adequate number of listings to choose from.
For example, an investor looking for an apartment in Greenwich Village under $600k only has 2 condos to choose from as of this writing.
However, there are 22 co-ops available which fit this maximum budget.
If this investor is unable to raise her or his budget or unwilling to consider other neighborhoods, she or he might have no other choice but to seriously consider buying a co-op as an investment property.
The odds of this investor having to settle for a co-op instead of a condo are even higher if she or he is executing a 1031 Exchange and under time pressure to find a replacement property. Simply put, this investor might not have the luxury of time to wait for a suitable condo.
Unfortunately, most co-ops in NYC are required to be used as primary residences. As a result, a typical co-op building has a limitation on the amount of subletting which is permitted. The rules regarding rentals are memorialized in a co-op’s sublet policy.
A co-op may only permit subletting for 2 or 3 years out of every 5 years, and there could even be an initial owner-occupancy requirement before subletting is permitted. This means you as the owner would need to reside in the unit for a certain period of time before you’re allowed to rent out the apartment.
To make matters worse, stricter co-op buildings have a lifetime cap on the number of years of subletting during the course of ownership.
For example, subletting may only be permitted for 3 years during the lifetime of ownership.
This prohibition effectively makes it impossible for an investor to buy into any co-op building with such a policy.
Subletting restrictions are obviously a deal breaker for an investor, as a property must be able to be rented out indefinitely in order to maximize rental income and minimize vacancy.
Here’s where it gets interesting. There are a handful of co-op buildings in NYC which permit unlimited subletting. Therefore, some NYC real estate investors do end up considering and buying a co-op as an investment property. But is this a good idea?
In our opinion, buying a co-op as an investment property is not a good idea, even if the specific co-op building you’re considering permits unlimited submitting.
Here’s why: a co-op which allows subletting today might not necessarily allow it in the future. The building could always vote to change the policy. This risk is particularly pronounced in a small co-op building, because all it could take is one or two resales in the building to flip the co-op’s culture and voting majority into opposing subletting.
Let’s say you’re an investor, and you buy an apartment in a small co-op building. Everything goes well for the first few years. But all of a sudden, there are 2 resales in the building.
The new owners are owner occupants and they’re strongly opposed to investor activity in the building and subletting in general.
Now let’s say that one or both of these activist owners gets voted onto the board. Next thing you know, the building changes its policy and implements restrictions on subletting.
If this were to happen, all investor owners in the building would be essentially forced to sell over time. You might be allowed to continue subletting for some period of time as the new restrictions ease into effect, but ultimately, you’ll be required to sell.
If all the investor owners start selling, this may put downward pressure on pricing in the building over time.
Even if pricing in the building isn’t meaningfully impacted by investor selling due to changes to the sublet policy, the threat of a policy change is a huge risk for you as an investor.
If the rules do change, you’ll eventually have to hire a broker, pay 6% commission and swallow all other NYC seller closing costs (like NYC & NYS transfer taxes), and execute a 1031 exchange to buy a replacement investment property.
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Another major problem with owning a co-op as an investment property is the issue of board approval each time you have a new tenant. While both condos and co-ops in NYC usually have an extensive rental application and pretty high fees, co-ops are also allowed to reject an applicant without any consequences to the building.
If you irritate the board president or a board member, you could literally be dragged through the mud as these people engage in petty retaliation against you by rejecting your rental applicant, or perhaps multiple applicants.
The co-op board could also take ages to review the application, thereby prolonging any vacancy period between tenants and costing you real money.
Condos, on the other hand, may not reject a rental applicant unless the building is willing to rent the unit from the owner on the same terms negotiated with the tenant. This is called the ‘right of first refusal’. In NYC, the likelihood of a condo exercising its right of first refusal is effectively zero. It only happens under extraordinary circumstances.
Moreover, condo boards are usually required to respond to a renter’s application within a set period of time, typically between 20 and 30 days.
If the condo board doesn’t respond within this timeframe, the rental application is automatically approved. There is no such safety mechanism for co-op buildings.
If the co-op board is lazy, overwhelmed or simply dislikes you, they could conceivably take 6 or even 8 weeks to review your tenant’s application.
It’s also important to keep in mind that both the complicated application and the uncertainty with respect to the timing of board approval discourages renters from applying for co-ops. It’s so much easier for a prospective tenant to consider a rental building (which might not have any application aside from a credit check) or a condo building with a less invasive and difficult application.
We personally don’t recommend buying a co-op as an investment property due to the additional risks involved compared to condo ownership.
If we look at the big picture, the rental yields are still similar for condos and co-ops despite the pricing disparity.
It’s just not worth the extra risk or hassle to own a co-op just to receive a slight bump in the rental yield compared to a condo.
If you want a significantly higher investment yield, it makes more sense to consider other asset classes or real estate in another city instead of taking on a lot of incremental risk to earn a marginally higher yield by way of buying a co-op instead of a condo in NYC.
Finally, we want to emphasize that there are many real estate investors in NYC who own co-ops without any issue. It’s absolutely possible to own a co-op as an investment property in NYC and be allowed to sublet immediately from day one, without any limitation.