Price Flooring? Will Boards Try To Stop Price Discovery

Posted by urbandigs

Mon Mar 16th, 2009 12:29 PM

A: I have been hearing stories lately about co-op boards rejecting purchase applications because they think the price is too low and may adversely affect future valuations for existing shareholders. I for one do not dismiss such rumors that quickly because of their source, past experience I have had with co-op boards, and colleagues of mine who I know and trust. In times like these co-op boards have a big problem on their hand regarding where to draw the line. Since the co-op board is comprised of, wait for it...., co-op shareholders, there is a vested interest in seeing price appreciation go through and avoiding what may be considered aggressive price deterioration because a shareholder must liquidate their shares. With the mortgage market significantly tighter than it was in the boom years from natural deflationary market forces, how will boards adjust? Will they loosen up guidelines if they were traditionally very tight? Will they tighten up guidelines if they were traditionally very loose? And most important, will they reject a purchase application because the price is deemed too low; a form of price flooring policy?

price-flooring.jpgThis is one of those 'look ahead' pieces that describes what ultimately will be an unintended consequence of a declining market. Like I discussed a year and a half ago, when the mortgage markets began to seize up causing the bid for RMBS to disappear, I thought there would be a problem with future new development closings, "New Dev Closings: A Potential Problem?". Well, now I seriously wonder about this co-op laden city and to what extent the boards of private corporations (buildings) will influence their power to 'further protect shareholder interests'.

When a neighborhood is dealing with foreclosures, the nearby homes that are in good standing start to seriously worry about the negative pricing effects that come with mark-to-market price discovery of that bank-owned auction. How will it affect homes next door? Down the block?

While Manhattan is not dealing with a foreclosure problem right now, I am hearing stories of co-op boards tightening up and being on guard against sales that are deemed 'too low' for current market conditions. Granted, these are just stories and I have not had a co-op board rejection to deal with personally, but I could see the potential problem. What rights do the co-op boards have to block a transaction based on price alone? What legal actions may be taken if a transaction is blocked? How will future buyers perceive the building if they will not allow market forces to determine value?

These are the important questions. Certainly boards will not intervene if the price was too high, because hey, that means the board's holdings have risen in value and everybody likes asset appreciation. But asset appreciation is hardly a term to be used today.

The Co-operator lists LOW PURCHASE PRICE as reason #9 for a co-op board to reject a purchase application; here are the rest of the reasons:

1. Financials
2. Job History
3. Bad Credit
4. Pied-a-Terre
5. Guarantor
6. Life Style
7. Home Work
8. Failure to Fulfill Additional Requirements
9. Low Purchase Prices
10. Pets
11. Noise
12. A Poor Interview

The problem is that co-op boards will be filled with people of vested interest in avoiding price depreciation; especially if a board member owns a similar line as the one in question. This is not a new phenomenon and Jonathan Miller would expect it to occur again.

In the NY Mag article, "Co-ops create new conundrums", Miller states:

"I'm finding co-op boards to be even further behind the market than sellers," said Jonathan Miller, president of appraisal firm Miller Samuel. "That's going to be a continuing problem during this period."

The practice of rejecting buyers because of their proposed low purchase prices occurred frequently in the recession of the early 1990s and continued sporadically as home prices in New York skyrocketed. Now, it's becoming more common as prices begin to dip again, Miller said. "Boards are turning down deals that are selling too low," he said.
Now, I have heard of old stories in the early 90's of co-ops amending the by-laws of the corporation to set a minimum floor on the value of its shares, to protect the value of other shareholders' investments. But I have no idea if this is in place today, especially after the boom this market has experienced when credit went parabolic.

Price flooring is not new; the question of legality and if its good policy is an ongoing debate. The one legal case I could find about this was discussed in a 2001 NY Times article:
Bruce A. Cholst, a Manhattan co-op lawyer, said that there has been only one reported court case that addresses the legality of minimum-pricing policies.

In that 1995 case, he said, the court held that a co-op board does not have the authority to reject sales whose contract price is below a predesignated level.

''The court concluded that such a practice constitutes an impermissible restraint upon a shareholder's ability to sell his unit,'' Mr. Cholst said. Mr. Cholst added, however, that since the decision was from a Westchester County trial court and was never appealed, other judges in other courts are not legally bound to reach the same conclusion.

''And I believe, as do many of my colleagues, that the court's reasoning was flawed,'' Mr. Cholst said. ''Since the establishment of a floor price does not actually serve to prohibit the sale of an apartment, the practice should not have been viewed as an illegal restraint against transferability.'' In fact, he said, as long as floor-price policies are enforced in a nondiscriminatory manner, they would appear to constitute a legitimate exercise of the board's business judgment and should not be subject to judicial second-guessing.


My two cents? You can NOT place limitations on the open market - and that includes price flooring policies! If a seller is distressed, and must sell below a price floor, what will happen to shareholders' maintenance when the unit owner goes into default? It will rise, and that will negatively affect all shareholders and market value of all units with the now higher carrying charges. The co-op board has no business trying to control sales prices. The market will do what the market wants to do, and meddling with open market transactions to 'protect shareholder interests' will do more harm than good. Another NY Times article titled, "Should Co-op Boards Set ‘Floor Prices’?" adds these three arguments:
It is an open secret in New York that some co-op boards have adopted what are known as “floor prices” — minimum sales prices for apartments in their buildings.

“It is understandable that shareholders want to keep the value of their shares as high as possible,” Mr. Sonnenschein said. “But the business of a corporation does not include trying to maintain the value of its shares.” He contends that doing so is “basically a form of stock manipulation.”

Aaron Shmulewitz, another Manhattan co-op lawyer, disagreed. “I don’t see why co-op boards should not be doing this,” he said. “Board members have a fiduciary duty to protect the financial interests of the corporation and all its shareholders. And allowing sales for below-market value would damage the financial interest of the co-op and its shareholders.”

Arthur I. Weinstein, a Manhattan lawyer who is a vice president of the co-op and condo council, said that while he believes boards have the power to impose floor prices, this power should generally not be exercised.

“The co-op board should not be trying to second-guess the marketplace,” he said. “And the marketplace determines what the value of an apartment is.”
There will be cases of this no matter what anybody says because greed sometimes overpowers rational thought. Hopefully the members of a co-op board review prospective purchase applications rationally, and it wouldn't hurt for them to get a lesson on what is happening in the broader market so they are prepared for what future purchase applications may bring. Losing today's price means potentially getting a lower price down the road!

It is up to the listing agent to educate the board and consider submitting a written listing history with the board package. Tell the board how long the property has been on the market, where the original price was, number of price reductions, traffic procured as a result, number of open houses held, and even marketing strategies to show the board members that the transaction price was a function of current market conditions. In the end, the market will do what the market wants to do. Outside meddling by anyone, especially co-op boards, will prove counter productive and do more harm than good for the seller and the rest of the shareholders of the corporation. Condos are not affected by this problem because of the nature of real property transactions and the boards right to first refusal. If a condo deal is deemed to low, the board can decide to purchase the unit using reserve funds, matching the deal agreed upon between seller and original buyer.

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