Home Prices Don’t Tell You Nearly as Much as You May Think

We all talk about home prices, price per square foot, record prices, comparable prices, etc. Professional real estate on-line platforms make it easy to compare prices and come up with beautiful printed CMA (Comparative Market Analysis) documents that can be given to clients. Zillow, a leading consumer real estate publishes “Zestimates,” its own (comparable-prices based) assumption of fair value and so, too do other sites. But how useful are they . . . really?

It’s too easy even for those knowledgeable in real estate to ignore other things that are important. Case in point: a 2/9/17 article on Zillow-owned StreetEasy.com, one of the most respected real estate sites in our neck of the woods, entitled See What Can You Get for $500K in NYC. All of the profiled residences were for sake and had asking prices close to $500,000. But they were not financially comparable, not even close. The article never mentioned or even hinted about the vast differences between the monthly payments residents would have to make. Those monthlies would have huge impacts on an applicant’s ability to get accepted (if in a co-op) or get a mortgage.

Table 1 lists each home, the listing price, and the estimated monthly based on the “default” numbers shown in the StreetEasy interactive calculator that’s part of its listing for each unit, and an assumption for the minimum annual income the resident would need (assuming monthly payment times 35).

Table 1

Neighborhood	Listing Price $	Monthly Cost $	Minimum Annual Income $
Upper East Side co-op	520,000	3,785	132,475
Kips Bay co-op	525,000	2,818	98,630
Clinton Hill co-op	515,000	2,570	89,950
Crown Heights condo	489,000	2,207	77,245
Northeast Flatbush multi-family	525,000	2,243	78,505
Murray Hill condo	499,000	2,431	85,085
Bay Terrace co-op	499,000	3,243	113,505
Staten Island muti-family	489,000	2,188	76,580
Morris Park muti-family	489,000	2,424	84,840
Riverdale co-op	515,000	3,447	120,645

Because monthlies are so impactful, we’ll take closer looks at monthly outlays for three different kinds of residences of great importance to New Yorkers, rental apartments, condos and co-ops, and how the numbers get to where they are.

Co-ops Versus Condos 

Condos are straightforward. You buy complete “fee simple” (that’s the cool legal term) title to your space, and co-ownership of all the common areas (hallways, grounds, laundry room if any, etc.).

With co-ops, you live in your apartment, not because you own it but because you lease it, like any other tenant anywhere else. What’s special here is who your landlord is. As with many buildings, the landlord is a corporation. But in this case, all of the owners of the corporation (the shareholders) are the people who lease the apartments. The purchase price you paid got you two things: (1) shares of the landlord corporation; i.e. part ownership of it, and (2) the right to lease a specific apartment (a proprietary lease).

Which is better? It’s a matter of taste. Here’s the overarching concept:

• Condos are better because they give you more freedom to do what you want (including continual subletting, meaning you can use the property as an investment rather than a residence).
• Condos are worse because your neighbors can also do what they want with their apartments, including serially sub-let to one noisy creep after another.

Let’s Follow the Money

Let’s imagine a hypothetical 100-unit apartment building; 123 Anyplace Ave. We’ll imagine it in three different ways, as a rental building, as a condo, and as a co-op. To make our lives easy, we’ll assume all 100 apartments are identical and “rent” for the same amount.

As a Rental Building

Fred Sinclair, the make-believe developer-owner spends $20 million to get the land and construct the building. He puts up 30% ($6 million) down and takes a 20-year mortgage with a 6% interest rate. The assumed payment numbers I’m going to use will be standard and can be found in any mortgage amortization table or computed using standard Excel functions.

I’ll assume the $20 million investment is 7 times annual rents. I’m also going to assume $600,000 per year in real estate taxes, and other operating expenses in an amount that works out to what real estate pros would refer to as a 5% “capitalization rate.” After  crunching my numbers, Fred winds up with a year-one 6.6% “cash-on-cash return.”

The numbers are all debatable. Rather than a precisely realistic example in the context of the current market, I’m aiming for a balance between realism and simplicity. Table 2 shows the financial profile for 123 Anyplace Ave.

Table 2

	Entire Building	For Each Apartment
	$ Per Year	$ Per Year	$ Per Month
Rents	2,857,142.86	28,571.43	2,380.95
– Real Estate Tax	600,000.00	6,000.00	500.00
– Other Operating Expense	1,257,142.86	12,571.43	1,047.62
– Debt Payments	1,203,604.18	12,036.04	1,003.00
= Operating Profit	396,395.82	3,963.96	330.33
RESIDENT PAYS EACH MONTH
Rent			2,380.95

As A Condo

Going from rental building to condo involves an important change. We can wipe out the $396,395.82 in annual profit. Condo owners aren’t looking to make money by pocketing something extra after subtracting costs from income. They make their money from the growth in the value of their equity investment. When it comes to annual operation, breakeven is fine; residents should pay each month the costs necessary to own and maintain the property, nothing more.

Thanks to a bit of 9^th grade algebra (I know kids today are smarter and learn it in earlier grades), I know that if I’m eliminating those profit dollars and the 6.6% cash-on-cash return they represented, I can cut the initial investment in the building from $20 million down to $14 million. Assuming a 30% down payment, the total mortgage now falls from $14 million to $9,800,000.

Here’s another important change. There is no developer-owner making the down payment. Come to think of it, there is no developer-owner paying off the mortgage, paying the taxes, and paying the operating expense. Fred Sinclair is out of the picture after selling the project (to those who buy apartments) for a total of $14 million. So I have to assume that everything is being handled by the 100 condo unit owners.

• That means there isn’t really a $14 million investment. Instead, we have 100 investments each one being $140,000.
• Instead of one big $9,800,000 mortgage, we actually have 100 smaller $98,000 mortgages.
• There are also 100 down payments of $42,000.

Taxes and other operating expenses are also allocated equally to all 100 unit owners. Table 3 shows the condo’s financial structure.

Table 3

	Entire Building	For Each Apartment
	$ Per Year	$ Per Year	$ Per Month
Rents	0.00	0.00	0.00
– Real Estate Tax	600,000.00	6,000.00	500.00
– Other Operating Expense	1,257,142.86	12,571.43	1,047.62
– Debt Payments	842,522.92	8,425,23	702.10
= Operating Profit	0.00	0.00	0.00
RESIDENT PAYS EACH MONTH
Common Charges			1,047.62
+ Taxes			500.00
+ Debt Payments			702.10
= TOTAL			2,249.72

Things to notice:

• The total monthly expense came down a bit from $2,380.95 to $2,249.72. That was caused by elimination of Fred Sinclair’s annual landlord profit.
• The common charges, $1,047.62 per month, the figure you see whenever you look at condos, is exactly equal to the operating expenses. If you see a condo with operating expenses that look too high, ask what expenses are driving the number upward.
• Don’t just look at common charges and stop there. You cannot ignore real estate taxes and the payments required for your mortgage!
• If you can’t find a number for taxes, look more closely to make sure you aren’t seeing a co-op instead (next topic). If it’s really a condo, your next question should be about whether it’s getting tax abatements from the government (it probably is). Be careful here. These are temporary programs and they all have expiration dates. Make sure you find out when taxers will have to be paid and what the amount will be.

By going condo, we’ve added a bit of complexity since you need to get a mortgage and you have to pay three things each month (taxes, common charges and mortgage) instead of just one (rent). But you save a bit each month in terms of total outlay; $2,249.72 instead of $2,380.95. And you have a powerful equity investment.

Now that we understand condos, let’s move on to co-ops, which are especially widespread in New York City.

As a Co-op

As with the condo, we continue to ignore rents (residents pay all expenses although with differing formalities, as we’ll see) and we continue to ignore Fred Sinclair’s landlord profit.

The big difference now, is that there is a new corporation in town to actually own the building. I’ll call it 123 Anyplace Ave. Owners Corp. There are two big dollars-and-cents differences residents experience.

• Unlike with condos, real estate taxes are not directly paid by residents. Its added to the co-op corporation’s operating expense and is covered by the monthly “maintenance” charges paid by residents.
• The cost of the total $14 million investment in the building (the original $20 million minus the $6 million we were able to eliminate by cutting Fred’s profit out) is not directly assumed by residents. Some of it is, when they buy shares. The other part is assumed by the co-op corporation. One way or another, they have to pay the same thing but now, the form of it is split between direct (i.e. down payment and mortgage) and indirect (corporation has to pay its mortgage and that expense is included in the maintenance charges).

Table 4 shows the co-op’s financial structure assuming, as I will for this example, that half of the $14 million investment is made through the corporation and half by the residents directly. Assuming each made a 30% down payment, that means:

• Each of the 100 residents paid $70,000 through a $21,000 down payment and a $49,000 mortgage.
• The corporation has a single mortgage of $4,900,000.

Table 4

	Entire Building	For Each Apartment
	$ Per Year	$ Per Year	$ Per Month
Rents	0.00	0.00	0.00
– Real Estate Tax by Co-Op Corp.	600,000.00	6,000.00	500.00
– Other Operating Expense	1,257,142.86	12,571.43	1,047.62
– Debt Payments by Co-op Corp.	421,261.46	4,212,61	351.05
– Debt Payments by Residents	421,261.46	4,212,61	351.05
= Operating Profit	0.00	0.00	0.00
RESIDENT PAYS EACH MONTH
Real Estate Tax			500.00
+ Other Operating Expense			1,047.62
+Debt Payments by Co-op			351.05
= MAINTENANCE FEE TO CO-OP			1,898.67
+ Debt Payments by Residents			351.05
= TOTAL			2,249.72

Things to notice:

• The total monthly expense is the same. Don’t be fooled by the fact that the resident pays more each month to the co-op ($1,898.67) than he or she would to a condo ($1,047.62).
• The debt service costs are the same, the difference being that some (half in this example), is being paid by the co-op and included in co-=op maintenance and half directly handled by the resident.

The Real World

I made a lot of simplifying assumptions here. I didn’t count management fees. I also ignored the need to save for capital improvements such as a new roof or elevator. These occasional-but-big expenses, common to what private home owners deal with, are handled by special assessments and/or the gradual buildup of reserves (collecting a little more each month than is absolutely needed for expanses).

Bear in mind, too, that the distribution of investment between co-op corporation and residents is rarely this neat. Market trends over the course of time influence the numbers. And, of course, we can’t really assume all apartments are equal. So we certainly won’t simply divide everything by 100. Still, the tables should give you a pretty good idea of how money moves through rental building, condos, and co-ops.

Finally, I’m not considering the impact of personal taxes on the part of the resident. That’s not because it’s unimportant. Quite to the contrary, it’s very important and can, at times, be the deciding factor between a “yes” or “no” decision. But in the interest of clarity, tax impact will be covered in a separate blog.

Summary

Table 5 summarizes all of the above by comparing residents’ monthly outlays for all three kinds of buildings.

Table 5

	Resident per Apartment Monthly Payment ($)
	Rental Apartment	Condo	Co-op
Rent	2,380.95	– –	– –
+ Real Estate Taxes	– –	**   500.00	*   500.00
+ Debt Service for Building	– –	– –	*   351.05
+ Other Operating Expenses	– –	*   1047.62	*   1047.62
+ Resident’s Own Debt Service	– –	**   702.10	**   351.05
= TOTAL	2380.95	2249.72	2249.72
* Submitted to “Building” as Rent, Condo Common Charge or Co-op Maintenance	2380.95	1047.62	1898.67
** Payments submitted to other recipients (not to co-op or condo)	– –	1202.10	351.05
TOTAL	2380.95	2249.72	2249.72
RESIDENT’S INVESTMENT	– –	140,000.00	70,000.00

What this Means for Buyers

It means a lot. It means you can’t just look at prices, even when it appears, at first glance, that they mean a lot. When I price co-ops and condos, I start by analyzing and comparing the monthlies. Once we narrow down to what a client can afford on this basis (i.e. where a co-op Board, if any, is more likely to say “yes” and units for which a buyer is most likely to get financing), we then examine the implications of price, which will be addressed in the next blog.