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Co-op and condo boards need to get smart about how much of their income comes from commercial tenants.
AUTHORLeslie Winkler, President, Halstead Management
Prior to 2007, there was an IRS rule that said a building couldn’t qualify for cooperative status if it didn’t receive 80% or more of its income from residential shareholders and no more than 20% of its income from other sources like commercial tenants. When that rule ended, co-ops with commercial space benefited enormously – until the pandemic. Before this hit, was the retail landscape healthy?
It was actually declining. It probably had its heyday between 2010 and 2015. After that, I think that anybody walking on the streets of New York, particularly on the Upper East Side, would see many more vacant storefronts as the years went on. Everybody was commiserating about that loss of tenancy. At co-ops that had entered into long-term leases with tenants, most of them were paying, and the commercial income was holding up. But I’m not sure that boards really understood how this changing landscape would impact them and their budgetary process in the long run. Even in the short run, I don’t think everyone understood how long it takes to do a lease negotiation, factoring in a loss of rent for the build-out.
When the pandemic hit and the commercial income shrank, or in many cases evaporated, what happened with your clients who had commercial income?
Well, it was very, very stark. Restaurants and some of the personal-service type tenants stopped paying rent right away, and everybody was asking for rent forgiveness. I don’t think any of us really realized how prolonged this process would be. Even the grocery and drug stores that really tried to stay in business ended up shutting down. So there were three problems: One, the immediate loss of income for businesses, and you had to renegotiate and reduce the rent for those that were staying. Two, you had the businesses that absolutely could not pay and wound up leaving within six or eight months. And three, the businesses that just renegotiated their leases did so for a longer term.
So that was a very rude awakening for boards.
I think the conversation was always out there, but the loss of income became a real problem for them. In March and April of 2020, people were really starting to feel the hit. By July and August, many of these buildings got Paycheck Protection Program loans and were able to recoup some of this loss of income, but they realized that they were still taking a hit on their operating income. And when that dried up by 10% or 20%, it really made them aware of how vulnerable they were.
Budgets still have to be balanced. How are these boards moving forward?
Well, really serious fiscal choices have to be made. Even though many projects were postponed during the pandemic and buildings probably had some cash around, there were many, many discussions about raising maintenance and doing assessments to recoup the loss of commercial income. They could also go for other revenue sources such as increasing storage license fees or flip taxes, or other streams like gym fees.
What about subletting? In condominiums, subletting is clearly an option, but in co-ops, not so much. Is this an area where co-ops could change their thinking in order to raise revenue?
I would think that it really is. I know it’s been typical for co-ops not to have subletting as a long-term option for owners, but it is certainly a revenue source, particularly when you factor in sublet fees and other kinds of charges for allowing people to sublet. That would certainly contribute to the building’s operating fund.
What’s your advice for boards facing a long-term future where commercial income will be less plentiful than it has been?
I think buildings have to understand that it is not this golden fund out there that will keep increasing from year to year and is an infinite source of wealth for them. Retail tenants are business owners who have their own businesses to worry about, and the price per square foot that boards were enjoying may not be attainable in the future. And they need to understand how that will impact the revenue they use to operate their buildings.