Second Thoughts on the Second Look -- Liquidated Damages Provisions in Real Estate Purchase and Sale Agreements

by Thomas V. Bennett

Why are co-operatives, the predominant form of ownership in some states so rare in Massachusetts?
 

What is a co-op? There is an important difference between condominiums and co-ops. A unit owner in a condominium owns the condo unit itself, together with certain rights to use common areas. The owner pays property taxes on the condo unit, and usually finances the purchase of the unit with a mortgage secured by the unit.
 

In contrast, a co-op is a corporation formed to own multi-family residential property. A co-op member does not own his or her unit. Rather, the co-op takes out a big mortgage on the entire building and then the co-operative owners buy shares of stock in the co-operative corporation. As a result of holding that stock, they are entitled to a proprietary lease to occupy an apartment within the building. The rent co-op members pay on their proprietary leases funds payments of the principal and interest due on the co-op's building mortgage, the real estate taxes payable by the co-op on the building, and maintenance charges for the upkeep of the building.
 

Many co-op purchasers need financing. When a cooperative is initially marketed, purchasers are able to take advantage of the co-op's mortgage on the whole building to partially finance their purchases of individual units. The portion of the building mortgage attributable to the unit in question is applied to reduce the unit's purchase price. Thus, at the beginning, when the building mortgage is large, co-ops are attractive because the co-op's building mortgage reduces the individual financing needed by the unit purchaser. Over time, however, as the co-op's equity increases and the building mortgage is reduced, the value of each unit increases and future buyers might be required to pay in cash or finance individually as much as 40% or 50% more.
 

Good financing remains difficult to obtain. Historically, banks and similar institutions were limited to making "first mortgages on real estate," defined as land and attached buildings. In the 1970's, the regulations governing financial institutions were changed so as to recognize a condominium as real estate on which a first mortgage could be taken. Only later did the regulations recognize as real estate shares of stock in a cooperative and related proprietary leases.
 

Thus, Massachusetts real estate brokers, developers, attorneys and bankers became familiar with condominiums at a much earlier time. Condominiums were simply better understood by consumers, bankers, attorneys, brokers and developers than were the more complex co-operatives. That better understanding led, in turn, to a profusion of condominium conversions in the 1970's and 1980's to meet the housing demands of the then-arriving baby boom. Consequently, most of the buildings in the Back Bay which were converted from singular to multiple ownership used the condominium vehicle rather than the co-operative to achieve that end. Condominium conversions are still the most popular option when converting a building into multiple units.
 

The relative unfamiliarity of, and lack of interest in, co-operatives has created a problem for co-op purchasers needing financing. The co-op market in Massachusetts suffers from a vicious circle. Because co-ops are less popular, a competitive market for co-op financing has not fully developed. Relatively few lenders deal with co-op loans due to the complicated co-op structure and the significant upfront investment cost associated with a bank entering the co-op lending market. Because a fully developed co-op lending market is lacking, rates remain higher than they would be with more competition, attractive financing remains difficult to find, and co-ops remain less popular.
 

Given the dominance of condominiums, and the problems with co-ops discussed above, the condominium option will likely continue to be the building to units conversion tool of choice in Massachusetts.