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Understanding differences among condos, co-ops, PUDs

A lesson in common-interest developments

What is the difference between a condominium, cooperative apartment, tenancy in common (TIC), and a planned-unit development (PUD)?

As we will see, there are major differences between these types of “common interest developments.” Please be sure you fully understand the distinctions because your legal rights will vary depending on what type of unit you decide to buy.

Purchase Bob Bruss reports online.

Condominiums are just airspace within the unit surfaces. When you buy a condominium, all you are really buying is very expensive airspace! Condo owners own only the inner surfaces of their walls, ceilings and floors. The building structure is part of the “common area” owned by the homeowner association, or HOA, of which all the condo owners in the complex are automatically members.

That means the HOA owns the walls, foundation, roof, plumbing, wiring, the land (although a few condo buildings are constructed on leased land – usually a very bad situation because when the land lease expires, the condos then belong to the landowner), parking areas, hallways, elevators, and other areas shared with other condo owners. Individual condo owners often have an exclusive right to occupy part of the common area, such as a patio or balcony, and an assigned parking space or two.

In some condo complexes, the recreation area is owned by the developer who signed a “sweetheart lease” with the HOA. Due to abuses by some developers, these sweetheart leases are now either forbidden or greatly restricted by law in several states. Prospective buyers should inquire if any part of the condo complex is leased and not owned by the HOA, such as the recreation center or parking area.

A Planned Unit Development is a condominium variation. PUDs are usually townhouse developments where each townhouse owner owns their structure and the land beneath it. But the HOA owns the common areas and is responsible for exterior maintenance, such as mowing the lawns and repairing the roof. If you are considering buying in a PUD, be sure to understand what is your maintenance responsibility and what the HOA maintains.

Cooperative apartments are rare, except in New York, Florida, Georgia, California, Illinois and Washington, D.C. A co-op building is owned by a non-profit corporation where each co-op stockholder owns a proprietary lease for their apartment unit. Although co-ops involve the sale of a personal property stock certificate rather than real estate, Congress has made co-op ownership virtually the same as condominiums for tax deductions and the 24-out-of-last-60-month principal residence $250,000 exemption resale tax benefits of Internal Revenue Code 121. Up to $500,000 tax-free resale profits are available for a qualified married couple filing a joint income tax return.

Co-ops are often created because they are usually exempt from condominium ordinances. To illustrate, suppose you own a luxury apartment building that you want to convert to condominiums so you can earn huge profits. But you discover the city condominium ordinance requires two parking spaces for each condo unit and your building doesn’t have that much parking. Unless you can get a parking ordinance variance from the city, your best viable alternative is probably a co-op.

Because there is usually a master mortgage on the co-op structure, when a co-op project is new it is relatively easy for the first buyers to purchase with an affordable cash down payment, such as 10 percent to 20 percent. However, as time goes on and the master mortgage balance is gradually paid down, each co-op owner’s equity slowly rises. Except in New York and a few other areas, it is often very difficult for a co-op buyer to obtain resale financing because the lender’s only security is the personal property stock certificate.

For this major reason, many co-ops have converted to condominiums, which can be financed almost as easily as single-family houses. As a result, when a co-op converts to a condominium, the market value often rises 25 percent to 50 percent or more because of the easier marketability.

Another major drawback of co-ops is the dreaded interview of prospective buyers by the co-op board of directors. This interview is easy and painless at some co-ops. But other co-op directors demand detailed financial statements from buyer applicants. There are many co-op interview horror stories, including radio personality Rush Limbaugh, ex-President Nixon, and many others who were rejected by New York City co-op boards of directors.

No reason for the co-op rejection need be given, thus sometimes leading to subtle racial discrimination. The alleged reason for the interviews is to determine if the co-op buyer applicant can afford the monthly payments, plus any special assessments, because the remaining co-op shareholders must make up any missing payments or risk default on the master mortgage.

By comparison, most condominium associations do not have the right to approve or disapprove prospective buyers. However, some condo HOAs have a “right of first refusal” to match any purchase offer received from a condo buyer – but this right is rarely used.

Tenancy in common is jointly shared co-ownership. Residential TICs are a variation of both condominium and cooperative ownership. TICs usually involve a small group of owners buying a building together, such as a four-unit apartment building, as tenants in common with rights of each co-owner to occupy a specific apartment exclusively. There is one mortgage on the entire TIC property and all tenants in common are legally responsible for the mortgage payments. TIC owner-occupants receive tax benefits similar to other principal residence owners.

TICs have primarily arisen in jurisdictions where condominiums, cooperatives and/or PUDs are difficult or very expensive to create. Examples include San Francisco, Berkeley and Santa Monica, Calif., where rent control makes apartment conversions to condominiums very difficult.

Although most TICs work out quite well, some have fallen on “hard times” where the owners disagree, or one or more tenants in common can’t or won’t pay their share of the mortgage payments and operating expenses. If one co-owner doesn’t pay his/her share, the other co-owners must either make up the deficit or watch the mortgage go into foreclosure. Removing a non-paying tenant in common can be very difficult since it is not as easy as foreclosing on a regular mortgage borrower.

Because of the many potential problems with TICs, they are not recommended unless there is no other joint ownership alternative available. Of course, TICs require a carefully drawn agreement among the joint tenant co-owners. Consideration should also be given to resales and whether a prospective purchaser must be approved by the other TIC co-owners. Due to TIC difficulties, many real estate agents refuse to handle TIC resales, thus limiting the number of prospective buyers and the potential for market-value appreciation.

However, residential TICs should not be confused with commercial TICs, which have become very popular with real estate investors making tax-deferred Internal Revenue Code 1031 exchanges. To illustrate, an investor can make a tax-deferred exchange from an investment or business property, such as an apartment building, into a management-free TIC share, such as an office building or shopping center, which is managed by the TIC development company. Although the long-term viability of commercial TICs has yet to be proven, many commercial TIC investors are very pleased.

EXAMPLE: I’ve written before about my friends Dory and Andy who sold their California rental house about 10 years ago for around $300,000. They made a tax-deferred IRC 1031 exchange into a TIC which owns and leases an Applebee’s Restaurant in Kentucky! Now in their 70s, Dory and Andy look forward to receiving their monthly TIC rent checks with no management hassles. Their TIC co-owners are individuals they have never met.

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