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The Valuation of Condominiums and Cooperatives

It is bound to happen sooner rather than later. The condemnation of an entire condominium or cooperative apartment house or development. It just hasn’t happened yet. What raised the subject was we being asked by both a potential condemnee and a potential condemnor how such properties would be valued. We gave the best answer we could at that point but it started us thinking about the subject. We are aware of no reported New York cases involving such a valuation, although recently the State of New York condemned a portion of the common area in a gated community operated as a condominium. The taking was for a road widening and the part taken was part of a common element, with the bylaws providing for payment for the taking of a common element to all of the owners proportionately. Claim was also made by four unit owners for depreciation in the value of their individual units by being placed very close to the road. On a motion to dismiss one of the claims the Court of Claims upheld the unit owner’s right to be separately compensated for the damage to his unit. (Murphy v. State of N.Y., Claim No. 103472, Motion No. M-63748, filed April 28, 2003, Nadel, J.). That decision is being appealed by the State on the ground of standing to make the claim in that the unit owner is barred by terms of the by-laws. If the State were upheld, it would be a result that was probably never intended by the drafters of the by-laws. Nor do we believe the by-laws should be read that way (we have read the provision).

In seeking answers to the problem, we consulted with appraisers, several attorneys who practice in the area of condo and coop law, and read the statutes and regulations in this area, texts such as the Appraisal Of Real Estate, 12th ed., by the Appraisal Institute, the Appraisal Journal and Nichols on Eminent Domain, among others, none of which provided much help. None of the texts or statutes directly addressed the problem. Whatever text there was focused almost exclusively on acquisition of part of the common element. While we learned how lenders view such properties for mortgage purposes from appraisers and how they are valued in tax certiorari proceedings by reading case law, none of this was helpful for the reasons hereafter discussed.

There appears to be nothing in New York case or statute law to tell us how a coop or a condo is to be valued in a condemnation proceeding. That conclusion was confirmed by others to whom we spoke. What we propose to explore here are the appraisal problems in a condemnation proceeding, which are separate and distinct from those in a tax certiorari proceeding, as well as those for mortgaging purposes.

It is well to first define the terms for therein lies the seeds of the problem. The Appraisal of Real Estate defines a condominium as “a form of ownership of separate units or portions of multitenant buildings that provides for formal filing and recording of a divided interest in property.” Not only does the owner have an individual title to a spatially described part of the building or development, but he owns an undivided interest, together with the other unit owners, in what is called the common areas or elements, such as lawns, lobby, corridors, elevators, etc.

The cooperative is a different entity, legally, although not in purpose. There, a stock corporation owns the entire building and issues proprietary leases for specific units, as well as use of the common areas, and proportionate stock in the corporation. Thus, different from the condominium, the coop corporation owns the building and the lessees merely have stock in that corporation, together with a leasehold interest. That distinction, if dealt with literally, might cause an entirely different valuation scenario, if one exalts form over substance. Sec. 339-i of the Real Property Law states that a condo unit, together with its common interest, constitutes real property. But the same can be said of the coop interest. A lease is an interest in real property.

In order to keep the cash down required to buy or lease a unit, before the sponsor puts a coop building on the market, he may place a mortgage on the building as a whole, with the carrying costs of that mortgage being part of the maintenance costs or common charges, together with the other operating costs. In a condo, unit owners can mortgage their individual units plus their rights to the common areas. Coop lessees can also borrow on their lease and stock interest in the corporation, but secured by a UCC. Each of these interests must be accounted for in a condemnation proceeding. Further, it is not unheard of for a coop to be built pursuant to a ground lease.

In the valuation of either form of ownership in a tax certiorari proceeding it is governed by statute (Real Property Tax Law, Sec. 581). There the property is valued as if it were a rental apartment building, with the value fixed as one entity. Since it is the corporation which pays the taxes, no further step is necessary. Where it is a condo and where each unit is assigned a separate tax lot number, it requires the further step of allocation to each individual unit of its proportionate share of the one overall value. This artificial valuation methodology was created as a form of subsidy to what, in real life terms, were individual home owners. It was to give them the benefits of lower taxes such as one and two family home owners enjoy. How this came about is explained by the fact that the value of an apartment house based upon its rental income is perceived to be and is in fact significantly less than the total market value of all the units in a coop or condo building. This statute, in effect, recognizes how the market place treats the two different types of ownership, i.e., a difference without a distinction, both being a form of home ownership.

Where a mortgage is placed on a cooperative building as a whole the bank’s appraisers will, for understandable reasons, not be interested in the sum total of the value in the coop market of the individual units but will instead value the building as if it were available for rent. We say understandable because, if a bank were to foreclose, it will not want to be in the business of selling individual units but be in a position to collect rents. It is different on loans to individual unit holders and/or lessees, where borrowing is based on the unit’s sale price in the market place.

The next fact to be put into the mix is that we have never seen nor heard of the sale of an occupied condo or coop building as a whole nor do the attorneys or appraisers tell us of any, except for bulk sales of unsold coops or condos by the developer. Clearly there is no discernable market as such. That is to be distinguished from sales of buildings available to be turned into one or the other. On the other hand, there is a ready market for the sale or resale of both condo and coop units. At any point in time, any appraiser can come up with multiple sales. Like all real estate, the prices will be influenced by location, underlying mortgages, condition, amenities and the like. In both, a major influence will be the amount of the maintenance charges and the amount of cash required, same as in buying a one family house.

So how do you value such buildings? The answer appears to speak for itself. You should not be able to value the condo or coop property, absent a statute which requires it, as a rental building. It is not such a building and considerable time, entrepreneurial effort and money went into converting it into either. Nor is there any market for sale of the building as a whole. The only sales are of individual units, whether coop or condo. The valuation as a rental will not only produce a value considerably less than the total value of all of the units but it will be valuing an entity which does not exist. Nor should the value be based on an average unit applied to the whole. The average of one and eleven is six, but that does not tell you anything about one or eleven.

Nor does the considerations as to a taking limited to part of the common elements shed any light on the problem. The bylaws of either the coop of condo usually provide for what happens when there is a taking of a common element but it and the proprietary lease is usually silent on the subject of a condemnation of the unit itself. We say usual in that we have seen a coop proprietary lease giving that lessee the right to file his own individual claim. We are also told that neither statutes nor regulations cover the subject, other than as to common elements, by being silent. It seems to us that it may be that all of them presuppose the individual unit owner or coop lessee will file his own claim or the drafters assume as such a taking has never happened it never will. In the taking of the whole, valuation principles dictate that no separate award would be made for the common elements as their value is reflected in the value of the units themselves and has but nominal value. It is no different than the valuation of property fronting on a street, the bed of which is owned by the abutting property owners and has but nominal value.

We perceive of no problem in the valuation of condos, since each unit is individually owned in fee. Coops present a different problem, in that each is occupied under a lease with the ownership in a corporation where the law in condemnation proceedings prescribes a methodology for valuation of a leasehold, which is totally inapplicable to a coop and does not produce its market value. The valuation of a leasehold involves the value of the rent advantage the tenant holds over the lease term i.e. the difference between the rent reserved in the lease and the rental value, multiplied by the years remaining in the lease discounted to present value. In a coop there is no rent nor rent advantage nor any term. In point of substance, the coop lessee owns as much of a fee as does the condo owner. In this regard, one can understand the problem in valuing a cooperative when one understands it in terms of the description in New York Jurisprudence, 2d, Sec 140; “the interest in a cooperative apartment is sui generis in modern property law, because it does not fit readily into traditional property classifications. The interest is represented by shares of stock which are personal property, yet in reality what is owned is not an interest in an ongoing business enterprise but a right to posses real property.” Later it states what we believe is the root cause of the problem in valuing coops in condemnation if you try to be guided by its form: “this unique dualism of personalty and realty interest has engendered numerous legal complexities in determining which property interest shall predominate in different types of actions involving cooperative apartments. Characterization of an interest in a cooperative apartment, therefore, is not resolved by uncritical resort either to the rubrics governing real property or those governing personal property”.

Nichols, Sec 12D. 02 (3)c) (3d ed.) in discussing the valuation of a condominium states: “There are two ways to assess the value of a condominium taken by eminent domain, either by assessing the value of the entity as a whole or by aggregating the value of the individual units”. “In general, a condemning authority prefers to value the condominium – – as one parcel, owners, generally fearful that a single valuation will produce a smaller award, prefer appraisal on the unit basis. Sound arguments can be advanced in support of either method. Not only is the unitary appraisal more simple than a fragmentary one, but it also enables the public authority contemplating condemnation to gauge its probable cost with a greater degree of certainty. Regardless of which method is used, just compensation requires that condemnees receive the fair market value of their property, not the cumulative worth of their various interest therein.”

The fact is that it is impossible to value either a condo or coop building without resort to the cumulative worth of all of the interests, if you are fixing the value of the entire building. But that begs the question as the issue should not be the value of the whole but just compensation to each individual owner. The real expediency is not what Nichol’s states but in the methodology of the coop or condo itself in dealing with ground leases, where applicable, and underlying mortgages, since there they relate to the entire property not just individual units. Assumedly each unit’s value is proportionately reduced by the amount necessary to pay off the mortgage or ground lease. The real problem is that these problems should be dealt with in the underlying documents and we are told that almost all are silent on the subject of condemnation of the units themselves. How does one value the entire, clearly not by rental as in an apartment house. They are not the same. Nor by rental or sale of the property as a whole, it never happens. Supposedly one could take sales prices of comparable units in other buildings and come to an average unit of value and leave it up to the underlying documents to apportion it among the various owners, treating the proprietary lessee as an owner, which he is, if you ignore form. And in all of this we are dealing with an entire taking or even of one or more units, less than the whole, where, clearly, justice, if not the underlying documents, requires valuation of the individual units involved.

Some of the problems we foresee in a valuation of the entire as a unit as Nichols suggests are as follows: (a) is the entire to be valued as the owners would sell them, one at a time, or some other methodology to get a value of the whole such as an average unit price; (b) how does one deal with unsold units in the sponsor’s hands; (c) how does one treat with tenants existing before a conversion who opt to continue as tenants and pay rent, rather than buy; (d) how does one value the whole in a mixed use building, stores, offices and apartments (which, no matter which method is used, is a problem); (e) since what we are dealing with is what in essence are peoples homes, no different than one family houses ,and these owners make modifications to their homes, affecting their value, how are they justly compensated in a valuation of all as single unit.

When starting to research to write this column we admit we were not on neutral, but it is only as we started to talk to appraisers such as Daniel Sciannameo and Robert Von Ancken who gave us insight into the appraisal process and we read the statutes, regulations and texts as well as sample documents that we have come to the firm conclusion that, in the case of all or specific units being taken, the only method that is both feasible and just requires a valuation of each individual unit. The problems of underlying mortgages and ground leases while complicating the process is handleable and on balance should not be the determinant. While it may be expedient to do it otherwise, it would not do justice. As one would value 20 row houses which are individually owned on a house by house basis, there is no reason to treat either condominium or cooperative units differently.

At the end of the day, we believe that if the information we have received is accurate, that the underlying documents for both condos and coops are largely silent on the subject of condemnation, that is a situation which should be rectified, or we may see some strange results in condemnation proceedings.

Reprinted with permission from the April 28, 2004 edition of the New York Law Journal © 2010 Incisive Media Properties, Inc. All rights reserved. Further duplication without permission is prohibited.