What Is a Co-Op? (Short Answer: Much More Than You’d Think)

Photo: Getty Images/Luis Fonseca

With so many different types of housing out there, you can’t blame first-time homebuyers in many large cities in America for asking themselves, “What is a co-op?” But a housing cooperative is more than a condo with a board of directors, bylaws, shares and complicated board approval process. It’s also a historic method for providing more affordable housing options for people in cities like New York City and of giving the people who live in these places more say in how their building is run instead of ceding that power to a landlord or management company. For many co-op owners, co-ops are essentially a mutually beneficial partnership with their neighbors for the common cause of homeownership.

What’s a co-op?

The first thing to understand is that a co-op isn’t a building, real estate or any sort of physical property, and that co-op ownership isn’t the same thing as owning “real property.”

A co-op, or cooperative, refers to a residential building owned by a corporation,” says Brian Shahwan, vice president and mortgage banker at William Raveis Mortgage. “Residents looking to purchase a unit within a co-op will own shares of the overall corporation rather than owning the walls-in unit itself. The number of shares a resident owns pertains to the size of the unit itself.”

In other words, when you “buy” a co-op apartment, what you’re really doing is buying into a corporation, a legal entity that’s the actual owner of the apartment building (or town house, brownstone, or what have you). As a co-op member, or more accurately, holder of co-op shares, you’re a partner in the ownership of the corporation that runs the building. Your shares entitle you to a unit in the building (or buildings, if, say, the co-op is for a grouping of detached, single-family homes).

The number of shares you own pays a big role in your benefits from and responsibilities to the co-op, including which unit you get to live in (more shares generally means you get to stay in the bigger or better units) and how your maintenance fees are calculated (more shares generally also mean that you have to pay a larger portion of the property taxes and charges for upkeep of the property, and so on).

Condo vs. Co-op: What’s the difference?

You probably couldn’t tell the difference between a co-op and a condominium just by looking at them. That’s because what makes a co-op a co-op versus what makes a condominium a condominium has nothing to with any of their physical attributes and everything to do with their legal distinctions.

“A condo refers to a private residence located inside a shared building that individual owners can purchase,” says Alex Ludwinek, co-owner of Houston’s Realty ONE group Optima. “A housing cooperative (co-op) is also contained within a building, but its residents don’t actually own their living spaces but own shares, which grant them the right to live in the co-op.”

A condo association may sound similar to a co-op association in that it’s composed of homeowners working together to take care of a property they have in common, but there’s a big difference. Condo owners are representing their individual units, while co-op owners are there as as co-owners of a mutual corporation. Their occupancy of co-op housing is, technically speaking, secondary to their roles as shareholders of the corporation. Either way, you’re expected to behave in accordance with the rules of the place you live in.

“Similar to condo buildings, co-op residents have bylaws they must abide by,” Shahwan says. “This is essentially a set of rules and regulations each resident agrees to regarding membership, financial decisions, use of property, meetings, etc.”

Co-op vs. apartment: What’s the difference?

The shareholders in a co-op are actual owners of shares in a corporation, giving them the right to live in one of the units the co-op owns. It’s a complicated and somewhat indirect form of homeownership, but it is universally accepted as just that: homeownership.

On the other hand, “an apartment is usually owned by a property management company that rents out and manages all of the units,” Ludwinek says. For the most part, the people who live in the building aren’t homeowners.

History of co-ops

The first modern-style housing cooperative is believed to have been formed in Rennes, France, after a huge fire burned down residential buildings and exacerbated the fact that there weren’t enough houses for people to live in. In the US, co-ops may have gotten their start in New York City either in 1876 at a W. 18th Street “home club” called The Randolph, or in 1881, at an apartment building called The Rembrandt, many blocks uptown on W. 57th Street. These were units in the style of the “French Flat,” luxurious digs several times the size of the tenements that the poor had to crowd into.

By the early 20th century in New York City, nonprofit artists’ co-ops had become all the rage, as had nonprofit cooperative housing specifically for workers, with shareholders not only sharing in the decision-making and common areas but also in philosophical and political ideas about putting more power in the hands of the people. Co-op associations evidently caught on: About three-quarters of New York City’s apartment-building-style housing stock is now co-ops. (The rest is condominiums.)

Buying a co-op

Co-ops can be complicated legal structures, so it should be no surprise that getting into one can be complicated too.

Before a potential homebuyer can finalize their purchase, they have to get the okay from the co-op board of directors, the elected shareholders who are, at least nominally, in charge of managing the place.

“Buyers will need to submit a board package and schedule a board interview to be approved by the co-op board,” Shahwan says. “If the buyer fails the board interview, even if they are approved for financing, they will not be able to move forward with their purchase.”

If you’re worried about getting approved to buy a co-op, it helps to know that there are things that every co-op board looks at first when assessing a shareholder candidate.

“Having a strong borrower profile in terms of high credit score, low debt-to-income, high loan-to-value, and substantial assets are all things that will make the borrower appear to be a better candidate,” Shahwan says.

And, naturally, it doesn’t hurt to show off that you have people in your corner rooting for you.

“Reference letters from the loan officer or sales agent may also help,” Shahwan says.

Keep in mind, however, that no two co-ops are exactly alike, and that some may have rules about how you finance your purchase. In other words, co-op restrictions may mean that you’re not the only who has to pass muster with the board—your choice of financing does, too, to the point where banks may not want to lend you money for this particular co-op because of its financing restrictions. Or it may mean that, even if you can find financing, the co-op bylaws will stipulate that buyers meet even higher standards than the bank’s.

“For example, conventional financing allows up to 50 DTI [debt-to-income ratio] on conforming primary residence purchases,” Shahwan says. “Many co-ops max their DTI eligibility at 35, or sometimes lower. This means that even though a lender may approve a buyer for financing, they may not fit within the co-op guidelines.”

It can get even hairier.

“Not only that, but many banks do not offer financing programs for co-ops,” Shahwan says. “Layering in the tighter guidelines for the borrower set by the co-op board and fewer banks able to finance the building make it harder for buyers to close on a co-op.”

It’s not all bad news though! Co-op buyers have a leg up when it comes to closing costs, Shahwan notes.

“Co-ops do not incur transfer taxes, so although the overall costs are similar to that of a condo, a buyer can save a substantial amount eliminating the transfer taxes,” he says.

Pros and cons of co-ops

Co-ops are popular for a reason, especially in highly populated markets where living close to your neighbors is the norm.

“Similar to owning stock in a public corporation, ownership rights in a co-op allow residents to participate in decision-making processes to share their perspective and voice their ideas regarding the property,” Shahwan says.

And because of the vetting process, co-ops, at least theoretically, ensure that the people who live there are on common ground when it comes to how to live in and run the place.

“Many believe that having a board interview will allow each buyer to be vetted into the building, providing more security to the overall community and its shareholders,” Shahwan says.

Finally, co-ops are generally less expensive to buy than a similar condominium.

There are downsides, too, of course.

For one, the monthly charges in a co-op tend to be higher than in a condominium, at least partly because co-ops tend to present shareholders with a single monthly bill that includes all the charges at once, like electricity, water and property taxes. If the co-op has had to make a major capital improvement, such as a roof renovation, the co-op board may vote to raise the maintenance to help pay for that, as well.

“Monthly common charges in a co-op are often higher than monthly HOA fees,” Shahwan says.

Secondly, you don’t get a deed, which may or may not be a big deal to you.

“Rather than a deed, owners of a co-op are given a proprietary lease allowing them rights to live in the specified unit,” Shahwan says.

Finally, bringing in new faces, either by subletting your unit or selling it, automatically brings on the scrutiny of the board of directors and may run afoul of co-op bylaws that may restrict sales or take a large percentage of the sale price to replenish the co-op capital funds. Many co-ops forbid renting out units altogether.

“It may be harder to sell the property if there are strict bylaws or a tough co-op board,” Shahwan says. “Residents that choose to rent out their unit may find it difficult as well. Each building will have different restrictions for renting out units, so it is important to review these prior to purchasing or renting out your unit.”

FAQs

How does a co-op work?

Instead of owning their unit outright, a co-op owner is a shareholder in the (usually nonprofit) corporation that owns and manages the building or buildings that house the residential units.

How much are co-op fees?

Co-op fees tend to be higher than condo maintenance or HOA fees because all the expenses tend to be rolled into a the monthly maintenance fees and because the board can vote to raise or add on monthly fees to pay for renovations and other co-op-wide expenses.

Do you have to apply to co-ops?

Yes, you must be approved by the co-op board as part of the process of being accepted as a shareholder in the co-op corporation (and thus entitled to live in a co-op unit).

What is a co-op board?

The shareholders in a co-op regularly elect a board of directors who make the major financial decisions for the corporation (and building) and who perform essential functions such as conducting interviews with and approving or rejecting potential new shareholders.

Can I rent out my co-op unit?

That depends on the bylaws of your co-op association. Some co-ops allow shareholders to rent out their units, while others ban it entirely. Others allow it but require board approval of your tenants and tack a surcharge for rentals onto your monthly fees.

Are co-op purchases harder to finance than buying a condo?

They can be. The specific bylaws of your particular co-op may dictate what kind of financial services you can use, what kind of financial history you need to have, and more. You may find that you can get financing from a bank only to run into a co-op requirement for a much leaner debt-to-income ratio.

Originally Appeared on Architectural Digest