Condos vs. co-ops: What’s the difference?

April 26, 2013

The Watergate is probably the most famous — or infamous — cooperative housing complex in the District. But did you know that there are more than 50 housing co-ops here, ranging in size from only four units to more than 100?

Many people confuse condominiums with cooperatives. As far as living standards go, the two are similar. However, from a legal and financial point of view, there are major differences.

Of the many definitions of “cooperative,” the one I like best is this: a multi-unit apartment building where each resident has an interest in the entire building, and a lease (or contract or share of stock) enabling the owner to occupy a particular apartment unit there.

If you own a condominium, your apartment and a percentage of the common areas (called the “common elements”) belong to you. A co-op owner — often called a shareholder — does not own the unit. In fact, you could call that person a tenant.

The co-op association, which is usually a corporation consisting of all the shareholders, owns the entire building, including all of the individual units. Each co-op owner either holds shares in the association — just like owning shares in any other corporation — or, if there are no shares, has what is known as a “proprietary” lease. That lease spells out the rights and responsibilities of the owner, as well as the obligations and duties of the association.

Management and financial decisions are made by the co-op unit members, either through voting at regularly scheduled meetings or by an elected board of directors that handles day-to-day operations.

Although that might sound complex, co-op living can be desirable. Co-op residents generally get the same tax treatment as other homeowners. If they have a loan that is secured by their ownership documents — the stock certificate or the proprietary lease — the yearly interest paid on that loan is deductible.

Additionally, if the co-op association has a mortgage on the entire building — called a blanket or underlying mortgage — shareholders can deduct their proportionate share of the interest on that mortgage. And under most circumstances, they can also deduct their proportionate share of the real estate taxes the co-op pays.

Perhaps the most important distinction between a condominium and a co-op is that most co-op associations require that a prospective purchaser be approved by a membership committee composed of current co-op owners.

There are only two legal grounds for rejection: financial criteria and an unwillingness to abide by the terms of the association’s rules and regulations. If the membership committee believes that a potential purchaser can’t afford to live in the complex or is unwilling to comply with the rules, it can reject the applicant. Under no circumstances can someone be turned down because of age, sex, race, sexual orientation or religion.

Until the mid-1980s, it was often difficult to obtain financing for the purchase of a co-op apartment. Thus, sellers often had to “take back” some of the purchase price by way of a promissory note. As security for that promissory note, the new owners would pledge the shares of stock (or the proprietary lease) that they received at settlement.

In recent years, however, co-op financing has been freely available and is referred to as “share loan” financing.

One interesting aspect of co-op living is that typically there is a higher rate of owner occupancy than with condominiums. In fact, many co-ops specifically prohibit renting of apartments. As a result, in my experience, co-op members are usually more active than condominium owners in the management of the property.

There are those who claim that a co-op is not as good an investment as a condo; however, after the mortgage meltdown that plagued this country, many condominiums are financially unsound and are just not good investments. Co-ops, with the ability to screen potential buyers to determine their financial capability, were not as hard-hit.

Much depends on the individual project: How is it managed? Is the board actively involved, and does it have the expertise to run such a project? What is the financial state of the association? Are there adequate reserves?

Potential purchasers must do their homework and carefully review the legal documents and financial statements before signing a contract to buy. It’s also a good idea to meet with the association president to get a flavor of life in the association.

Benny L. Kass is a Washington lawyer. This column is not legal advice and should not be acted upon without obtaining legal counsel. For a free copy of the booklet “A Guide to Settlement on Your New Home,” send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036.

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