Renting out their unit has long been a strategy for condo owners (and some co-op shareholders) who—usually because of an extended absence, or as an extra revenue stream—wish to retain ownership of an apartment that they’re not living in at the moment. The tanked economy has expanded this trend throughout the region as more owners are looking to save or even make money on their apartments.
While this trend may be a boon for rental brokers enjoying a surge in requests for their services, it hasn’t been an unalloyed blessing for co-op and condo buildings themselves. Allowing owners to rent or sublet their units has its pros and cons, as does living in a mixed rental/owner-occupied building. Most rental tenants are model citizens who wouldn’t dream of flouting their building’s rules or making trouble for themselves or their neighbors. But others don’t feel that sense of responsibility, which can be frustrating for board members and owners alike. Allowing owners to sublet their units or use them as investment properties can mean more revenue for the building in the form of sublet fees, but it can also make it harder for a building to open a line of credit, or refinance its underlying mortgage.
Co-op vs. Condo
How well a building’s rental/ subletting policy functions is strongly influenced by how building administrators handle the process, and how clearly and consistently a building’s rules are communicated and enforced among both unit owners and rental tenants.
Most co-op buildings simply forbid renting and leave it at that—and as private corporations, they have that right. Others allow limited subletting under certain circumstances, but usually with strict rules, maximum allowable rental terms, and the imposition of a sublet fee paid to the building. The recession has changed that slightly however, and sublet restrictions vary depending on where the building is located, who lives there and even on what the market is doing.
“During a bad real estate market, many shareholders can’t sell their apartments without suffering a loss in equity,” says Robert Harwood, chief operating officer of Century Management in Manhattan. “And many boards realize that they have to accommodate their constituents by letting them sublet.”
Dan Wurtzel, president of Manhattan-based Cooper Square Realty, agrees. “The most restrictive co-ops do not permit sublets—or if they do, it’s only in the event the shareholder incurs employment, medical or personal hardship,” he says. “Less restrictive co-ops will permit shareholder sublets with limits on the number of consecutive years the apartment can be sublet.”
Condo boards have less say when it comes to whether or not owners can rent their units, and for how long. Some condo developments stipulate in their original governing documents that only a certain percentage of units may be purchased by non-resident owners as investment properties. According to one managing agent, if such restrictions aren’t in place, “The condo should amend the bylaws to add them. Without that, you have no teeth. You could have 100 units with 95 rented out. It leads to chaos.”
“Boards don’t want people buying as investors,” agrees Gerard J. Picaso, president of his own Manhattan-based property management company. “Originally, sublets were used when people went on a sabbatical. But when you allow a lot of people to sublet, you take that many people out of the process of running the building.”
Co-op buildings have the added consideration of an underlying mortgage that may at some point need refinancing—perhaps to pay for a major capital project, or to use as a line of credit for ongoing upgrades or operating expenses. When a co-op is overrun with renters, lenders tend to get squeamish about loaning it money.
“Lenders are worst-case scenario thinkers,” says Patrick Niland, a mortgage broker, who is the principal at First Funding of New York. Even in flush economic times, a high percentage of non-owner-occupied apartments can negatively impact the loan terms available to a co-op corporation—in today’s hostile banking environment, a high percentage of renters poses even more of a potential black eye.
“The optimum profile for a co-op is 100 percent sold and 100 percent owner-occupied,” says Niland. “The next best scenario would be 75 percent or above owner-occupied. Over 20 percent sublet, you start raising eyebrows.” He adds, “Over 40 percent, you’ll be in trouble. It could mean than an extra eighth to a quarter point or even more on a mortgage. At only 45 percent owner occupied, [a co-op] looks more like a rental building, and it’s a much more complicated underwriting.”
As another Manhattan-based mortgage broker puts it, “Beyond an average ten to 20 percent sublet ratio, banks look at it with a jaundiced eye. They feel there are too many levels to deal with if we have to take this building to court.”
When Problems Arise
Even if your building allows rentals and is on the right side of the “safe” renter-to-owner ratio, one of the biggest potential problems with rentals in co-ops and condos doesn’t actually originate with the renters themselves. Often, problems originate with unit owners who aren’t clear on their own building’s rules, and then pass that ignorance on to their tenants. Before owners even consider subletting their unit, they should do a close read of the most recent version of their bylaws and house rules, and make certain their incoming tenant is clear on what is and isn’t okay.
One managing agent recalls a situation in a condo where the unit owner allowed her rental tenant to have two dogs—not realizing that the condominium documents now prohibited dogs. The agent describes the fallout from that situation as a “whirlwind,” where the association fined the owner $50 a day and threatened to foreclose on the property. The tenant had to move out and ultimately sued the owner. All in all, a very expensive mistake that could have been easily avoided had the unit owner taken the time to read the building’s rules more carefully.
“Make sure that the condominium association documents are included in the lease—that’s the moral of that story,” says the agent.
It’s also imperative that unit owner landlords be aware that their tenant is their responsibility—not the board’s or the manager’s. According to Andrew Brucker of the Manhattan law firm of Schechter & Brucker, “If a tenant makes too much noise, it’s up to the [shareholder] or unit owner to stop the tenant from doing whatever it is that’s causing the disturbance. The contractual relationship is with the co-op and the owner of the shares. If there’s a problem, the board can go to the shareholder and tell them that they are bringing action against him or her [because of their problem tenant.] The shareholder/owner must then go to the sub-tenant and straighten it out—or kick the tenant out themselves.”
So when a unit owner’s rental tenant breaks the building’s rules, Brucker continues, the building must give notice to the unit owner—not the rental tenant. If the problem is not remedied, the building does have the right to sue the owner, or even terminate the proprietary lease in the case of a landlord shareholder.
When the issue is the unit owner and not necessarily the rental tenant themselves, it can get a little more complicated.
“In the event that an owner should stop paying his maintenance—although his tenant is still paying him rent—there are two things that a board of a co-op can do,” says Brucker. “First, they can bring a non-payment action against the owner and hopefully foreclose on the apartment. This may not be the greatest solution, because if no one purchases the unit at the foreclosure sale, and the co-op purchases it, they can only collect the statutory rent from the tenant. Thus financially, this is not a great result, except for the fact that the co-op now would own an asset that certainly would be worth much more when the tenant moves out.”
Brucker says that the second action that the co-op board might consider is set forth in the General Business Law, which allows the cooperative corporation to collect the rent from the tenant. So, even if there is a shortfall, at least some money is being received by the cooperative corporation.
Whether the issue is making a repair to a boiler or handling rental residents, it’s important for boards to be proactive rather than reactive. That doesn’t necessarily mean hosting potluck mixers where renters and unit owners can mingle, or posting newsletters in a common area so that renters can see them (although neither of those are a bad idea). It means making sure that rules and regulations are clearly stated, fairly enforced, and kept current with the building’s needs and expectations.
As previously mentioned, boards can also help avoid costly legal hassles by insisting that any rental lease used in their building include language requiring tenants to abide by building bylaws. It’s also wise for condominium boards to maintain right of refusal for tenants—and to exercise that right. As one attorney notes, once a renter has moved in, it’s much harder for a board to take action.
A building’s rules only protect the quality of life for other unit owners if those rules are kept effective and current, and haven’t been left to molder for decades. For example, one co-op and condo attorney based in Manhattan says he still reads noise clauses that prohibit unit owners from playing “phonographs” too loudly—which isn’t all that helpful when the racket is being blasted from an iPod or satellite radio.
And sometimes the rules aren’t just outdated—they simply don’t cover a given situation. Take one example the attorney ran into a couple of years ago, when a condo owner in a small building in Manhattan found a creative solution to bring in money. Her nine fellow owners became concerned when they kept running into luggage-toting strangers in their entry hallway every few days. It turns out she was running a bed and breakfast out of her unit. The kicker: There was nothing in the building’s governing documents that prohibited her from doing so. It took several months to first amend the bylaws and then persuade the unit owner to stop using her apartment as a B&B.
“If you are consistent, the board has a wide range of policies they can set,” says attorney Alan Fried, a partner at the Manhattan law firm of Braverman & Associates, P.C., who handles co-op work and commercial litigation. “But they must adhere to the policy and fee structure as set out in the lease, or it can come back to haunt you.”
If problems arise between rental tenants, their landlords, or a building’s board, the state’s Division of Housing and Community Renewal Office of Rent Administration (ORA) offers a mediation program that can help resolve common disputes between owners and tenants without the time-consuming paperwork and procedures that are required when formal complaints are filed.
According to www.housingnyc.com/ resources, the program covers four basic types of issues: tenants’ complaints regarding services, tenants’ complaints of owners’ failure to renew a lease, owners’ claims of tenants’ refusal to sign a renewal lease and certain types of tenants’ complaints of harassment.
The mediation program attempts to reach a solution acceptable to both parties within the context of the rent regulatory laws. The process is not open-ended. If a resolution cannot be reached quickly, or within a reasonable period of time, the mediation terminates and the complaint is forwarded for formal docketing and processing. Processing takes 14 days, during which the complaint can be deemed ineligible for several reasons. If the complaint is eligible for mediation, the counselor contacts both parties to see if they agree to cooperate and work through the mediation process, including the correction of any problems. The counselor then follows up to see if the problems have been corrected.
All-in-all, a creative, and flexible, sublet policy can alleviate hardship for individual shareholders, while protecting the interests of the majority. In addition, when monitored carefully, sublets can generate capital for a building without undermining its mortgage viability. And that certainly looks good on the balance sheet in these tough economic times.
Yvonne Zipp is a freelance writer and a frequent contributor to New England Condominium magazine, a Yale Robbins’ publication. Additional reporting by Hannah Fons.