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Too few owner-occupants can cause make lenders wary.
AUTHORSeth M. Sahr, Partner, Novitt, Sahr & Snow
PAGE #p. 41
Boards have to keep an eye on the number of sublets in their buildings before mortgages are denied.
Some of the shareholders living in a 90-unit co-op could not get financing to refinance their mortgages or sell their apartments. The problem was that when prospective purchasers and the shareholders went to lenders, they found that the building had too many sublets and too few owner-occupants. This became a problem because Fannie Mae, which is the largest provider of loans out there, had started to vigorously enforce some of its regulations – one of which is you must have more than 50 percent owner-occupancy. So the people in this co-op were being shut out of opportunities to get financing.
We needed to go back to the proprietary lease and some of the other sections of the offering plan, and review with the board the tools that we had to attack the issue. We also had to take a look at who was subletting. Part of the problem was that the sponsor still owned about a third of the building. The sponsor’s shares come with certain rights that other shareholders do not have, one of which is the right to sublet without board approval. We also had a couple of other smaller investors who had sublet their units. The issue had not been addressed by the board, so the situation was a bit out of control. There were also some individuals who had been subletting their apartments for many years and felt they had a right to continue to sublet. However, for the good of all, we needed to address this issue and figure out what we could do. First, we went to the biggest offender, the sponsor, and we attempted to get his cooperation voluntarily, which was a struggle.
The sponsor has recently gone into contract to sell a unit. This particular sponsor had not sold in 30 years, so that was already quite an accomplishment. The board continues to put great pressure on him and we’ve threatened litigation, because the shareholders feel that their co-op is no longer viable. We also instituted – because the proprietary lease allowed us to – a number of new rules forbidding more sublets until we brought the percentages down.
Boards must keep an eye on the number of sublets they permit in their building. If boards allow the situation to get out of control, it can be hard to reel in, and shareholders are hurt because the low owner-occupancy levels can interfere with their ability to finance and sell. Prices in the building could fall because of the inability to sell.
Boards need to be aware that the number of sublets in the building is important, and to keep a handle on it. First, check to make sure what rights you have to stop sublets. Then enforce those rights to the point where you know that your sublets do not exceed 30 or 40 percent of the property (the lower, the better).