The Risks of Buying a Coop in NYC

The risks of buying a coop in NYC include many factors which may be outside of your control, such as a poorly managed building or an inept co-op board. There may be crazy neighbors down the hall or on the board, and the building may have very poor fiscal management.

You may face unexpected special assessments levied by the board for major building repairs that you didn’t expect, and maintenance payments may rise faster than inflation. Even more distressingly, the co-op board may change the sublet policy and you may find yourself unable to rent out your apartment.

And don’t forget about the nightmare scenario of you having already moved, but being unable to sell your co-op apartment due to arbitrary board rejections of your prospective buyers, perhaps because of a petty neighbor on the board who holds a grudge against you.

Corrupt or inept co-op board

One of the biggest risks of buying a coop in NYC is that you will be purchasing in a building with a corrupt, inept or simply lackadaisical co-op board.

Board members may be corrupt and engage in self-dealing

An absolute nightmare scenario is a co-op board that is utterly corrupt and engages in self-dealing for their own personal interest, at the expense of all other shareholders whom they supposedly have a fiduciary duty to.

Corrupt board members and officers could hire friends and family members for large contracts, or simply contractors who have promised to give them a kick-back or other referral fee.

This behavior can be extremely lucrative to the corrupt board member since referral fees are often 25% or more, and are often paid in cash to avoid detection. This can mean a post-tax profit of $25,000 on a $100,000 contract to fix the roof of the building.

This type of self-dealing is extremely harmful to all other shareholder residents in the building because presumably the board member didn’t bother to source competitive quotes from other contractors, and the contractor the corrupt board member selected already marked up the price to account for the referral fee.

Everything is expensive in NYC, and especially in Manhattan, meaning quotes can vary wildly from one contractor to the next.

There are many risks of buying a coop in NYC, including corrupt or inept board members, a lazy managing agent who accepts kickbacks, assessments & more.

The co-op board is incompetent

Another major risk to buying a co-op in NYC is the possibility that the co-op board might consist of individuals who are utterly incompetent, and who should have no business being on any sort of board of directors.

For example, board members might not be corrupt, but what if they don’t speak English as a primary language? What if they can speak conversationally, but are entirely lost when it comes to any real estate jargon?

Co-op board members are lazy

Perhaps an even greater risk to buying a co-op in NYC is the risk that the coop board’s members are simply too lazy to do anything except approve whatever the managing agent suggests.

Remember that being on the co-op board is an unpaid, volunteer job (unless the board member is corrupt and takes kickbacks), and as a result many New Yorkers on co-op boards simply don’t feel like actively participating or being bothered by management duties.

When all members of the building’s board feel this way, that they are too busy or important to actively participate as a board member, then the situation becomes a classic tragedy of the commons problem in economics.

Every board member slacks off in the hopes that other board members will pick up the slack and do free work on behalf of everyone else. What ends up happening in this situation is that everyone is worse off, as no one ends up taking an active role on the board.

This can result in a managing agent essentially running the building without input from the shareholders or board members, and can result in drastically increased costs as the managing agent may not wish to do more work to check for competitive quotes.

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Bad building management

Another risk to buying a co-op in NYC is that the managing agent for the building is corrupt, incompetent, non-responsive or simply lazy.

The managing agent is corrupt and accepts kickbacks

The scariest situation of all is a rogue managing agent that pushes overpriced contracts for work on the building so that they can secretly pocket a kickback or other illegal referral fee.

Given that managing agents routinely work with contractors on presumably multiple buildings, it’s no surprise that contractors will try to befriend managing agents anyway. However, it’s one thing to try to wine and dine a managing agent, but it’s one step further to essentially bribe managing agents to choose them with illegal, often all cash, kickbacks.

A corrupt managing agent may not bother to solicit multiple competitive quotes for a big job in the building, or may even pretend to have solicited quotes, only to select a very expensive option where they are getting a secret kickback.

The managing agent is utterly inept

A major risk to buying a coop in NYC is the fact that you’ll be buying into a building with a managing agent that you did not choose.

This managing agent could be utterly incompetent, and could have been a legacy choice from years ago, perhaps due to nepotism or some sort of kickback arrangement from a former corrupt board member.

The managing agent doesn’t respond to you

A super infuriating risk you might face is a managing agent who simply doesn’t respond to you, even if you’re on the board.

We’ve seen too many situations where a managing agent decides to only respond to the board president or some other board member, and literally ignore questions and emails from every other board member, let alone a mere shareholder.

Perhaps the managing agent feels that the board president is the only one who makes decisions or has influence.

In this bizarre situation, other shareholders and even board members essentially don’t have a say in how the building is run because the managing agent only communicates with the board president.

The only remedy for this totally insane situation is to gather up the necessary votes to send a letter from an independent lawyer to the managing agent, asking for their resignation.

The managing agent doesn’t care or is lazy

An extremely scary situation is to find out that the building you’ve just purchased in is run by a managing agent that is asleep at the wheel.

In this situation, you literally might have letters, notifications and other important deadlines being missed by the managing agent, with fines and city code violations piling up.

This is an extremely dangerous situation, as ignoring notices and fines from the city can lead to ever larger penalties which will eventually have to be paid by the shareholders.

Crazy neighbors

A well known risk to buying a coop in New York City is the high likelihood that you will have absolutely crazy neighbors, neighbors who might be down the hall from you or on your co-op board.

Petty neighbors on your co-op board

A fairly common risk to buying a coop in NYC is the risk of having petty, small minded neighbors in a position of power. Petty neighbors on your co-op board might want to retroactively punish you for some small infraction of the co-op house rules for something you did that they didn’t like months earlier.

For example, let’s say you held a large party on your building’s roof 4 years ago that got a little out of control. Of course you amicably paid all of the fines levied against you, and of course apologized for the party being larger than you had expected. Well, certain small minded neighbors on your co-op board may not have forgiven you even multiple years later, and are simply waiting for the right opportunity to punish you again.

For example, let’s say that you forgot a small step in the alteration agreement process when replacing your windows 4 years later. Instead of simply allowing you to keep your windows which look exactly the same as everyone else’s, the co-op board decides to punish you by making you replace the windows entirely for $10,000 simply because you hadn’t properly filled out the alteration agreement.

As you can imagine, this was essentially payback for what you did 4 years ago, and is the result of a petty neighbor who simply couldn’t let go of the fact that you dared hold a large party once upon a time.

Neighbors on the board who “power trip”

Then there are the crazy type of neighbors who are simply drunk with power. Perhaps they’ve never been in a position of authority at work or otherwise, and as a result take their role on the co-op board way too seriously.

Your “power-tripping” neighbor on the board may demand that shareholders address him or her properly as an officer of the co-op board, or as a member of the building’s board of directors.

Even more hilariously, a power-tripping board member may address you disparagingly as a shareholder tenant, or simply a tenant, while he or she is presumably the de facto building owner (i.e. as the board member of the co-op corporation that owns the building).

More insidiously, a power hungry coop board member may threaten other shareholders with fines or even board rejections.

For example, a power hungry co-op board president who also happens to be a real estate broker may threaten potential sellers with co-op board rejection of their prospective buyers if the seller doesn’t use the real estate broker as their listing agent.

Neighbors who refuse to close out renovations

This next situation may seem odd, but we’ve seen it all in New York City. Only in New York will you have situations where a crazy neighbor simply refuses to finish their renovations.

This situation is exacerbated in new construction buildings where renovations in one unit never finished, and the neighbor was never required to sign an alteration agreement which might have otherwise limited the amount of time allowed for renovations.

As a result, you might have a simply crazy neighbor who is simply never satisfied with his or her renovations, and continually gets in disputes with contractors. In a new building, this can be very problematic as the building will not be able to get a Permanent Certificate of Occupancy without all permits being closed out first. In this annoying situation, the building will have to continually roll over a Temporary Certificate of Occupancy every 90 days until all permits are closed out.

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Poor fiscal discipline in the building

An extremely scary prospect is the the thought of buying a co-op in a building that has extremely poor fiscal discipline. As a result, monthly maintenance fees continually increase every year significantly more than what might be expected due to inflation.

Lazy managing agent that doesn’t shop for multiple quotes

A lazy managing agent is an example of the classic principal-agent problem. The managing agent gets paid a fixed monthly fee, and typically won’t get paid more for doing more work.

As a result, what incentive is there really for the managing agent to hustle and source many quotes in order to get the most competitive price possible for a big job in the building?

More likely than not, the managing agent will just go through the motions and source one, two or three quotes from familiar contractors.

Unfortunately for shareholders in most co-op buildings, managing agents won’t hustle to find the most competitive quote because it’s not their money that’s being spent.

Very rarely will you see a managing agent actually go out of their way to source 5 or 10 competitive quotes, and then try to get vendors to bid against each other. It’s simply too much work for no upside for the managing agent!

Lazy co-op board that doesn’t dispute quotes and rate increases

Even more dangerous than a lazy managing agent is a comatose co-op board that accepts prices, rate increases and quotes for projects as is without ever disputing or fighting charges.

We’ve seen too many cases of co-op or condo boards who simply accept price increases and quotes sourced by the managing agent as is, without any push back.

Perhaps it’s due to laziness or imputed self-importance, but all too many co-op board members fail in their fiduciary duty to shareholders by never bothering to price check quotes for big projects, and to assume that the quote recommended by the managing agent is as good as it can be.

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Unexpected special assessments

A serious financial risk of buying a co-op apartment in NYC is the risk of a large, future, unanticipated co-op special assessment.

Remember that everything is expensive in New York City, and especially Manhattan. This means large scale jobs and repairs for your building can easily cost six or seven figures, which must be paid pro rata by all shareholders. In a smaller building with fewer shareholders, a large special assessment can simply be catastrophic.

For example, you’re initially quite happy with your apartment purchase because both the price and the monthly maintenance was low. However, you didn’t expect to be hit with a six figure special assessment only a year later for major repairs to the building’s facade after failing a Local Law 11 inspection.

Perhaps the cost of the job becomes astronomically inflated due to the building having landmark status with the LPC.

Or even worse, perhaps your lawyer did a terrible job at due diligence and didn’t realize that the building is built on a land lease that is expiring in 5 years. As a result, your building is levying a special assessment of $1 million or more per shareholder to pay for the cost of anticipated litigation or a buyout of the underlying land.

Or perhaps the building has been running at a deficit over the past few years and the building’s reserve fund is slowly being drained. As a result of the negative cash flow, you get surprised by a hefty special assessment to top up the reserve fund. This can be especially agonizing for a new buyer who thought that the building had really low maintenance payments.

Inability to sublet due to unreasonable sublet policy

One of the biggest risks of buying a coop in NYC is the inability to sublet (i.e. rent out) your apartment when you need to move, but don’t wish to sell.

Remember that co-ops were originally designed for primary occupancy, and not as an investment vehicle. As a result, most co-op buildings will have relatively restrictive sublet policies which will vary by building.

Unlike condos, co-ops are not considered to be real property, and are subject to house rules and sublet policies established by the building’s co-op board.

This means that co-op apartment owners cannot freely rent out their apartments, but rather are only allowed to “sublet” their apartments per the co-op’s rules and regulations.

Some co-ops will allow some subletting, such as every two out of five years, while others many prohibit it altogether.

Some co-ops will allow a maximum number of years of subletting ever, such as 2 years total. Most co-ops will only allow a sublet lease term of 1 year, with the sublease needing to be approved each year.

Keep in mind that sublet policies are subject to change per the whims of the co-op board, so that the sublet policy you thought you had bought into might suddenly change the following year.

Also remember that even if sublets are allowed, most co-ops will charge some sort of sublet fee on top of any application fees. These fees will vary by building, but may even be a significant percentage of the monthly rent!

Flexible co-op sublet policies do exist

Not all co-ops are so draconian when it comes to their sublet policies. There are rare instances of co-op buildings with very relaxed, almost “condo like” house rules and sublet policies.

For example, you might be lucky enough to find a co-op that has a current sublet policy that permits unlimited subletting from day one, without any requirement to first occupy the apartment for any period of time yourself.

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Inability to sell due to board approval

An extremely dangerous situation to be in is to need to sell, perhaps because you need the proceeds to purchase a new apartment, but to not be able to do so because your co-op board keeps rejecting your prospective buyers.

Remember that unlike a condo board which only has the right of first refusal, a co-op board has the right of approval over any prospective buyers of units in the building.

This means co-op boards can reject a prospective buyer for any reason whatsoever, as long as the reason is not discriminatory.

However, because co-op boards are not required to reveal the reason for rejection (and never do so for liability reasons), even discrimination can’t be prevented in practice.

Any co-op shareholder’s nightmare is to have moved to another state, but be unable to sell their empty co-op apartment.

It’s expensive to maintain an empty apartment

If you are unable to sell your apartment due to consistent board rejections, but you have already moved, then you’ll have to pay for the upkeep of an empty apartment. Maintaining an empty apartment in New York City is no joke, and just the co-op maintenance fee can be thousands of dollars per month.

Furthermore, you might have to participate in any co-op special assessments that come up, which can even be six or seven figures for bigger jobs such as major facade repairs.

The board may demand primary residency

What’s worse is that the board may demand primary residency, perhaps because the building does not permit sublets, or you have already exceeded the maximum number of years allowed for subletting.

In this situation, not being able to sell but having already moved puts you in a real pickle with the board. The board could conceivably initiate a coop foreclosure against you due to a major violation of the house rules and sublet policy, because you “refuse” to abide by the sublet policy.

Disclosure: Hauseit® and its affiliates do not provide tax, legal, financial or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, financial or accounting advice. No representation, guarantee or warranty of any kind is made regarding the completeness or accuracy of information provided.

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