GUEST BLOG: by Marc Gerstein
Marc Gerstein is a Forbes Columnist and Director of Research at Portfolio123 as well as a former assistant research director at Value Line. Please follow him on Twitter: @MHGerstein
If you’ve ever shopped for a two-bedroom co-op or condo, you may have browsed a popular web portal such as Zillow.com and produced a list of possibilities such as: Condo Unit A with an asking price of $499,900; Condo Unit B priced at $546,000; Condo Unit C priced at $625,000; Co-op Unit D priced at $279,888; Co-op Unit E priced at $795,000: and Co-op Unit F priced at $579,000.
The identities of the apartments are, of course, disguised but they are drawn from a recent set of real-life listings in a particular Queens neighborhood.
So, are you ready to choose? Many people will quickly zero in on Unit D. You won’t immediately decide to buy it. You’ll want to know about the location, the layout, the appearance and condition of the building, board rules, etc. But the typical buyer would probably approach D with an innocent-until-proven-guilty presumption. At the other end of the scale, many would be turned off by Unit E, the highest-priced apartment.
What about Unit A? It’s the cheapest condo? Condos do not require board approval. You can sublet more easily. Many would rather have a condo than a co-op, but are put off by higher condo prices.
Guess what: Complete analysis of the numbers will show that D is indeed, the cheapest apartment, but also that the difference between A and D is so narrow, you could easily treat yourself to A if that apartment better suits your fancy. And if you’re an upscale buyer, E is not priced as aggressively as the first impression suggests.
A More Thoughtful Basis for Comparison
Even if the units would be identical in terms of appearance, location, etc., we should not choose based on price alone. No matter where we live, we have to deal with property maintenance, real estate taxes, and mortgage costs. This is crucial because the total monthly housing cost compared to your monthly income is important to lenders who decide whether to give you a mortgage loan, to co-op boards who decide whether to accept you as a shareholder, and to yourself as you decide whether the expenses associated with a particular home will leave you enough money to live the rest of your life as you choose.
So we need more information some of which may be easy to find on consumer real estate web sites and some of which may not. But a real estate agent who is a member of the local MLS can easily get the raw data you need and might present an analysis that looks like this. (By the way, there is no reason for a buyer to avoid using a real estate agent; the fee for a purchase is paid entirely by the seller.)
This helps. Unit D has a very low asking price, but the monthly maintenance is quite high. And now, we see why F might not be such a crazy possibility for upscale buyers. The seller is, indeed, asking top dollar, but other upscale co-ops come with higher maintenance charges.
In comparing the co-ops and condos, many will assume condo common charges are equivalent co-op maintenance. But what about co-op real estate taxes? Also, why on earth are co-op maintenance charges so much higher than condo common charges? And by the way, what about taxes in general? You may have heard something about income tax breaks associated with real estate ownership. Is that for real and does it apply to co-ops and condos?
The answers come from the fundamental difference in ownership structure. With a condo, you have direct ownership of your apartment plus joint ownership of common areas such as hallways, grounds, elevator, etc. With a co-op, the entire building is owned by a corporation; you are a part owner of that corporation and the most important privilege of ownership you have is the exclusive right to occupy your apartment (under a “proprietary lease”). Therefore . . .
- The co-op corporation, the owner of the building, is the one that pays the real estate taxes. It comes out of the monthly maintenance charges you pay. Condo owners, who have direct title to their units, pay real estate taxes directly.
- As a direct title holder, condo owners pay the entire cost of their respective apartments. For co-ops, the cost is divided. Much of the “investment” was made by the co-op corporation which finances its purchase with a mortgage loan. The costs associated with that mortgage are an important part of your monthly maintenance.
- There is no building-mortgage cost in the condo common charge. But since you are making the entire investment in the apartment rather than sharing the burden with a corporation, your personal purchase price and mortgage are likely to be higher.
Are you confused? That’s OK. Forms of real estate ownership evolved over many years and sadly, clarity was never anybody’s goal. For more details on differences between co-ops and condos, and how those differences impact monthly costs of ownership/occupancy, click here. For now, it’s enough to know that co-ops and condos involve the exact same costs. What differs is how they appear to owner-residents, whether as direct costs (those borne by the owner-resident) and indirect costs (those borne by a co-op corporation and passed on to the owner-resident).
Now, We Know What to Look For
Since co-ops and condos really involve the same costs, albeit presented differently, we now know how to compare apartments, how to make sense of the constellation of numbers we saw in Table 1. For each apartment, we (or at least your real estate agent) can translate all those numbers into a single monthly total.
- For condos, we calculate: monthly personal mortgage expense plus monthly common charge plus monthly personal real estate tax (taxes are paid quarterly so we take those figures and divide by three).
- For co-ops, we calculate: monthly personal mortgage expense plus monthly maintenance.
As a result, we wind up with a single number for each apartment and regardless of differences between co-ops and condos and all of the numbers can be directly compared. Table 2 shows what this looks like.
(NOTE: For this and subsequent Tables, I make a set of standard assumptions regarding mortgage rates and terms, taxes, etc. all of which can be modified as changes in real-world conditions and/or client circumstances warrant.)
Going back to the comparison between A and D, we see that Unit D is still a lot cheaper than Unit A, but we’ve narrowed the gap. On the basis of asking price, Unit D is 44% cheaper. But when we translate everything into overall monthly costs, we see that Unit D is, in fact, 23% cheaper.
We Aren’t Finished
Remember that question about tax breaks. It’s now time to look at those. Interest on mortgages is deductible against your income taxes. So, too, is real estate tax. Condo owners (and/or their accountants) know exactly what those numbers are. Co-op shareholders know about the interest on their personal mortgages, and the co-op (through the managing agent) tells them each year how much of their maintenance was spent on real estate tax and interest on the building mortgage.
Using this new information, Table 3 adds a column that displays the after tax (net) monthly costs for each apartment.
We Could Stop Here – But Let’s Not
Notice that while all are two-bedroom apartments, several have more than one bathroom. Should that justify a higher price?
That’s a matter of individual taste. Frankly, though, if your household is big enough to warrant the purchase of a two-bedroom apartment, and especially if it includes one or more teenagers, you may decide it is well worth paying up for another bathroom. Because many buyers think this way, I assign a room score to each apartment I evaluate. I assign one point for each bedroom and 0.65 points for each bathroom (and adjust if a client has a different set of preferences).
My final comparative number is something I call Standardized Monthly Apartment Cost (SMAC). It’s the net (after tax) monthly divided by the room score. The complete set of numbers is shown in Table 4.
Look again at A and D. Now, Unit D is only 4% cheaper than Unit A. When we started, it was all D all the way. Now, we see that Units A and D are equally viable and we base our decisions entirely on other things; location, appearance, condition, desired equity investment-buildup (D requires a bigger up-front cash outlay, but would also produce a bigger equity buildup over the years), etc.
Let’s now take another look at the upscale apartments.
At first, we were put off by the very high $795,000 price being asked for Unit E. Now, however, we realize that the most aggressive seller is the one who listed Unit F. Its SMAC is driven up by its much higher monthly maintenance and the fact that it has only one bathroom. Even Unit C, the most expensive condo, looks like a much better deal when we compare SMAC figures.
Technology, Love It, Use It
Insights like these are why, as soon as a client says the world co-op or condo, I run my MLS searches, download lots of data into my Excel models and crunch SMAC scores for each apartment being considered and for others in the area. I also use it to help me understand the market as a whole, as in a recent blog post in which I showed that Flushing, deemed hot by The Real Deal (together with Long Island City), a noteworthy real estate industry trade publication, is actually developing a bit of a chill.
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