Housing cooperatives, known as co-op apartments or co-ops, provide an alternative to the traditional methods of acquiring a residence. Should real estate investors consider them for investment?
Real estate properties come in different shapes and sizes and with different potentials to generate income. This is why property investors should carefully study their options to decide which type is best based on their circumstances. If you’ve been shopping around for an investment property, chances are you’ve come across co-op apartments and wondered if they make good investments.
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To answer this question, things like the location, method of financing, investment strategy, and the future profits you’re aiming for should be taken into account. In this blog post, we’ll explain what co-op apartments are and how they differ from other housing options in the real estate market to help you decide whether or not to invest in them.
What Are Co-op Apartments?
Many beginner property investors think that co-ops are condos, but these are two completely different types of properties. Condos are multi-unit dwellings with privately owned residences and shared common areas. A condo is classified as real property, meaning a property that you can buy and own outright. To learn more about investing in condos, read this: What Investors Need to Know About Buying a Condo for Investment.
Co-op apartments, on the other hand, are not real property. When a real estate investor buys a co-op, he/she becomes a shareholder in a corporation that owns the property. As a shareholder, you have the right to exclusive use of a particular apartment housing unit in the property. So, you don’t actually own the unit, but because you’re an owner of the company which owns the building, you’re given the right to live in it. This right is formalized by a lease between you (as the shareholder) and the corporation.
Features of Co-op Apartments
A co-op is less expensive than other types of apartments because it operates on an “at-cost” basis, meaning it collects money from its residents to pay outstanding bills. In real estate markets where the cost of living is high (like New York City and San Francisco, for example) co-op apartments are an attractive option from a financial perspective.
Though co-ops must abide by laws governing fair housing, they can be more restrictive when it comes to ownership requirements. In addition, the rules for buying shares in cooperative housing are set by the members because co-op apartments don’t have landlords. For instance, a new buyer must have a specific net worth and demonstrate the ability to meet the financial requirements of the co-op purchase. Thus, they may do a background check on property investors looking to buy. Other co-ops only carter to senior citizens or other specific groups.
Moreover, the structure of co-op apartments varies, depending on the country. In the US housing market, the most popular options are:
- Market Rate Co-ops: Allow members to buy and sell shares at whatever rate the market bears.
- Limited Equity Co-ops: These set restrictions on the price at which shares may be bought and sold.
- Leasing Co-ops: In this option, the corporation leases the building (rather than own it) and builds no equity.
Another feature of co-op apartments that a real estate investor should know is regarding their social aspect. Typically, a smaller-sized co-op is run by its residents or shareholders. Everyone pitches in to take care of duties like maintenance and setting rules. A larger-sized co-op, in contrast, is normally run by a board of directors (only a subset of shareholders). In both cases, there are certain rules that you must follow and a certain degree of social interaction.
Costs of Owning a Co-op Apartment
In order to buy shares in a housing cooperative, you’ll need to take out a “Share Loan” rather than a regular mortgage loan. This loan still operates like a mortgage where loan payments need to be made to the lender. However, in addition to loan payments, residents of co-op apartments also have to pay a share of the building’s running and maintenance costs. Typically, these costs are paid monthly to the corporation and, as mentioned, are billed on an “at-cost” basis. This means when the cost of living goes up, so do these prices.
Additionally, it’s possible that there’s a mortgage on the building itself, held by the cooperation, not by an individual shareholder or member. In this case, the costs of the property’s mortgage are included in the monthly fee, which you’ll be obliged to pay even if you have paid off your share of the loan. This is because the “Share Loan Financing” will pay the costs of buying into the corporation and has nothing to do with the mortgage on the property.
Further costs of co-op apartments include monthly utility bills (paid on an individual basis) and insurance costs. The building itself is covered under a blanket insurance policy, but the contents of each individual housing unit/apartment are not. Thus, you’ll need a personal insurance policy to protect your personal possessions from things like water damage, fire, theft, etc. One thing worth mentioning here is that shareholders are entitled to tax deductions, like deductions on interest and real estate taxes, like any other homeowner.
Pros and Cons of Investing in Co-op Apartments
Now that we’ve covered what exactly housing cooperatives are and the costs of being a shareholder in one, let’s discuss the perks and drawbacks of a real estate investor becoming a co-op member.
The main advantage of buying a co-op is that they are more affordable and cheaper to buy than a condo. This is one reason this type of housing is popular in cities with a high cost of living. What’s more is that you typically get better square footage for your money. In addition, because the real estate investor is a shareholder in the corporation, he/she will have a say in how the building is run.
If you’re planning on renting out your co-op, however, there are some things that could affect your investment. First of all, co-op apartments will have strict subletting rules and policies. One standard rule is that the shareholder must live in the housing unit for a period of time (typically 1 – 3 years) before it can be rented out. In addition, you’d need to get the board’s approval of your tenant first. For a real estate investor looking to make passive rental income immediately, this means co-op apartments are not a good investment. This is one reason why most property investors gravitate towards buying condos.
However, just because you can’t buy a co-op for the purpose of renting it out for cash flow doesn’t mean that co-op apartments are generally bad investments. As long as you’re willing to hold onto the property over the long term, you’ll get the benefits of homeownership AND real estate appreciation.
The Bottom Line
When it comes to buying a co-op as a real estate investor, you must evaluate whether it’s the right type of investment property for you. Moreover, make sure to read all of the board’s rules and regulations carefully, understand how the cooperative works, what you’re required to pay for and how much those payments will cost. There’s no harm in meeting with a lawyer or a tax adviser to figure out how co-op apartments will impact your investment plans and overall financial situation.
If you don’t think a co-op is the right type of investment property for you, start looking for an alternative with Mashvisor. To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.