A Primer on Housing Cooperatives

There are three ways to own real estate in the United States: fee simple, condominium, and cooperative. Fee simple is the most common-- it is the legal method of owning a single family house and the plot of land below it. Condominium owners hold the right to the interior space of a defined unit and a share of the land it sits on. Cooperatives, or co-ops, are where a corporation owns the entire building and shares of the corporation are sold to buyers. A person who owns shares is entitled to occupy a specified unit within the building, but does not directly own that unit. Daily life within a co-op is very similar to a condominium, but buying, selling, and subleasing substantially different.

House cooperatives are largely a historic relic. The legal basis for owning a condominium wasn't established until the National Housing Act of 1961. So if the unit you are considering buying is inside a building older than 1961, there is a good chance it is a co-op. Even though most new buildings are condominiums, cooperatives still have their uses in modern real estate development. All fifty states have laws on the books to allow cooperative housing. The most frequent new type of co-op is a mobile home park, where residents buy a share of the land and gain the right to park their trailer on the property. Rental apartment buildings that lack individual utility metering are frequently converted to cooperatives when they are sold. Co-ops are also found in situations where the building does not own the land it sits on.

According to the National Association of Housing Cooperatives, 1.2 million Americans live in cooperative housing. Co-ops are common is older cities like Philadelphia, San Francisco, and Washington because there are many buildings constructed before 1961. The largest preponderance of co-ops is in New York City, where 85% of all multifamily units are owned as cooperatives. Co-ops are also found in situations where a group of people desires communal facilities and specialized living. Student cooperatives offer inexpensive housing near many college campuses. Artists, the hearing-impaired, and elderly individuals have also established co-ops throughout the country.

Co-ops fall into three categories: full market rate, limited equity, and no-equity. Full market rate co-ops are similar to condominiums-the shares can be sold for whatever the market will bear. Limited equity co-ops restrict the resale price of shares to enhance their affordability. No-equity co-ops are the cheapest, and least common, of all. As the name implies, the owner's shares cannot appreciate in value. It is important to understand which type of co-op you are considering buying, since lenders usually steer clear of no-equity and limited-equity co-ops.

Mortgages can be obtained for a co-op. A primary difference is that a buyer must select a lending institution from a pre-approved list maintained by the co-op board. Banks demand that the co-op board sign an agreement to foreclose on the owner's shares if the mortgage defaults. A list of approved lenders can be obtained from the co-op's management office. "Share Loans," as co-op mortgages are officially known, are available in most varieties available for traditional mortgages. Purchasers can select from adjustable rate, fixed rate, or hybrid loans. Because of the added risk of writing a co-op share loan, rates are generally .25% higher. Most major banks have gotten into the co-op mortgage business, so buyers should be able to find financing with a well-known, reputable institution. A 20% down payment is required for a co-op mortgage. Home equity lines of credit (HELOC) are generally not available for co-ops. Of course, a monthly fee is charged to owners by the co-op board to maintain the communal property.

There are several advantages to purchasing shares in a housing co-op. Foremost is the affordability of the share purchase price. Because co-ops require a large down payment and usually cannot be subleased, prices are generally lower than a comparable condo. Even though the purchase price is lower, owners can expect the property to appreciate at the same percentage rate as comparable condos. Co-op owners are eligible for all favorable tax treatments available to other real estate owners, including mortgage interest and real estate tax deductions.

Cooperative housing has other financial benefits. Real estate taxes are almost always lower than condominiums because the building is assessed a whole instead of as individual units. Imagine there are two identical buildings, one of which is a co-op, the other a condominium. The condominium is comprised of 10 individual units whose value is $100,000. Taxes due on each unit come to $500 a year (or 5 mills). The co-op is assessed as one big piece of property worth $500,000. Using the same millage rate, the building owes taxes of $5,000. Divided among the shareholders, this is only $250 a year.

Of course, there are drawbacks to co-op ownership. Many co-op boards strive to keep owner-occupancy very high by forbidding or severely restricting the ability to sublease a unit. Boards can also implement rules that condo boards cannot. Examples are: owning of pets, playing of musical instruments, and the number of nights a guest can stay with you. Co-op boards can also block a sale of shares for any reason. Finally, the housing corporation has final say on disposal of the property. If the majority of shareholders want to sell the property, it can be sold over the minority's objection.

Buyers will find that housing cooperatives are a viable option for them to live. While they are somewhat nontraditional, co-ops fill an important need for housing in older cities and areas with high cost of living.