Landleases: When The 'Worst Case' Scenario Happens
Picture this: you know that the land rent for your doorman co-op building will increase in 2009 but you don't know by how much. You know you bought your apartment for below the market value of comparable apartments in the neighborhood because of the uncertainty of being in a land-lease building. Since the land-lease has another 50 years, you're not that concerned about it and felt like the discount was priced in.
You go to a shareholder meeting about 18 months before the land rent is going to be renegotiated with the leaseholder and the "worst case scenario" presented is that the land rent will go up by 150%. The land rent of $500,000/year is 25% of your maintenance. So your understanding after the meeting is that the "worst case scenario" is that your maintenance could go up by 50%. It's a bummer, but only 2 or 3 people who attended the meeting put their apartments on the market because the outlook doesn't seem that bad.
Fast forward 18 months. You receive a notice that the land rent is going up to $2,500,000. Your maintenance is going to double! The entire building is in shock. Based on the research you did on land-lease buildings before buying the apartment, this kind of land rent increase is unprecedented for a land-lease building in Manhattan.
Property values in the building plummet:
Straight studios that once sold for ~$350K are now asking:
$290K
Alcove studios that were once selling for ~$400K are now asking:
$239K
$325K
Junior 4s that were once selling for $675K are now asking:
$555K
The only thing that the shareholders can do is to negotiate with the leaseholder to buy the land. Your maintenance will still be very high, but at least then you wont have to worry about the land rent increasing every 10 years or the landlease expiring (which has never happened in NYC to my knowledge). And at least the interest on the underlying mortgage will be tax deductible whereas I'm 99% sure that land rent paid to a private owner is not tax deductible.
What could have been done to prepare for this? Every few years, the board could have increased the maintenance to build up a reserve fund over time to buy the land when the 25 year fixed land rent period was up. Instead of planning for the renegotiation of the land rent, the board chose to keep the maintenance as low as possible for as long as possible.
What could be done now to lower the maintenance & increase property values? Allow everything: pied-a-terre and co-purchases are already allowed, and the building only requires 15% down. After two years you can sublet your apartment for two years - change the policy to allow unlimited subletting. Allow investors to purchase in the building. The pet policy is that only pets under 40 lbs are allowed - start allowing pets of all sizes. Right now there is a full time doorman - cut the doorman back to part time or eliminate the doorman entirely. Increase the supers salary and ask him to take packages and dry cleaning. Un-landscape the roof deck so it doesn't need as much maintenance. Find or create room in the basement to rent out storage. Sell the commercial space. There are still rent stabilized tenants in the building. Try to get anyone who doesn't meet the rent stabilization laws out of the building so the building can benefit from the flip tax when those apartments turn over in the future. Put a cell tower on the roof deck to generate monthly income.
NOTE: A land-lease owned by a private owner is very different from a land-lease owned by the City of New York. So if you live in Battery Park City and are reading this, please don't freak out!
To be continued...
Comments (13)
Toes, really interesting article. Do you have a sense of the range that the co-op owners should offer to the land owner to purchase this piece of land?
Posted by AA | December 18, 2008 11:02 AM
The alcove stuio is less than the straight studio and is 100 square feet bigger. Go figure.
Posted by Donald | December 18, 2008 4:44 PM
UPDATE: The $239k alcove studio is now $195,000!
Posted by Donald | December 18, 2008 4:50 PM
Why would any sane person ever enter into an agreement like this? If you erect a large valuable, immovable building on top of someone else's land you become a "captive audience" to the landlord. If I had a deal like that I would extort every last penny out of the building owner(s)- what are they going to do? move the building?
Am I missing something here? Are there clauses in these contracts that either force the landlord to buy the building on the property or otherwise compensate the building owner? If not, it just seems like a recipe for disaster.
Posted by kevstev | December 19, 2008 1:03 PM
All of your comments are true about what should have been done 25 years ago, but is obviously too late now. However, shouldn't the shareholders somehow feel a little at fault as well for voting for a board that didn't understand their land lease for all those 25 years. Was there turnover on the board over the past 25 years? Had maintenance been increased over the years, then the building would be sitting on cash to pay the increase...right? Has the board changed and do they have people on the board now that are professionals that understand this?
So, if the building buys the land....what happens to the value of the apartments? Does it go up and by how much? Is this an investment opportunity now? How much does the maintenance being as close to 100% tax deductible (due to the new mortgage debt that you mention) affect the value of the apt vs. something that is only 30% tax deductible?
Posted by Confused | January 15, 2009 10:37 AM
What recourse do tenants in buildings have against the board? It seems like boards who did not see this coming, were fairly negligent. Also once this happens, what is the responsibility of the board to keep tenants / owners informed of next steps around either buying the land or taking some of the steps you've described to lower the maintenance?
Posted by Anonymous | February 20, 2009 4:35 PM
The board is elected by you, your fellow shareholders, or prior shareholders each year. This isn't something that happened overnight so I am not sure how you would have recourse back to them.
From a legal perspective and monetary perspective keep this in mind. If you try to go after the board, all board of directors are covered under board of directors insurance. The insurance policy likely has a deductible that will cause the shareholders to have to pay...meaning it comes out of your pocket anyway. Plus if you lose, you might be responsible for the buildings legal bill as well as your own. So be very careful.
The board does not have to keep shareholders informed as it is not customary and required unless so written in the bylaws (likely it isn't). However, boards will typically provide information when it will not affect anything that is being negotiated, ie. price for a purchase of land outlined above, mortgage discussions, leases for retail space that are being negotiated, etc.
However, boards are required to hold annual shareholders meetings. What I suggest is that you work with your board in an amicable manner. They didn't put you in this situation. They are in the same boat as you and have the same interests as you, which is to increase the value of everyone's apartment in the long run. It is too late to change anything in the short run.
Posted by Neil | February 25, 2009 3:45 PM
Christine and Anon,
I'm sure some shareholders lost out substantially because they were uninformed, but in my opinion the board did nothing wrong. They simply chose to delay paying up for as long as possible -- it's just one way of doing business.
I'm going to use a sports analogy, specifically, the baseball free agency system. To try to make it as simple as possible (i'm gonna ignore arbitration to make things simpler) -- star players generally cannot hit the open market and make the big bucks until 6 years into their career. Some teams, like the Cleveland Indians, will see that they have a young budding star, and after (say) 2 years they will choose to sign the player to a long term contract that pays them significantly more now but significantly less once they would have been eligible for free agency. Other teams like the New York Yankees prefer to keep costs on young players as low as possible for as long as possible and then pay the player the big bucks once free agency is upon them. This is simply a business decision.
I think what is really interesting is what kind of relationship the original sponsor had with the land owner. I agree with kevstev that agreeing to land lease like this just makes no sense -- except that unless buyers are savvy it really does not impact the sponsor as long as he is able to sell the units. Perhaps the sponsor is even related to the land owner -- wouldn't that be interesting.
Posted by Regular Anon | March 24, 2009 5:45 PM
Anyone notice that Junior 4 is now asking 435k! I'd be amazed if they get that..
Anyone have any comparable regarding 2 BR rentals in that area? $3400 a month maintenance YIKES!
Posted by Regularanon | March 24, 2009 8:51 PM
Christine, you forgot to mentioned that you are a sales agent with Corcoran, and previously with City Habitats (I believe). Good for you!
What's not so great is that you used to own a studio in the building that you sold after 2 years of ownership in 2008 for 400K!... to a sucker who didn't know what was coming... the renegotiation of the rent lease on Jan 1, 2009. The value of the apt is now 190K at the most based on recent sales.
You are a great salesperson! I guess Good for you! again.
Posted by Resident | July 13, 2009 2:07 PM
Christine,
weren't you the person telling people to not sell and not to panic at a shareholder meeting in 2007 when it was first announced that maintenance could potentially go up significantly? not sure you provided great advice then and not sure if you do that now either.
Naomi
Posted by naomi | October 24, 2009 6:43 PM
I think another reason fees are not being paid and free months not offered is that prices have come down. Apartments are moving but part of the reason is that prices came down to a point at which they will move.
Posted by Mbt | June 2, 2010 11:34 PM
not bad,a good idea.
Posted by dragonfu | August 13, 2010 3:26 AM