Real Estate Weekly
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Rise of commercial co-ops: High risk, high reward

By Rab N. Nalavala, Special Counsel,
and Matthew S. Schneid, Associate, Cole Schotz P.C.

$140 million, $86 million, $42 million * — are these purchase prices for entire buildings?


No, quite the contrary, these are the reported prices for retail co-op units under contract or sold in the past year.

While these prices seem hefty, with rents on lower Fifth Avenue at $400 per square foot and $600 per square foot in SoHo (and a lofty $975 per square foot near Broadway), the potential for big returns is drawing investors to riskier commercial co-op units.

Reaping these rewards, however, can be complicated, time consuming and expensive – as investors must navigate a minefield of commercial, legal and practical concerns.

This article highlights some of the critical asks, wants and must-haves for potential purchasers of retail co-op units.

Individual vs. Collective – Who Owns the Retail Co-op Unit?
Understanding the risks of the asset class you are purchasing is critical – condominium units are comparable to purchasing real property, whereas the purchase of co-op units constitutes the obtaining of shares in a corporation, along with an accompanying leasehold interest.
Retail co-op units are either owned by the co-op or by a third party (pursuant to the purchase of such co-op unit from a sponsor or the co-op).
When dealing with the co-op itself, either the co-op has previously issued the co-op shares or there remains unallocated space in the building for the further issuance of co-op shares.
In order for the co-op to issue new shares for a proposed retail co-op unit, the co-op typically must seek approval for such co-op unit from the New York State Attorney General’s office.
TIP: In a Contract of Sale with a co-op seller of unissued shares, purchasers should provide for enough time to procure AG approval, however, with the right counsel such approval should be obtainable.


“Master Leases” – Are You a Servant to this Age-Old Co-Op Structure?
As a result of the “old” 80/20 rule (restriction on no more than 20 percent of the co-op revenue coming from a co-op retail unit), many retail co-op units, whether shares were issued or not, were operated under a leasehold structure as follows: (i) co-op would “master lease” the unit to itself or a third party and (ii) the tenant under the “master lease” would in turn sublease the unit to a retail tenant.
If you purchase a “master lease” you have no direct interest in the co-op and accordingly your rights may be substantially limited, including possibly having a limited term left on the “master lease”.
TIP: Lenders often incorrectly equate “master leases” with ground leases, and accordingly are looking for similar protections.
Unless co-op boards are willing to provide such additional protections, such “master lease” purchases can be difficult to finance.

Approvals – Bored of Boards?
One of the biggest issues with the purchase of retail co-op units is ascertaining whose approval is required for the sale.
For third-party resales, once you strike a deal with the Seller, the sale should then only require approval of the co-op board.
If purchasing directly from the co-op, the co-op documentation prevails – which could constitute unanimous approval or likely a super-majority of shareholders (e.g., two-thirds, eighty percent, etc.).
Approval by the board can be complicated – shareholders have varying economic interests (some are eager to reap the rewards of a sale, while others are concerned about the tax consequences from distributions pursuant to the sale) and time frames for approvals can vary due to never present shareholders or the inability of existing shareholders to agree on all details.
TIP: With respect to a third party resale, purchasers still need to put in the “leg work” to charm the board, as they are not receiving the spoils of the sale and may be wary of changing the status quo.
In certain instances, purchasers (in cooperation with sellers) have swayed co-op boards by providing financial incentives to the building as a whole.

Proprietary Leases, By-Laws and House Rules – Static or Alive Documentation?
When purchasing directly from the co-op, purchasers may be in a better position to revise the existing proprietary lease, by-laws and house rules, which, as initially drafted, may not have the protections that investors or lenders want and need.
Such protections include the ability to transfer and/or lease the retail unit, without the co-op’s approval, and to minimize the ability of the co-op to charge additional costs to the owner of the retail co-op.
Whereas, when purchasing directly from a third-party seller, there is limited ability to renegotiate the underlying co-op documents (thereby not receiving the aforementioned protections) – in fact, there may be additional costs baked into the purchase price, including a flip tax to be paid to the co-op.
TIP: A critical purchaser protection, whether purchasing directly from the co-op or a third party resale, is to restrict the ability of the co-op from dissolving without the consent of the retail co-op owner, whereupon such dissolution a purchaser may only receive proceeds from the dissolution comparable to those of the residential co-op units (in relation to proportionate number of shares owned), rather than the increased value of the retail co-op unit.

Financing Co-op Units –You Better Recognize?
Purchasers should anticipate the following financing hurdles: lower loan-to-value ratios than traditional financing as a result of the added risk arising from the co-op structure, limited lender pools and increased lender deliverables due to the complex nature of the asset.
Lenders will require a recognition agreement from the co-op board, which can be difficult to procure if the co-op documentation is outdated or fails to account for customary financing provisions.
TIP: As part of the Contract of Sale, purchasers should require a recognition agreement from the co-op board as a closing deliverable, and, in turn, should ensure that their lender is signed-off on such form of recognition agreement.

While this initial primer on retail co-up units can serve  as a guidepost for retail co-op unit purchase and sale transactions, the above highlights the need for investors to have a strong team of consultants and attorneys providing guidance.


* As of August, 2015, The Carlyle Group and 60 Guilders are in contract to purchase a retail co-op unit at 106 Spring Street and the adjacent 93 Mercer Street for $140 million.

* As of April, 2015, Wharton Properties closed on the purchase of a retail co-op unit at 85 Fifth Avenue for $86 million.

* As of January, 2015, Joe Sitt closed on the purchase of a retail co-op unit at 1114-1120 Madison Avenue for $42.3 million.

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