Economy Down, Rentals Up?

As a longtime member of the board, you recall the economic downturn of 1989-92 with a shudder. Money was tight, interest rates were on the rise, and the shareholders in your co-op had a difficult time selling their apartments. When expanding families or job relocation sent them elsewhere, your board was sympathetic to their requests to allow subletting – otherwise they would sell at a huge loss.

Alas, crafting new rules about building policy using the heart and not the head can frequently lead to additional woes, as many boards discovered. For as subleasing in apartments increased, so did the problems for the remaining resident-owners. Besides giving the building an air of transience, with renters who cared less than owners about the upkeep of the co-op, a more serious problem sometimes developed: banks would frequently not grant/refinance individual and/or building mortgages if the ratio of owners to renters was below a certain percentage (if 40 to 50 percent of the building were rental, it was frequently considered a risk).

It took many co-ops years to bring their sublets under control – and now they may have to do it all over again. “As the economy gets worse,” says management executive Gerard J. Picaso, president of Gerard J. Picaso, “a number of boards will probably have to rethink their sublet policies.” Indeed, in a crisis, do boards relax their subletting policy or hold the line and hope for the best? And what policy is right for their buildings?

Donald Levy, vice president at Brown Harris Stevens, says many of the properties he currently handles are holding the line. Despite the stomach-churning roller coaster ride of the market, the plight of would-be sellers trying to attract buyers “is not generating an enormous amount of sympathy on the part of boards,” Levy says. From the boards’ point of view, well-heeled shareholders bought into their buildings knowing the rules, profited handsomely from sales when the market was at its peak, and boards were not now going to amend the subletting clause of the proprietary lease because some shareholders might be experiencing hardship in selling.

All these boards, says Levy, agree that market price is not the board’s responsibility. For them, the biggest concern is the long-term damage such relaxed policies would do the building, both in its upkeep and the future sales prices of the units once the market stabilized.

That view is not unique to Levy’s co-op. Of nearly a dozen management executives and board directors contacted, only one says that his cooperatives were willing to reconsider their rules on subletting.

For instance, Bay Terrace, a large co-op in Queens, is reluctant to lift its restrictions because of the hassles its board encountered when it had more liberal policies. Back then, it wasn’t so much that the tenor of the co-op might change, explains Warren Schreiber, president of Bay Terrace, as it was the lack of control the board had with subtenants. If there were problems the board found itself having to make certain that the non-resident shareholders dealt with them. The chain of responsibility was stretched too thin, observes Schreiber.

“If people in apartments are not following the rules,” he notes, “that creates additional problems for the board,” which does not want to spend its time or resources enforcing good neighbor policies against tenants who have no vested interest in the co-op.

Nonetheless, some boards are considering change – although with concerns. Management executive Picaso reports that two co-ops in his portfolio have been reviewing their sublet policies. One, a 100-unit building in Greenwich Village, has amended its policy to allow owners to sublet for three years – instead of two – once every five years. In a 200-unit building on the Upper East Side, the board has okayed a request for a sublet, its first in ten years. While the board was sympathetic to the shareholder’s request, says Picaso, it debated long and hard over the issue because it was nervous about setting a precedent: accommodate one shareholder and the co-op would have to relax the rules for everyone.

Mort Rosen, a partner in the law firm of Rosen & Livingston, says a few boards have asked him to take a look at their sublet policies and have asked whether it’s time to do a revision.

“It really depends on the board and the circumstances,” says Rosen. While a board has a fiduciary responsibility to the entire building to ensure that the bylaws are financially sound, there are ways to amend the bylaws while avoiding opening floodgates for subletting.

One way to control subletting is to phase it in slowly, says Rosen. Boards can set a minimum time line that shareholders have to live in the building, one to five years before they can sublet. And then they can limit the number of years a shareholder can sublet: for instance, two years in any five-year period. Boards can also limit the number of years a unit can be sublet and then insist that a shareholder move back into the apartment or sell it.

Some boards have a “hardship” policy, the attorney points out: for example, if a shareholder is posted overseas for an assignment and is going to be gone for one to two years. Boards can consider expanding the definition of hardship to allow shareholders having a difficult time paying their maintenance to sublet while they get their financial house in order.

To avoid a run on requests for subletting, boards can consider charging a fee, payable up front when a shareholder wants to sublet. But be careful about setting it, warns Rosen; the higher the fee, the greater the chance of accusations of gouging.

In Bailey vs. 800 Grand Concourse, for instance, a Bronx cooperative owner was having difficulty paying maintenance. The board approved a sublet, with the caveat that Bailey pay a 30 percent fee up front. Although he paid it, the amount was apparently too high, and trapped by the high fee and high mortgage costs, the shareholder fell behind in his mortgage, and the bank foreclosed. Furious, the aggrieved party turned around and sued the board, claiming the sublet fee was illegal. He won the suit and the co-op had to compensate him for his lost equity.

The moral of story is that the board, in trying to protect the co-op, was not only too rigid in its stance on forcing the shareholder to pay 30 percent up front, but also had set the fee too high. Bailey didn’t have the cash flow, so the board lost the shareholder and then ended up losing a lot more when the building had to reimburse him for his lost equity.

When reviewing requests for sublets, boards have to take a lot of factors into consideration. At the very least, they need to consider expanding the definition of hardship cases, says Rosen, so shareholders can keep their apartments, and keep paying their maintenance and mortgage on time. And, adds Picaso, “they need to be ready for the worst.”