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GROUND LEASE NEARLY DOOMS CO-OP

Ground Lease Nearly Dooms Co-op

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Oct. 5, 2010 — The "ground lease" on the 132-unit co-op at the corner of East 61st and Lexington Avenue in Manhattan (at right; click to enlarge) was set to expire on June 30. If the co-op failed to negotiate a new lease with the land owner, then it would simply cease to exist: The building would revert to a rental property, and shareholders would lose their equity.
 
 That didn't happen, mercifully, because the co-op's board of directors woke up and realized no one was going to bail them out. With the help of its professionals, the board managed have to save the co-op. It was no mean feat.

There are roughly 100 ground lease co-ops in the city, an unconventional arrangement under which the co-op corporation leases or owns the building but a separate entity owns the land it sits on.

In the case of 150 East 61st Street, the co-op had until December 2009 to exercise its option to renew its 30-year ground lease. The owner of the land announced he wanted to raise yearly rent from $135,000 to $5 million — subject to arbitration — with unspecified increases every 10 years.

For the co-op, it was a grim prospect: an overnight four-fold increase in maintenance; unknown increases in the future; plus the reality that people hoping to buy into the co-op or refinance their mortgages would run into difficulty since banks are reluctant to lend in ground-lease buildings where the lease runs fewer than 60 years. Plus, there was no guarantee a new lease could be negotiated when the 30-year lease expired. For the co-op, it was a lose-lose-lose deal.

Steven Orenstein, a shareholder for the past 28 years, joined the board as treasurer four years ago specifically to work on a new ground lease. Orenstein realized the board needed to rely on its management company during negotiations that promised to become Byzantine.

"You've got to align yourself with people who have some expertise," Orenstein advises other boards facing any complex negotiation. "I've got a 35-year background in finance, but you've got to separate ego from business concerns. So, I took a back seat to our management company." Jeffrey Lamb, a principal in J & C Lamb Management, became the principal negotiator on behalf of the co-op.

When you don't have leverage,

you have to create leverage.

A number of attorneys had advised the co-op it had no legal recourse to fight the landlord's position. The landlord's attorney was in an "adversarial" mood, according to Lamb, because the landlord felt the rent had been artificially low for 40 years.

To further complicate matters, the building has three commercial spaces: a parking garage whose "sweetheart" master lease with the co-op generated $135,000 a year in income (which covered the cost of the co-op's ground lease); plus a Duane Reade drugstore and an AT&T Wireless store, whose leases were controlled by a bank. If the co-op renewed its ground lease for 30 years, the leases on the commercial spaces would be renewed at terms extremely favorable to the commercial tenants. Naturally, those tenants wanted the co-op to renew.

Lamb asked himself: "How could we finesse [the commercial tenants] to give up their under-market leases?" Adds the board's attorney, Stuart Saft, a partner at Dewey & LeBoeuf, "When you don't have leverage, you have to create leverage. It was the only way to get the commercial tenants into a better bargaining position for us."

One key to creating leverage, as it turned out, was to stop thinking of the negotiation as a real-estate deal or a legal deal and start thinking of it purely as a business deal. As a result, lawyers were not generally welcome at the bargaining table.

"We were able to convince [the landlord's] business people that it would be worth their while for the co-op to continue to exist," says Lamb. "I came up with a theory, contrary to accepted reasoning, that there's a risk to the landlord if we go to arbitration to set a new ground rent. That was the hammer. I convinced him I could persuade an arbitrator to set a rent much lower than the $5 million he was asking."

"We played a very logical card," adds Saft. "We pointed out that by hitting us with a $5 million rent, they would wind up with a rent-stabilized building. The real value for them was the commercial space. If we could get them the rent money from the commercial spaces, then they would be more flexible on the co-op's rent."

In a major act of brinksmanship, the co-op board decided last December that it would "go naked" – that is, not exercise its option to renew the ground lease, thus putting enormous pressure on all involved parties to come to an agreement.

Next page: On the brink of disaster >>

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