For nearly 60 years after the first cooperative was organized by Edmund J. Flynn in 1920, bank financing was not available to coop buyers. D.C. banks, organized under the Federal Charter, were not authorized to loan money secured by a pledge of a borrower's ownership interest in a coop. This lack of financing adversely affected not only the value but also the marketability of coops.
This situation changed in 1979 when the Federal Home Loan Bank Board issued its final regulation authorizing federal savings and loan associations to make loans on individual coop units. That same year the principals of the Edmund J. Flynn Company convinced American Security Bank to develop a pilot loan program for financing coop resale's. Harbour Square, a cooperative located on the waterfront in Southwest D.C., was eager to participate in the development of such a loan proposal. This was the first time a D.C. lender entered into a formal arrangement, called the Recognition Agreement, with a coop association to provide purchase money for financing resales.
Although American Security's pilot loan program was short-lived due to market acceptance, high interest rates and a $50,000 loan limit, this first D.C. area cooperative loan program became the basis for future participation by other lenders. As a result, bank financing for Washington coops began.
The Loan Process
Applications for coop loans are underwritten in the same manner as applications for any residential loan. Lenders follow the underwriting guidelines prescribed by the secondary lending market, typically Fannie-Mae.
A lender will verify sources of income and confirm the borrower's financial obligations including installment debt, student loans, alimony/child support, and investment property. The lender will then obtain the borrower's credit report from a consumer credit reporting agency. The next step is the coop unit appraisal, which is performed by an appraisal firm that has been approved by the lender. Costs for the credit report and the appraisal are paid for by the borrower either separately or as part of the lender's applications fees (check with your lender).
The lender may require a report of termite inspection prior to settlement depending on the type of unit, i.e. townhouse, or the location of the unit relative to the ground in a multi-family building. The report is ordered and paid for by either the seller or the purchaser/borrower as stipulated in the sales contract.
Hazard insurance, which covers the replacement value of the unit, is generally not a requirement because the replacement value of the unit being financed is covered by the cooperative corporation's master insurance policy. The lender, however, will require the settlement officer to obtain a certificate of insurance from the coop's insurance carrier verifying such coverage.
Typically, there is no title search performed on the unit because the ownership interest in a coop unit is considered personal property. Any transaction involving the transfer of personal property is not recorded among the land or real property records in the Recorder of Deeds office.
It is, however, common practice for a lender to have the settlement office order a search of the non-land or chattel records in the Recorder of Deeds office to determine if there are any issues, which encumber the seller's ownership interest in the unit or affection the credit worthiness of the borrower.
Lastly, there is no survey requirement because no land or real estate changes hands in the transfer of a cooperative unit.
The Loan
It should be noted that, in the Washington D.C. area, the price quoted for a cooperative unit is the full price which inlces the allocated portion of any corporate or blanket mortgage financing. Since the price of a coop unit includes the unpaid share of the blanket mortgage allocation, the current balance of the balances of the blanket mortgage is included in the total financing permitted by a lender.
Coop unit financing differs among the participating lenders since there are a variety of home loan programs from which to choose. Each lender has minimum down payment requirements. Not every lender offers coop financing. Among the lenders that do, not all have a Recognition Agreement with each and every cooperative. (Ask Winston Real Estate for our lender list!)
Financing a Coop unit (simplified example)
Purchase Price $100,000.00
Present Corporate Mortgage Allocation - 25,000.00
Seller's Equity $75,000
Lender's loan is based on the equity value.
For example, if lender will financing 80% of the units equity value:
Equity value $75,000.00
x80%
Loan Amount from Lender $60,000.00
Therefore, at Closing:
Lender's Loan $60,000.00
Blanket Mortgage $25,000.00
Cash Payment $15,000.00
PURCHASE PRICE $100,000.00
Recognition Agreement
The loan documents for coop unit financing are akin in principle to those needed to perfect a lien on real property: a note states the loan amount, rate of interest, payment schedule, etc.. Also a security agreement outlines the borrower's obligations to repay the loan and the circumstances leading to foreclosure in the even that the borrower defaults in his or her obligations to the lender or to the coop.
The single document that is absolutely unique to coop unit financing is the Recognition Agreement. This pre-approved form is signed by the borrower, an officer of the coop association and an officer of the lender at the time of settlement.
Simply stated, a Recognition Agreement is a legal document wherein the cooperative association recognizes the lender as having a security interest in the borrower's unit. It also establishes the steps that either the lender or the coop will take in the event the member/borrower defaults to the lender or to the association. The terms of the Recognition Agreement must be mutually agreed upon by the coop association and the lender before any loan closing.
A cooperative association may require that some monies be escrowed at settlement in connection with a Recognition Agreement. This escrow is applied to the loss of any monthly assessment income in the event the lender or the association institutes a foreclosure action against the member/borrower. The amount of escrow varies with each association, but generally the amount ranges from one to three times the member's monthly assessment payment.
A loan on a coop unit is secured by an assignment of the borrower's Ownership or Proprietary Documents to the lender as collateral security for the debt. The lender holds the Proprietary Documents until the loan is paid. The borrower's indebtedness is recorded in the office of the Recorder of Deeds among the chattel or non-land records with the filing of a Uniform Commercial Code Financing Statement (UCC-1).
A loan on real property is secured by a pledge of the owner's deed to the real estate. This pledge is in the form of a Deed of Trust in favor of the lender that is recorded among the land records in the office of the Recorder of Deeds. The unit owner retains actual possession of his or her deed or title to the property even though it has been pledged to secure a debt.
Part III
Settling a Coop Sale
What does the term "settlement" mean as it applies to a coop sale? Settlement is the act of depositing with the Settlement Officer the purchase monies and such documents that are required to effect a valid transfer of a unit from seller to buyer, and the buyer's assumption of seller's obligations under the Ownership or Proprietary Documents. These actions are considered good and sufficient tender of performance.
The Settlement Officer conducts the settlement in accordance with the terms and conditions of the Sales Agreement. All contingencies much be fully satisfied by supporting documentation before settlement can take place, including the requirement of the purchaser to be approved for membership and occupancy by the Board of Directors.
Coop settlements differ from real property settlements in that a coop settlement involves the transfer of personal property. An ownership interest in a coop unit is an interest in personal property, not real estate.
Evidence of ownership in a condominium unit is referred to as fee simple title with an undivided interest in the common elements of the condo association. Ownership in a condominium is represented by a deed. The evidence in a cooperative unit, however, is most likely to be represented by a form of cooperative ownership contract or shares of stock and a proprietary lease or some other document commonly referred to as Proprietary Documents.
There are certain economies involved in the transfer of an interest in a coop unit.
October 1st, 2009 the District government began charging an economic interest tax on the sale/transfer of co-operatives. This economic interest tax (some may say recordation tax) of 2.2% will be assessed on the transfer of co-operative units less than $400,000 and 2.9% for transfer greater than $400,000. The rates and consideration numbers were intended to mirror recordation and transfer taxes currently charged on fee simple Real Estate transactions.
There is no mechanism among the land records in the Recorder of Deeds Office to record the chain of ownership within a cooperative corporation; hence, there is no title search fee nor the need to purchase title insurance. On the other hand, the non-land or chattel records on file in the Recorder of Deeds office are searched prior to closing to determine if there are any purchase money liens, tax liens and the like filed against the seller of the coop unit. The buyer pays for the cost to conduct a search of the non-land or chattel records. In addition, the cooperative?s ownership records are reviewed by the Board or by the coop?s Transfer
Parties to a Coop Settlement
Besides the buyer and seller, the cooperative corporation is an important party to the transaction. First of all, the sale is conditioned upon the coop approving the buyer for membership and occupancy. Without formal written approval by the Board, there can be no sale or settlement. Also, by approving the transfer, the cooperative is confirming that the seller is a member of the cooperative and the rightful owner of the unit being transferred. If a lender is involved, the cooperative must agree to enter into a Recognition Agreement with the lender whereby the cooperative recognizes the lender as having a security interest in the unit for which a loan is being made.
Application and Approval
A number of important steps must be taken before settlement can occur. The most important, of course, is that the transfer of membership and occupancy be approved by the board. Approval must be in writing, and signed by an officer of the Board.
To obtain Board approval, the buyer must make application to the cooperative for resident membership. Each coop has its own requirements for the sale and transfer of ownership. Typically, an application form seeking information about one?s employment status and income, as well as a list of one?s assets and liabilities, is completed. This information is reviewed by the Board to assess the applicant?s ability to handle the monthly carrying costs associated with ownership. Verification of employment, a consumer credit report and letter of personal reference are usually part of the application package. The cooperative may require the seller or buyer to pay a fee for the cost of obtaining a credit report and for handling the review process. Following submission of the application package to management, most coop boards schedule an interview with the buyer to greet the prospective owner, answer any questions and explain some of the more important policies concerning the cooperative?s operation.
Settlement and Transfer
In preparation for closing, the settlement officer will initiate a written request to the cooperative?s managing agent for a statement concerning the status of the seller?s account, as well as verification of the monthly assessment payments allocated against the unit, i.e. the monthly coop fee. The total monthly coop fee covers the unit?s share of the cost to operate and maintain the property, including the unit?s pro-rata share of the real estate taxes. The monthly fee also includes the principal and interest payment for any corporate mortgages indebtedness which may be allocated to the unit. Special assessments payments are also verified. All payments are pro-rated according to the terms of the agreement.
In transferring an interest in real property there is no need for the seller to bring his deed to settlement since a title search would have confirmed the seller?s ownership interest in the property. It is imperative, however, that the seller of a coop unit bring his original Proprietary Documents to settlement as these are the seller?s evidence of ownership which the seller assigns to the buyer. If the seller is unable to locate his Proprietary Documents, the coop will issue substitute Ownership Documents provided that the seller completes one the of following requirements as dictated by the Board policy: (1) provide an affidavit of loss, (2) require the seller to purchase a bond in favor of the coop to indemnity it and the buyer against loss, or (3) initiate a suit for Quiet Title. Both the bond and the suit of Quiet Title are costly measures. The purpose of these actions is to ensure that the seller?s ownership interest has not been conveyed or pledged by a third party.
If the Proprietary Documents have been pledged by the seller as collateral security for a note or sale loan, then the Proprietary Documents are released by the note holder or lender upon pay-off and returned to the cooperative.
Settlement can be scheduled when the settlement officer has all of the verifications and supporting documents in hand. A settlement statement is prepared which follows in principle the standard HUD-1 form.
At settlement, the seller will assign his right, title and interest in the Proprietary Documents to the buyer. The buyer accepts the assignment and pays the balance of the purchase monies to complete the sale.
Following settlement, the settlement officer must arrange for the President and Secretary of the cooperative to sign and seal the Proprietary Documents, and if there is a purchase money loan involved in the transaction, the Recognition Agreement and related documents. This is usually coordinated through the cooperative?s Transfer Agent.
The members of the Board in each and every cooperative are themselves resident owners who volunteer their time. The process of transferring ownership is a reasonable process provided that the policies and procedures established by the cooperative and followed and the Board?s involvement in the process is respected.
PART IV
Brief Description of Cooperative and Condominium Ownership
The cooperative and condominium forms of ownership are similar in some respects, but there are also some important differences. Most of the similarities are operational in nature while the differences are generally in their legal framework and financing arrangements. Let?s take a closer look.
Cooperatives:
The basis for the cooperative form of ownership is typically founded in laws establishing corporations. No special legislation is needed to organize a corporation for the purpose of housing its stockholders/members.
The first cooperative was organized in New York City in the 1880?s. The 1920, Edmund J. Flynn in associated with Alan E. Walker introduced the first ?100% Plan of Cooperative Ownership? to Washington area residents.
Housing cooperative are owned and operated by the stockholders or member owners. The corporation holds title to the property of which the individual units are a part and each stockholder or member owns a proportionate share of the corporation.
Housing cooperatives are non-profit corporations that are organized either as stock or non-stock corporations. If organized as a stock corporation, each member is a stockholder who receives a stock certificate indicating the number of shares assigned to a unit. The member also received a proprietary lease granting him/her the exclusive right to occupy a specific unit in the project and to use and enjoy the common elements subject, of course, to the Articles of Incorporation, By-Laws, Rules and Regulations of the cooperative. This right of use and occupancy is appurtenant to, and inseparable from, ownership of an interest in the cooperative entity.
These two instruments, the stock certificate and the proprietary lease, constitute the member?s evidence of ownership or ?title? to the unit. The member?s ownership of the unit is an interest in personal property, not real estate.
Cooperatives organized without capital stock are membership cooperatives. Although still organized as a non-profit corporation, a membership cooperative typically issues a single Ownership Document in place of stock and a proprietary lease. It reflects both the member?s ownership interest in the corporation and the member?s exclusive and permanent right to occupy the unit and to use the common elements. The evidence of ownership in a membership cooperative varies from one cooperative to another, sometimes called a Cooperative Ownership Contract, Perpetual Use and Equity Contract or a Mutual Ownership Contract. Because of its many forms, the evidence of ownership in a coop is commonly referred to as Proprietary Documents.
The affairs for the cooperative are managed by a Board of Directors elected by the unit owners to oversee the care, maintenance, operation and administration of the association. The cost to operate a cooperative is proportionately allocated among the unit owners as stipulated in the Articles of Incorporation and/or By-Laws.
Loans made to purchasers and owners of cooperative units are secured by a pledge and assignment of the unit owner?s Ownership Documents, i.e. Proprietary Documents. The lender holds the borrower?s Proprietary Documents as collateral security for the loan. The lender?s security interest in the Proprietary Documents is further perfected by recording a Uniform Commercial Code Financing Statement (UCC-1) with the Recorder of Deeds which evidences the borrower?s debt on the public records.
The organizational documents of a cooperative can be structured to serve the financial need of the present and future owners. These associations are referred to as ?limited equity? or ?low yield? cooperatives in contract to the more common ?market rate? cooperatives. Limited equity cooperatives limit the market value of a unit being sold so that it can be purchased by people with low or moderate income.
Cooperative ownership provides the same tax benefits as all other forms of home ownership. The tax deductions available to the cooperative corporation, as result of the payment of real taxes and interest on the corporation?s mortgage, are passed through to the individual unit owners in proportion to their ownership interests provided that the coop qualified under Section 216 of the IRS Code. Briefly state, if in a particular year more than 20% of the coops gross income is derived from non-tenant stockholders, it cannot pass through interest and real estate tax deductions to its otherwise qualifying ?tenant stockholders? (i.e. the unit owners). Also, interest on an individual unit owner?s loans, likewise, tax deductible.
Each cooperative associate has its own policy governing the sale or rental of individually owned units.
The cooperative form of ownership may also be applied to such entities as office buildings, medical centers, home parks, as well as commercial business enterprises.
It should be emphasized that in the Washington area, the price quoted for the sale of a cooperative unit is the full price including the unit?s pro-rated share of any corporate mortgage financing on the coop?s property.
Condominiums:
The basis for the condominium form of ownership is found in state and local law.
Each of the 50 state has laws that enable condominiums to be formed. Sometimes referred to as Horizontal Property Acts, these laws require that a project be declared a condominium and that the legal documents conform to the format stipulated in the state laws.
Condominiums were first legally established in the United State in 1958, when the Commonwealth of Puerto Rice passed a law providing for condominium ownership. Legislation for condominium ownership in the District of Columbia was passed in 1963.
A condominium is a form of ownership in which the individual unit owner owns fee simple title to the unit as well as an undivided interest in the common elements of the condominium, which interest is appurtenant to, and inseparable from, the ownership of the unit. The individual?s ownership interest is subject to Declaration, By-Laws, Rules and Regulations of the condominium.
Each condominium unit owner is a member of the condominium association. Like a cooperative, the affairs of the condominium association are managed by a Board of Directors elected by the unit owners to oversee the care, maintenance, operation and administration of the association.
The cost to operate a condominium association is proportionally allocated among the unit owners as stipulated in the Declaration and/or By-Laws.
Loans made to purchasers and owners of a condominium unit are secured by a mortgage or Deed of Trust which is recorded among the land records in the jurisdiction where the condominium is located. The Deed of Trust is a lien against the unit in favor of the lender who provides the collateral security for the loan.
The condominium unit is always treated as real property for tax purposes and there are no limitations on the owner?s ability to deduct interest, real estate taxes and the like.
A condominium association may have some form of policy governing the sale, lease or disposition of individually owner units.
The condominium form of ownership may also be applied to office buildings, industrial parks, medical centers and almost any other form of real property.
PART V
Condominiums vs. Cooperatives
General Characteristics:
Living Space:
Cooperative: Owner by cooperative corporation and leased to individual cooperative member (tenant-stockholder)
Condominium: Separately titled: owned by the individual
Financing:
Cooperative: Corporate mortgage allocation, unit share loan
Condominium: Unit mortgage
Collateral:
Cooperative: Project mortgage project (land & improvements), Unit Share Loan?shared and occupancy agreement
Condominium: Condominium unit and undivided interest in common elements
Mortgagor:
Cooperative: Project mortgage?cooperative corporation, Unit Share Loan?cooperative member
Condominium: Unit owner
Common Area/Facilities:
Cooperative: Owned by cooperative corporation
Condominium: Owned collectively by unit owners as tenants in common, each unit owner having an undivided interest
Real Estate Taxes:
Cooperative: Paid by cooperative corporation
Condominium: Tax on each unit as its undivided interest in the common estate paid by
each unit owner
Basic Documents:
Cooperative: Articles of Incorporation, By-laws, Proprietary Documents, Special share loan documents (Recognition Agreement, Security Agreement, UCC-1 Financing Statement)
Condominium: Declaration, By-Laws, Rules and Regulations, Unit Deed
Income Taxes:
Cooperative: Pass-through deduction to members in cooperative qualified under Section 216 for proportionate share of project mortgage interest and real estate taxes. Direct deduction of unit share loan interest.
Condominium: Direct deduction of unit mortgage interest and real estate taxes.
Why Condos Became Popular
If coops are such a sound and sensible form of ownership, why aren?t there more coops being organized and sold? Coops continue to be organizes and are typically located in densely populated urban areas. On the East Coast, New York City has the greatest number of coops followed by Washington, DC. Unlike condominiums, no special legislation is required for a group to form a corporation and purchase a rental apartment building in the name of the cooperative housing corporation.
Nevertheless, why are condominiums more popular? The answer can be summed by in one work: financing. Coops in Washington were first organized by Edmund J. Flynn in 1920. For nearly 60 years thereafter, bank financing was not available to purchases of coop units. Banks in the District of Columbia are organized under Federal Charter and federally chartered banks were not permitted to loan money secured by a pledge of one?s ownership interest in a coop. Cooper purchasers had to pay cash for their unit or the seller had to take back a note for part of the cash requirement.
The lack of bank financing adversely affected coop ownership in two ways. First of all, it made coops difficult to sell; second, it suppressed the value of coops. Just think of what today?s real estate market would be if buyers could not finance their purchases.
In 1979, an important event took place that would ultimately improve the marketability of cooperatives. On August 2, 1979, the Federal Home Loan Bank Board (FHLBB) issued its final regulation authorizing federal savings and loan associations to make loans on individual cooperative units in accordance with the rules governing loans on single-family dwellings and to otherwise amend its rules to provide similarity of treatment between coop loans and other home loans. The effective date of the new regulation was September 6, 1979.
The new rule allows loans up to 95% of the appraised value of the cooperative unit, less the allocated portion of the corporate mortgage. Loans in excess of 80% have to be insured according to other FHLBB regulations.
Therefore, as of September 6, 1979 federal savings and loan associates were permitted to make loans on individual cooperative units to be secured by assignment of the borrower?s Proprietary Documents to the lender. For insured or guaranteed loans, such loans may be made on any terms acceptable to the guaranteeing or insuring agency.
Banks were slow to tap the potential of this new lending opportunity. More importantly, bank managers were generally resistant to involve their institution in making loans collateralized by personal property. And yet, at the time, these same banks were aggressively marketing other loans secured by personal property of diminishing value, i.e. car loans, boat loans, and the like.
About the time when sources of bank financing for coop resales was gaining momentum, enabling legislation for condominium ownership was enacted. In DC, the year was 1963. Even though condominiums were not real estate in the traditional sense (i.e. land) the enabling legislation said they were. As ?real estate,? condo?s soon found favor among bankers, developers and consumers.
Why Oh Why Should I Favor Coops?
As a form of multi-family ownership, coops offer several distinct advantages. A few of the more significant advantages are highlighted.
First of all, title to the land is in the name of the housing corporation. This is significant because the corporation has a mortgageable asset. For example, if there were a need to fund a costly capital improvement, the membership could decide to fund the cost by placing a mortgage on the property resulting in small payments every month over time as opposed to one or more special assessments. Condominium associations have no ?property? or equity to mortgage for long term financing.
Second, most delinquencies and other problem matter can be handled administratively, thereby avoiding costly and time-consuming legal action.
Thirdly, the membership can establish policies to control the owner/investor ratio within the association. A rental policy can be established to insure that the number of investor-owned units does not exceed the secondary market requirements for the First Trust financing. Furthermore, the real estate tax rate on the coop?s property in the District of Columbia is likewise affected by the owner/investor ratio. Depending on the organizational structure of the condominium when first established, the condominium board would have legal difficulty in restricting an owner?s right to rent.
There are other advantages as well. Another obvious benefit is the relative simplicity in organizing a coop. For example, in convert an existing rental building from an investor-owned rental property to property owned by a coop association involves only a change in ownership. Simply stated, the property as a whole is conveyed from the seller of the apartment building to the cooperative corporation. The property does not have to be subdivided into individual lost in the case of a condo conversion, which reduces the costs to convert.
Coops are taxed more like rental buildings. There is one tax bill. The bill for a coop corporation is typically much less than the taxes in the aggregate for the unit owners in a condo. A contributing factor is that coop sales are not recorded.
A more subtle benefit is the incidence of delinquencies in a coop. Delinquencies are minimized as a result of the application process. Typically, coops require prospective owners to apply for resident membership. This includes a statement of income, assets and liabilities, a credit report and the like. The process of having one?s financial status reviewed by the Board (i.e. future co-owners) discourages applicants with questionable credit. The coop relies on the membership to meet its financial obligations which include, among other obligations, real estate taxes and the monthly payment on its corporate mortgage. Therefore, the credit worthiness of a prospective member is vital to the financial well being of the association. The process minimizes the delinquencies. Lenders are quick to state the coop borrowers, as a group, are reliable payers and that foreclosures are nearly non-existent.
