Growing a real estate business is all about expanding your rental property portfolio. If you’re located in a major city and have been thinking about growing your investment portfolio, chances are that you’ve already heard of co-ops.
However, before getting your feet wet in any kind of investment, you ought to be sure about what you’re getting yourself into and what it entails. You want to be sure about whether it will be a worthy investment, the risks involved, and the potential return on investment.
The same applies to co-ops. You should know what it entails and how to invest in one. Today, we’re going to provide an in-depth insight into co-ops then you can assess whether they are worth investing in.
First things first;
What Is a Co-op?
Primarily, you can describe a co-op as a housing cooperative. It’s a housing unit where the inhabitants who live in different units co-own the property.
Co-ops are usually not-for-profit. When you invest in one, you’re not actually owning a home. You become a shareholder in the corporation that owns the housing cooperative. Each of the shareholders is entitled to use one unit in the cooperative.
The shares within the property are allocated depending on the units’ market value. The size of the apartment also determines the owner’s share in the co-op. The rest of the units are common property.
Like any other cooperative, each co-op is run by a board of directors. This board is elected by the members to oversee the management and maintenance of the property. However, every shareholder has a say on how the property should be managed.
Are Co-ops Synonymous With Condos?
Many people think that co-ops are the same as condos. However, condominiums can be classified under real property, where once you buy one, you get a title to show ownership. Condos give you an advantage when the value increases.
In short, when you purchase a condo, you gain outright ownership. You can use the property as collateral against a loan or decorate and renovate it in any way you wish. It’s also much easier to secure financing to purchase a condo.
On the other hand, when you invest in a co-op, you’re typically buying shares in a cooperative. You might have a place to live but you don’t own it. You also can’t sell the co-op building or flip it. As a member, you’re never asked to leave unless you break the cooperative’s laws.
When you finally leave, you relinquish your shares back to the cooperative. They are then given to the next person who becomes a member.
As you can already tell, co-ops are quite restrictive when it comes to ownership, compared to other housing options. They have some stringent requirements for investors willing to buy. Part of the application process also involves an interview with the board before you get approval to buy shares.
Though you don’t own your unit, you might be required to meet a certain net worth or debt-to-income ratio to show that you’re able to meet the fees needed for upkeep and maintenance.
Also, most co-op units don’t allow subleasing.
How Do Co-ops Work?
A housing cooperative owns both the exterior and interior of the unit. This means that you’ll need to seek the board’s approval even for the slightest renovations, such as kitchen remodeling.
Once you invest in one, you’ll be required to pay a monthly fee that will go into facilitating the maintenance costs. Part of the fees may also go into paying the property’s mortgage.
One of the core values of co-ops is mutual responsibilities and financial obligations. Members split costs, such as property taxes and other utilities. The amount you pay is determined by your unit’s value. Splitting up such costs in this manner can work to your advantage because the expenses tend to be more expensive collectively.
The board of directors is responsible for creating policies that are in the best interest of the co-op. These policies are commonly known as by-laws.
For example, the board may pass a by-law that prohibits subletting. They could also pass a by-law for the threshold new shareholders need to meet before they are approved.
Investing in a co-op limits the amount of equity you can own if at all you can earn equity anyway. There are three different types of co-ops when it comes to equity:
- Market Rate Co-ops– These types of co-ops allow shareholders to buy and sell shares at the market rate.
- Limited Equity Co-ops– With these types of co-ops, the board is in control of the rate at which the members can buy and sell shares.
- Leasing Co-ops– Here there’s no equity accumulation. The co-op leases the property instead of owning it.
Should I Buy a Co-Op?
Like any other investment, you need to have a deeper insight before you can invest your hard-earned cash. Here are the pros and cons of buying a co-op apartment:
Pros of Investing in a Co-Op
Many people, especially those living in big cities, choose to buy co-ops because they provide them with entry-level housing. Below are some advantages of investing in a co-op:
- Lower buying and closing prices: Co-ops are generally cheaper than condos and have lower down payment requirements. The closing costs are also lower since the title deed doesn’t change hands. You’re not required to pay transfer taxes.
- Minimal responsibility: Unlike owning a property outright where you’re fully responsible for maintenance and repairs, you can take a backseat with co-ops. It’s more like renting, so you’re not in charge of management or maintenance other than your unit.
- Know your neighbors: While you may not have an outgoing personality, you’ll get to know a lot of information about your neighbors. Remember, all potential shareholders have to reveal a lot of information about themselves before approval. However, while the board can reject an application on the basis of financial situation or character, they’re not allowed to do so based on race, religion, or other protected categories.
- Get heard: As a shareholder, you might not be on the board of directors. However, you’re still listened to when you have an opinion on how the property should be run.
Cons of Investing in a Co-Op
Investing in a co-op may already seem like the right investment. However, there are a few things you need to consider. Here are some disadvantages of buying a co-op:
- High monthly fees: Co-ops might have lower purchasing and closing fees, but the monthly fees are higher. The monthly rate is determined by what expenses need to be sorted. In some, you may need to pay parking fees and for other utilities.
- Restriction: Always make sure you understand the terms before investing in a co-op since some boards are notorious for going overboard. Ensure you read the by-laws outline and understand what’s not allowed. For example, some may not allow you to repaint your unit, they may make it easier to sell later on.
- Less liquidity: Co-ops have a limited pool of potential future buyers because of restrictions on resale. This makes them far less liquid than other forms of real estate investments.
How Do I Invest in a Co-Op?
Always do your homework beforehand and carefully review the legal and financial documents. Before you can sign the contract see how much repairs the unit needs and be sure about the potential for equity accumulation. If it’s possible, you can have a home inspection done on the unit.
Before you can invest in a co-op, you’ll first have to seek approval from the board. The board runs the same as a homeowners association, deciding who’s supposed to live where and how the property should be run. You can meet up with one of the board members to get a feel of the association and determine whether you want to be part of it.
Most importantly, you need to get your credit in order and have a great financial history. You’re trying to qualify for both the lender and board.
Can I Borrow Money to Invest in a Co-op?
Yes. Instead of a conventional mortgage, you can take out a share loan. With a share loan, the shares you own in the cooperative act as the collateral. Remember, you don’t get a title to show ownership for the unit, so you can’t use it as collateral.
Share loans may be harder to come by compared to traditional loans, but they’re available. Credit unions are usually good lenders for real estate investors looking to buy co-ops.
When applying for a share loan, the lender will require information to understand how the co-op operates. They’ll also look into the board of management and see if there’s any underlying mortgage.
Some co-ops have built special relationships with some lenders to make the financing process for potential shareholders easier.
Can I Earn Rental Income Through Co-Ops?
The answer to this question is entirely dependent on the co-op’s by-laws.
If the board allows subletting, they may have certain measures in place to stipulate how long you can rent out a unit. For example, there may be a two-year limit for renting out every five years. This may restrict the kind of leases you offer. Other buildings may allow some tenants to stay well past their lease term, on a month-to-month basis.
For those co-ops that allow you to use them as income property, it’s common to find clauses that say you must have lived within the unit for a specific amount of time before you’re able to rent out.
Tenants and subletters may also have to go through the same approval process as buyers. In addition, subleasing involves additional expenses that you have to pay to the co-op or managing agency.
Should I Buy a Co-Op?
You might have to ask yourself the following questions to know whether you should invest in a co-op:
- What are your business goals?
- What do you intend to use the co-op for?
- How much are you willing to spend?
If you’re looking for something more pocket-friendly, co-ops might be your best option since they tend to be inexpensive. However, consider the fact that you’ll have to work harder to get approval from the board and probably work with a lender you haven’t worked with before.
Also, remember that co-ops tend to be harder to sell. When selling, the seller is responsible for the transfer fee, which is about 3% of the selling price. When you factor in broker/agent fees, transfer taxes, and other miscellaneous closing costs, you might end up spending up to 10% of the proceeds from the sale.
If you’re looking for property to give you cash flow immediately after buying, co-ops may not be the most ideal option for you. However, they could be great if you want a place to call your own in the city, or you want to rent after living in it after some years. You could also buy one if you’ll have a child going to college in that city and will need a place to stay for a few years.
Key Takeaways
Co-ops are great investment options for investors looking to buy real estate. Like any other investment opportunity, you need to do your due diligence to evaluate whether it’s a suitable investment for you. Get your finances in order, go through the legal documents and ensure that you know all the board’s by-laws.
Remember that you’re not going to own the home outright. There are also stringent requirements that may bar many investors. However, it may be suitable if you want a place to call home in the city.
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