Take a look at the three photos above.
From the property line, 3 Eastway Road #A in Greenbelt, Maryland, looks like a typical white, brick cottage.
The second, 3433 Lindenwood Drive in Laurel, Maryland, looks like a run-of-the-mill townhouse.
And the third, 7101 Bay Front Drive #207, is a snappy, two-bedroom unit in a luxury resort.
Despite their dramatically different appearances, however, these three properties share one important trait. All are what’s known as “co-ops.”
Whether or not a property qualifies as a co-op has nothing to do with the unit’s size, floor plan, exterior or any other physical factor. A property is a co-op because ofthe way it’s owned.
Cooperatives as a form of homeownership differ greatly from the more traditional “fee simple” or “condominium” properties. What exactly are co-ops and what are the advantages and disadvantages of owning one?
Forms of Homeownership
The fee simple form of property ownership grants the highest interest a person can have in real estate. With fee simple, the owner is entitled to all of the rights of the property.
Condominium ownership, on the other hand, provides the owner title to an individual unit, plus an undivided interest in the ownership of the common areas associated with the unit.
Co-ops, a third form of ownership, are different from both. In fact, many home buyers are surprised to learn that co-op owners do not actually own the units they live in. Instead, a corporation owns the units.
When a buyer buys into a co-op, they're actually purchasing shares of stock in the corporation that owns the units. A co-op member receives a proprietary lease to a unit that entitles him or her to occupy it. Co-op owners do not, however, receive conventional deeds.
The leases granted to co-op owners are valid for the life of the corporation. Through their control of the corporation, shareholders of the co-op control the properties.
Co-ops: Factors to Focus On
One important factor to consider when purchasing a co-op is how shares of the corporation may be transferred to new owners. These rules differ, depending on the co-op at issue.
Another key factor to consider is that, even when a buyer submits a satisfactory bid for the property, the co-op board controlling the unit must approve the buyer as the purchaser. In practice, co-op boards sometimes reject buyers. Most boards are not required to give a reason why.
There's a famous story about how Richard Nixon, after his presidency, sought to buy into a swanky New York City co-op. The co-op board rejected him, however, citing a fear of Nixon’s notoriety. If Nixon could be rejected by a co-op board, anyone probably can.
Co-op Boards Focus on Buyer Finances
One thing that most co-op boards will do when weighing a purchase offer is to dig deeply into the buyer’s finances. Some boards will require the buyer to use a certain lender for the purchase, and some boards will require that the buyer put down a certain percentage of the purchase price -- sometimes 10 percent or even more.
Co-ops pay a lot of attention to buyer finances for an important reason: If the buyer defaults on the purchase – or the buyer experiences another sort of financial setback -- the other members of the co-op can suffer from those problems.
Condo associations have the authority to place a lien on one of their member properties if a condo owner fails to make their monthly condo payments or pay the special assessments levied by the association. That's the condo association's method for recouping the lost funds. This practice protects the fellow condo owners from having to cover the missing payments of a deadbeat owner.
Co-ops do not work this way. Because co-ops cannot place liens, each shareholder is directly affected by the financial ability of the others to pay.
Thus, if one member of a co-op cannot pay his or her monthly fees or other assessments, the remaining co-op members may have to make good on those debts of the deadbeat owner. This is a risky proposition for some co-op buyers, particularly when the co-op they’re targeting is located in an area where there are lots of distressed properties, like REOs, foreclosures and short sales.
Other Factors Buyers Should Consider
There are other factors to consider when purchasing a co-op. For example, when a member resells his/her unit, some co-ops require the member to sell the stock back to the corporation at the original price they purchased it. This means that it’s the corporation that realizes any profits when the shares are re-sold, not the co-op seller. In contrast, with condos and fee simple properties, the property owner receives any profits (or losses).
Another factor to consider is the monthly fee that co-op members are required to pay. These fees can be considerably greater than the fees charged by homeowner associations and condo associations for similar types of units.
With 3 Eastway Rd. #A, above, for example, the monthly co-op fee is $445. Given that the property sold for $98,500, that fee is relatively high. And, of course, it is not tax deductible.
Still, the $445 monthly fee for Eastway Road is only a drop in the bucket compared to what some co-ops charge. At the ultra-swanky Chesapeake Bay-front co-op at 7101 Bayfront Drive in Annapolis, for instance, the co-op fee for the two-bedroom, two-bathroom unit is – gulp! -- $3,932 per month. This property includes every imaginable amenity, however, including water views, a pool, a fitness center, maid service, one meal a day and more.
When weighing monthly fees, co-op buyers should keep in mind that the benefits of buying real estate include the tax deductions that owners can claim. In this respect, homebuyers who pay high HOA/condo/co-op fees may not be maximizing their investment potential.
Advantages of Owning a Co-op
There are several advantages to owning co-ops, however, and co-ops are very popular in certain areas of the country.
Mortgage companies usually view co-op shares as collateral for obtaining the financing needed to purchase. Plus, a co-op owner has more control over their property than a renter would.
Co-op owners do not have to perform their own maintenance. And, for income tax purposes, the Internal Revenue Service does recognize the deductibility of mortgage interest, property taxes and home seller’s tax exclusions for co-op owners.
In summary, buyers need to do extra research when weighing whether to purchase co-ops. Many realtors are not familiar with these types of properties, and there are many potential complications that can arise.
Jerry Kline is a Realtor with the Odenton, Md., office of Keller Williams Flagship Realty (1216 Annapolis Rd., Odenton.) For more information on the local real estate market, contact him at (443) 924-7418
