What Exactly Is a Cooperative? And Is It Smart to Buy Shares In One?

Whether you dream of ducking out for pizza at 2 a.m, or you want your home to support a sustainable future, if you’re shopping for a home in some areas of the country, you might stumble across a co-op. Even though the real estate listing shows two bedrooms and a balcony, and it’s similar to a condo, a co-op purchase is unique.

Ariel Pena, an experienced agent in New York City who handles more condos than the average agent in his area, says that ”the most common misconception about co-op’s is that buyers confuse them a lot with a condo.” If you’re moving to the city from an area where co-ops are uncommon, then it’s definitely confusing!

To clear up this confusion, here’s what you need to know about buying into a cooperative.

What is a cooperative, also known as a co-op?

It can be helpful to think of joining a co-op as buying into the entire building as compared to buying a single condominium unit within a building. A cooperative or co-op is a collection or group of households that jointly own equity shares in a big piece of real estate. Each household owns a share rather than an individual unit.

The co-op divides shares according to the size and desirability of the units. Square footage, corner units, and balconies all add value to a unit. A person buying shares for a two-bedroom unit would purchase more shares than someone buying a studio unit.

According to Pena, when you buy into a co-op, you don’t get a deed like you would with a home or condo purchase. Instead, “you get a proprietary lease that gives you the right to occupy the space that pertains to the number of shares for the units you purchase.”

The co-op itself is a corporation that owns and operates the real estate in question; it’s run by a board of directors and controlled jointly by the shareholders/homeowners. It has governing documents similar to a condo association (COA) or homeowners association HOA. If you purchase shares in the co-op, you have to follow these rules.

Where do you find co-ops?

Co-ops are most common in buildings with multiple units, similar to apartment buildings or condominiums. But you’ll also find them in mobile home parks or retirement communities. Some home types are especially popular for co-ops:

• Townhouses
• Apartment complexes
• Garden apartments
• Senior housing
• Student housing
• Special needs housing
• Mobile home parks
• Single-family homes (yes, even these can be in co-ops!)

They’re popular in certain geographies like Chicago or New York City, where it’s estimated that co-ops make up 75% of the city’s housing stock. Areas where high rises dominate and development is very concentrated lend themselves to co-ops. In the Midwest, they’re more commonly found in mobile home parks.

Examples of co-op communities

Examples of co-op communities can be found all across the United States. Some co-ops center around a shared vision of living — such as co-ops organized around religious ideals, or an artists’ co-op.

Others, like one in Jamaica Plain, Massachusetts, seek to combat gentrification by selling shares to families that meet lower income thresholds. Co-ops built around a common purpose can have a strong sense of community.

Doña Betsaida Gutiérrez Cooperative, Jamaica Plain, Massachusetts

This co-op was built to help residents who are visually and mobility impaired live independently. The mixed-use building includes affordable apartments and condos for first-time homebuyers.

Lowertown Lofts, St. Paul, Minnesota

These artists’ lofts have been a part of the Lowertown community for more than 30 years. Formed as a limited equity residential housing cooperative, they combine living and working spaces for artists.

Oak Center Homes, Oakland, California

This co-op consists of 89 units and duplexes scattered across the property. The community focuses on fostering diversity and opportunity for members.

What types of co-ops are there?

There are three types of co-ops. The type of corporate structure a co-op chooses is often related to its overall purpose.

Market-rate co-ops

A market-rate co-op is the closest thing you’ll find in this world to buying and selling an actual unit on the open market. Whenever the owner wants to sell, they can sell their shares for their market value. It’s very similar to selling a condominium or home, but sometimes other co-op owners might need to approve the buyer.

Limited-equity co-ops

A limited-equity co-op is a type of affordable housing where typically the home purchase is somehow subsidized for the buyer. In exchange, there’s a limit or cap on the amount or percentage of equity the shareholder can accrue while they live in the co-op.

These co-ops place limits on equity to stay true to their purpose of providing affordable housing in otherwise expensive areas. Often, the owners can only sell their shares to buyers who meet income limits and other needs-based requirements.

Group-equity or zero-equity co-ops

In a group-equity or zero-equity co-op, the individual shareholders do not obtain equity in the property when they buy into the co-op. They also don’t accrue equity as owners, but the rates they pay to live in the unit are below the market norms.

Can you get mortgage financing for a co-op?

Financing for buying a co-op is different than for a single-family or condo purchase. It’s technically not a mortgage; it’s a loan to purchase shares. The down payment required might also be higher than with a traditional purchase.

In addition to providing a lender with financial documents, the co-op board could request proof of financial solvency from you as a buyer. Pena says that he has seen some co-ops that don’t allow financing at all. A good agent will be able to research and share this information with you.

Doni R. Feinberg has over 20 years of experience as a real estate lawyer in New York City. She has both lived in a co-op and also worked on many co-op conversions in the 1980s and 1990s.

When looking for co-op financing, she warns buyers that “Not every lender or mortgage company will be approved by a co-op board. The lender has to approve the co-op board; the co-op board has to approve the lender.”

Because co-op boards can turn down a buyer if they don’t approve of the lender, see whether your agent can find out which lenders the co-op board prefers before putting in an offer.

What are the perks to living in a co-op?

Once you understand the ownership structure, there are some real perks to buying into a co-op.

Become a homeowner sooner

If it’s a limited-equity, group-equity, or zero-equity co-op, then you can often get your foot in the door of homeownership sooner than when buying a house or condo. You can qualify at a lower income level and with a lower down payment.

You won’t be accruing equity in a zero-equity co-op the same way you would with a house or condo, that said — but you’ll still be living in a property that you own instead of rent!

Maintenance and repairs are easy

Like with a COA or HOA, the co-op will handle repairs and maintenance of shared areas. But the maintenance fees might pay for more than general maintenance.

“On a co-op, the maintenance usually covers the taxes and might also include utilities such as electric, cooking, gas heat, hot water,” Pena explains.

You’re only responsible for what’s within the walls of your unit. In a condo, you’d pay a monthly common charge, but taxes and utilities would be separate.

Feinberg says that since “the pass through’s —  extra rents from common area, trash to maintenance — are allocated by shares; the maintenance is lower in a co-op than in a condo.”

If you buy into a co-op, you won’t have to worry about snow removal, grounds upkeep, or garbage, but you will pay less to have these services covered than when paying an HOA or COA fee. For some people, it’s a no-stress lifestyle.

Independent but supported living

For seniors or people with disabilities, this might be a good way to get support while maintaining some independence. They can live in their own space but receive support from the larger community.

For those residents who are unable to handle upkeep and maintenance, the co-op board ensures that they’re living in a clean and safe building.

Tax benefits

Don’t worry: the interest paid on your loan to buy co-op shares is tax deductible. You’ll receive the same tax benefits as with a mortgage. However, you might get an extra tax deduction!

If the co-op pays a mortgage on the building or land, your portion of that interest is also deductible. You might also be able to deduct some of your maintenance fees.

When you sell, you’ll realize another tax benefit. In New York and many other states, there’s a real estate transfer tax. It can be a flat fee or based upon increments of the sale price. But Feinberg points out that “in a co-op, there’s no real estate transfer tax when you sell, because you’re not selling real estate, but shares.”

What are the disadvantages to living in a co-op?

It’s not all sunshine and rainbows in a co-op, even if you’re buying into an eco-friendly community in California. There are some downsides to co-op living.

Interview with the board

The co-op board has to approve your application to buy shares in the co-op, and that can be intensive. Expect to sit down with the board for an in-person interview. If the co-op is organized around a shared set of beliefs or lifestyle, the board will want to gauge your fit with the community as a whole.

They could also look closely at your debt-to-income ratio and net worth when approving your application. Because everyone in a co-op shares financial responsibility for the building, it’s important to a co-op board that you can contribute.

Feinberg says that,

“Most of the time, they’re going to block things based on either someone who doesn’t meet their financial standards, or someone they don’t think could comply with the building rules or regulations.”

If a buyer hasn’t been properly briefed by their agent and lawyer, they may not understand the rules and bylaws and could respond poorly to learning (for example) that they can’t sublet their unit during the co-op board interview.

Co-op boards are bound by the Fair Housing Act, however, and cannot discriminate based on a buyer’s race, color, national origin, religion, sex, familial status, or disability.

Following the rules and chipping in

Just like when you live under an HOA or COA, you’ll have to follow the co-op’s rules and regulations.

Not all co-ops outsource upkeep and maintenance! You might have to shovel snow, or take out the garbage.

In a sustainable community, you could be digging rows in a community garden or composting. It’s a lifestyle that involves community responsibilities that you can’t outsource, so be sure it’s what you want before making the commitment.

Difficulty selling

If it’s not a market-rate co-op, you might not be able to sell it easily. In a limited-equity or zero-equity co-op, it could take a while to find and vet a qualified buyer.

Even with a market-rate co-op, some buyers don’t want to go through a rigorous application process. Others might prefer outright ownership of their unit as opposed to purchasing shares.

No sublets, and restrictions on improvements

Thinking about generating some extra cash by listing your unit on Airbnb when you go out of town? You might not be able to rent your unit at all depending on co-op rules. Even if the co-op does allow sublets, “the process of subletting can be much more difficult than with a condo,” Pena says.

It’s also harder to make improvements like renovating your kitchen or bath. You might have to bring in an architect. The board will have to approve your plans and could require changes to them.

Maintenance fees and capital improvements

Monthly maintenance fees can be high, so make sure what they provide is worth it to you.

Pena recommends having your lawyer and accountant review the co-op’s financial statements and reserve funds. If there have been constant increases in maintenance fees, it’s a red flag. As well, ask for information about the last time that the co-op took care of capital improvements, such as a new roof or elevator.

“It could be a very nice building, and you like the space, it works for you,” Pena says — but if  the co-op hasn’t been on top of major repairs, “an assessment might be coming.”

Whether or not a co-op is right for you will depend on your homeownership goals and the lifestyle you desire. A good agent can help you ask the right questions to help you determine whether you should include co-ops in your home search.

Header Image Source: (Felix Rossel / Unsplash)