Is buying a co-op in NYC as an investment property a good idea?
We’ll demystify this topic in the following video.
I’m Nick at Hauseit.
Visit https://hauseit.com to learn how to save money if you’re buying or selling a
co-op, condo or townhouse here in NYC.
So let’s get started!
Most buyers in New York City are attracted to co-ops because they’re less expensive
than condos.
The main reason why co-ops are cheaper is because there’s a much greater supply of
them compared to condos, here in New York City.
A co-op can be anywhere from 10% to 40% less expensive compared to an identical condo.
This is great news for someone looking for a primary residence in NYC.
By choosing a co-op instead of a condo, you can live in the same size apartment but pay
a lot less for it.
Of course, there are many downsides to co-ops compared to condos, but that’s a separate
discussion which we cover in another video.
So let’s say you’re an investor.
You don’t plan on living in the apartment you’re planning on buying.
As of now, you’re also not fully familiar with the downsides of co-ops.
As a result, you might be thinking that a co-op’s lower purchase price will provide
you with a higher rental yield compared to a pricier condo.
So shouldn’t you and every other NYC real estate investor buy a co-op instead of a condo
in order to generate a higher rental yield?
Well, the problem is that most co-ops in NYC are required to be used as primary residences.
As a result, a typical co-op building has a limitation on the amount of subletting which
is permitted.
A co-op may only permit subletting for 2 or 3 years out of every 5 years, and there could
even be an initial owner-occupancy requirement before subletting is permitted.
This means you as the owner would need to reside in the unit for a certain period of
time before you’re allowed to rent out the apartment.
To make matters worse, stricter co-op buildings have a lifetime cap on the number of years
of subletting during the course of ownership.
For example, subletting may only be permitted for 3 years during the lifetime of ownership.
This prohibition makes it impossible for an investor to buy into the co-op building.
This is because subletting restrictions are obviously a deal breaker for an investor,
who naturally is looking to rent out the apartment indefinitely in order to generate long-term
cash flow.
But here’s where it gets interesting.
There are a handful of co-op buildings in NYC which permit unlimited subletting.
Therefore, some NYC real estate investors do end up considering and buying a co-op as
an investment property.
But is this a good idea?
In our opinion, buying a co-op as an investment property is not a good idea, even if the specific
co-op building you’re considering permits unlimited submitting.
Here’s why: just because a co-op allows subletting today, doesn’t mean it will allow
it in the future.
The building could always vote to change the policy.
This risk is particularly pronounced in a small co-op building, because all it could
take is one or two resales in the building to flip the co-op’s culture and voting majority
into opposing subletting.
Let’s say you’re an investor, and you buy an apartment in a small co-op building.
Everything goes well for the first few years.
But all of a sudden, there are 2 resales in the building.
The new owners are owner occupants and they’re strongly opposed to investor activity in the
building and subletting in general.
Now let’s say that one or both of these activist owners gets voted onto the board.
Next thing you know, the building changes its policy and implements restrictions on
subletting.
If this were to happen, all investor owners in the building would be essentially forced
to sell over time.
You might be allowed to continue subletting for some period of time as the new restrictions
ease into effect, but ultimately, you’ll be required to sell.
If all the investor owners start selling, this may put downward pressure on pricing
in the building over time.
Even if pricing in the building isn’t meaningfully impacted by investor selling due to changes
to the sublet policy, this is a huge inconvenience for you as an investor.
You’ll eventually have to hire a broker, pay 6% commission and swallow all other NYC
seller closing costs (like city and state transfer taxes), and execute a 1031 exchange
to buy a replacement investment property.
Another major problem with owning a co-op as an investment property is the issue of
board approval each time you have a new tenant.
While both condos and co-ops in NYC usually have an extensive rental application and pretty
high fees, co-ops are also allowed to reject an applicant without any consequences to the
building.
If you irritate the board president or a board member, you could literally be dragged through
the mud as these people engage in petty retaliation against you by rejecting your rental applicant,
or perhaps multiple applicants.
The co-op board could also take ages to review the application, thereby prolonging any vacancy
period between tenants and costing you real money.
Condos, on the other hand, may not reject a rental applicant unless the building is
willing to rent the unit from the owner on the same terms negotiated with the tenant.
This is called the ‘right of first refusal’.
In NYC, the likelihood of a condo exercising its right of first refusal is effectively
zero, and it would only happen under extraordinary circumstances.
Moreover, condo boards are usually required to respond to a renter’s application within
a set period of time, typically between 20 and 30 days.
If the board doesn’t respond within this timeframe, the rental application is automatically
approved.
There is no such safety mechanism for co-op buildings.
Before we let you go, we do want to emphasize that there are many real estate investors
in NYC who own co-ops without any issue.
It’s absolutely possible to own a co-op as an investment property in NYC, and be allowed
to sublet immediately from day one, without any limitation.
The point of this video is to alert you of all risks of buying a co-op apartment as an
investment property, and we’ve therefore focused on rather remote downside scenarios.
In conclusion, we personally don’t recommend buying a co-op as an investment property due
to the additional risks involved compared to condo ownership.
If we look at the big picture, the rental yields are still similar for condos and co-ops
despite the pricing disparity.
It’s just not worth the extra risk or hassle to own a co-op just to receive a slight bump
in the rental yield.
If you want a significantly higher investment yield, the truth is that it makes more sense
to consider other asset classes or real estate in another city instead of taking on a lot
of incremental risk to earn a marginally higher yield by way of buying a co-op instead of
a condo.