Co-op Boards Cannot Prevent Sales They Think Are Low Without Damaging Shareholder Values
I have spoken with buyers, sellers or real estate agents that were told by co-op board members their sale may not be approved by the board because the resulting “price per share” of the sale (purchase price/apartment shares) is less than a prior similar sale in the building. Here are some thoughts about co-op boards who try to “protect” shareholder values by preventing transactions.
Co-op boards wield a lot of power over a sale within their building. In a research study I coauthored that was published by NYU Furman Center for Real Estate and Urban Policy with Michael H. Schill and Ioan Voicu called The Condominium v. Cooperative Puzzle: An Empirical Analysis of Housing in New York City found that there was an inherent cost of a co-op board’s power over their shareholders, unlike the relationship between a condo association and their respective unit owners. It is important to note that market forces are far more powerful than a co-op boards intention to “protect” the market within their building. Much of this gateway mentality stems from the legacy of no public record for co-op sales prior to 2003 (made public record in 2006, but retroactive to 2003). When a co-op overextends it reach and stops a sale because the price is considered too low – often because it falls short of a recent similar apartment’s sales price – the co-op board is doing a disservice to their shareholders, despite best intentions. Why? The decline of a transaction where the listing was properly exposed to the market creates a public perception that the board is disconnected from the market. Brokers are less likely to bring buyers to listings within such a building in the future. Less market exposure for listings in the building means fewer potential buyers and ultimately a lower achievable sales price.
Housing markets do not always rise. This was made clear during the housing bubble and bust cycle a decade ago. The mindset of requiring a current sale to be higher than the last highest similar sale would prevent any sale from occurring when a market is flat or falling. This taints the building in the market and would make values fall much harder in a down cycle once the board capitulated. This would serve as a significant miscarriage of board power during such a cycle. I saw a lot of this circa 2009 after Lehman collapsed. A board would consistently nullify deals on a specific listing that was properly exposed to the market. By the time the third market vetted contract was signed at about the same price, the seller would give up and be possibly exposed to significant financial hardship. And since many co-ops are restrictive about a temporary rental scenario, the seller would be unable to rent the apartment after they moved out.
One of a few valuation remnants of the past includes a co-op board valuing a current contract sale on a price per share basis. This is a “shotgun” approach to determining a reasonable market value and is at best case, a broad brushstroke approach that is not suitable for an individual apartment valuation. Valuing by share allocation does not reflect the fair market value. When the sales price per share is consistent with a building average or trend, it is simply coincidence within a wide bandwidth of price probabilities. Such a price per share valuation philosophy would appear to violate the board’s fiduciary responsibility to protect its shareholders by penalizing them for a share allocation perhaps done decades or even a century ago. There is no science to the original allocation of co-op shares and the patterns are often fraught with inconsistencies. For example, the perception of value for a certain exposure in the building may be different today than it was in 1927. A buyer doesn’t look at a per share valuation in a building as market value for guidance – they never have. They look at competing properties in the market surrounding the property. Incidentally all of those co-ops with competing listings likely had different rationale for their respective allocations when they were built or converted.
Investor value can be mistaken for market value. In the case of the co-op board judging an adequate sales price based on the price per share within the building is known as investor value. It is the value to them, not the value to the market. This is why sellers can be so disconnected from the market when setting their asking price. A seller might think that a purple formica entertainment center in the living is worth another $50 thousand to a buyer when the buyer is thinking it is worth minus $2 thousand for the cost to remove it. Co-op boards are responsible to protect the interests of their shareholders but they can confuse that with market value.
A few definitions of Fair Market Value
IRS: “The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”
Investopedia: “Fair market value is the price that a given property or asset would fetch in the marketplace, subject to the following conditions:
1. Prospective buyers and sellers are reasonably knowledgeable about the asset; they are behaving in their own best interests and are free of undue pressure to trade.
2. A reasonable time period is given for the transaction to be completed.
Given these conditions, an asset’s fair market value should represent an accurate valuation or assessment of its worth.”
Merriam-Webster: “a price at which buyers and sellers with a reasonable knowledge of pertinent facts and not acting under any compulsion are willing to do business”