Selling Common Space: A Primer

Several years ago, for instance, one of our co-ops found that that large areas of the building, including a swath of stairwell space covering the entire height of a tower, required bracing and shoring. One of these stairwell shafts abutted the A-line apartments' kitchens and the D-line's master bedrooms. During the course of massive structural repair to the stairwell, the board realized that the space could be finished and partitioned with walls, floors, and ceilings and then leased to A- and D-line shareholders for use as extra pantry and closet space. The board also realized that once the cellar space at the bottom of the stairwell was shored up that it could also be finished and converted into storage rooms and bicycle racks that could be rented out to all the tenants

License to Make a Killing

The first step for any co-op board is to decide whether to sell the space to a shareholder by issuing additional stock, with the new area then going under the purchaser's proprietary lease, or renting the space by issuing a revocable license agreement. When a space is sold, it's automatically passed on to successor shareholders. When the space is rented through a license agreement, the right of use reverts to the co-op at the time the arrangement is terminated.

Co-op boards typically elect to sell rather than rent their extraneous space because they can more easily justify charging a large upfront payment when they are transferring ownership, thereby adding permanent value to the apartment.

With condominiums, it works differently. Here each unit-owner owns a portion of all common space as a tenant-in-common with every other unit-owner. Since condominium boards cannot sell what they do not own, the only way they can dispose of extraneous common space is through a the kind of license agreement discussed above.

The second step is to appraise the space. Condo and co-op boards issuing license agreements need to determine the fair rental value. Co-ops specifically must decide on the appropriate share allocation for the area being sold. The additional monthly maintenance to be paid by the acquiring shareholder is a function of this share allocation.

IRS regulations require that each share allocation in a building be "reasonably related" to every other share allocation. Otherwise, every shareholder could lose his or her tax deduction for mortgage interest and real estate taxes — and thus an appraiser's opinion letter attesting to the "reasonableness" of the share allocation and the fair market value of the subject space is absolutely necessary. The appraiser's fees and all other costs (including the board's legal fees) associated with a sale or rental of common space are typically borne by the acquiring shareholder or unit-owner.

Since license agreements, on the hand, don't involve the sale of square footage or of stock, co-op or condo boards that rent rather than sell may proceed with the negotiation and execution of their license agreements once they get the appraisal.

The "No Action" Action

The next step for co-op boards is obtaining a "no action letter" from the attorney general's office. Broadly speaking, New York State securities laws provide that whenever newly minted shares of stock in a corporation are to be offered for sale, they must be accompanied by a prospectus.

However, recognizing that preparation of that document is an extremely cumbersome process, and so for very small offerings of cooperative stock, the attorney general created a streamlined procedure. Basically, you file an application describing the nature of the stock offering and provide detailed background information about the cooperative corporation, along with a corporate resolution authorizing additional shares. Then the attorney general will typically produce a letter assuring the board that its office will take "no action" against the corporation for offering shares without a prospectus. The board is then free to proceed with its stock sale.

Following receipt of such a letter, the board adopts corporate resolutions setting the price per share of the newly issued stock, and authorizes execution of a sales contract with the acquiring shareholder. Then it all goes to closing, where the shareholder receives a new stock certificate and proprietary lease combining the new shares with his or her existing shares. After that, the acquiring shareholder is billed for maintenance and assessments based on his/her new share allocation.

Boards, of course, need not wait for disaster to strike before locating available extraneous common space and tapping into such hidden assets. Architects can be commissioned to review building plans and spatial configurations with an eye toward identifying areas as fertile ground — or patio, or walkway, or basement area — for the board's cultivation of new revenue.

 

Bruce A. Cholst and Mary L. Kosmark are each a partner at Rosen & Livingston.

Adapted from Habitat February 2008. For the complete article and more, join our Archive >>