Problems With Subletting a Co-op in NYC
Go Back To Previous PageBuyers searching for investment properties typically fall into two categories. The first group is looking for a condo to rent out with minimal hassle, and the second group seeks a co-op with a flexible sublet policy. The appeal of co-ops is understandable; they are generally much cheaper than condos, which can lead to higher returns, all else being equal.
However, while the attractive headline numbers may draw buyers in, many underlying issues are associated with subletting co-ops and using them as investment properties.
Sublet Policies – The Fundamental Problem With Co-ops as Investment Properties
The main challenge with co-ops as investment properties is that you need board approval to rent an apartment. This is called “subletting” in co-op terminology since owners technically
rent under their proprietary lease.
Each co-op has a sublet policy outlining the eligibility for subletting an apartment. Typically, these policies state that you can only sublet after residing in the apartment for a specific period and often restrict how frequently you can do so.
For instance, a standard sublet policy might allow for subletting two years after living in the apartment for two years, with a maximum of two years of subletting allowed within five years.
In this situation, after you have sublet the apartment for two years, you would need to either move back in, leave the apartment vacant for three years, or sell it. The first two options are often impractical, leading many property owners to choose to sell instead.
However, some co-ops have more flexible sublet policies that allow you to indefinitely sublet the apartment. While these can be potential investment rental properties, they still come with their own set of challenges.
Policies Can Change
It’s important to remember that sublets are always subject to board approval. Regardless of the sublet policy, an application can be denied. We often emphasize this point when a sublet policy has no specific cap but suggests that subletting is discouraged. Escalating fees may indicate this.
Additionally, the co-op board can change the building’s sublet policy if subletting becomes problematic. This could be due to a few troublesome subletters or an excessive number.
Most banks are reluctant to lend in buildings where most units are rented. If a building approaches a 50% rental threshold, the board may limit subletting to maintain access to financing. Property values can decrease significantly if financing options are restricted, as rental units will be limited to cash buyers. Unlike condos, where renting is virtually unrestricted, even flexible co-ops can restrict subletting.
Co-op Sublet Applications Are Cumbersome and Take A Long Time
One of the most overlooked challenges of subletting co-ops is the cumbersome process. A sublet application is similar to a purchase application, requiring significant effort. Prospective renters must compile extensive life documentation into a PDF for the board’s review and undergo an interview. This process demands a lot of work and can take considerable time.
In contrast, renters in a rental building can typically sign a lease (or subletting agreement) on the spot with just a pay stub and a credit check, making co-ops less appealing. Coops often need to offer lower rent to incentivize renters to endure this lengthy process. Furthermore, the drawn-out approval process can result in co-ops remaining vacant for extended periods, resulting in significant costs.
Significant Sublet Fees Charged by the Co-op
Co-ops do not allow subletting out of pure generosity; they are also motivated by financial gain. Almost all co-ops, including those with flexible sublet policies, charge shareholders a fee for the right to sublet their apartments.
These fees are typically calculated as a percentage of the maintenance costs, often ranging from 20% to 30%, and are applied for the duration of the sublease. Alternatively, the fee might be structured as a percentage of the rent or a fixed amount per share. Such fees can significantly reduce the investment’s gross capitalization rate (cap rate), making the net cap rate less appealing. Additionally, these fees might increase over time to discourage prolonged subletting.
Besides sublet fees, landlords usually pay a real estate agent one month’s rent, and management earns revenue by charging various fees such as application fees, credit check fees, and move-in fees. There are ongoing maintenance costs, such as replacing broken appliances and repainting. It’s important to note that these fees apply to condos as well.
Subletting Doesn’t Always Go Smoothly
Being a landlord involves more than just the time spent subletting the apartment; it is not a completely hands-off job. This is particularly true if you encounter difficult renters.
While it’s easy to envision an ideal situation where the rent check arrives on the 1st of the month, and you rarely hear from your tenants, that’s often not the reality. Issues can arise, such as broken appliances, missed rent payments, or complaints from neighbors. As the landlord, you will need to address all of these concerns.
So When Does Subletting a Co-op Make Sense?
Having the ability to sublet can be pretty valuable if the need arises. For instance, subletting can be a convenient solution if you suddenly get transferred to Los Angeles and don’t have time to sell your apartment. Although the subletting process can be cumbersome, it is generally easier than selling your property, and the rental market tends to move much faster than the sales market.
Subletting also offers the flexibility to wait out a weak market. During the height of COVID, many potential sellers opted to sublet rather than sell their homes. However, if you need the equity from your current home to purchase a new one, this option may not be feasible.
It’s important not to overestimate the benefits of this flexibility. We strongly recommend analyzing the numbers to determine how much you can realistically earn after considering all associated costs. You may find that these returns are minimal compared to the purchase price of the apartment.
In other words, the cap rate for co-ops is often very low, which means that subletting is often more about speculating on the overall New York City real estate market, with the hope that you will be able to sell for a higher price in the future.
Subletting and/or Selling Your Co-op with NestApple
If you’re interested in subletting your co-op, NestApple can manage the entire process! We’ll create an eye-catching listing featuring professional photos, a video tour, a virtual tour, and a fresh floor plan. Once the rental is complete, we can also manage your property.
Are you considering selling? We can assist with that, too, and we’ll reduce your closing costs by up to 4%! We’re happy to guide you through either process. If you’d like, we can also list your apartment for both sale and rent concurrently, allowing you to explore both options.
Additionally, suppose you’re looking to buy a co-op and want to learn about co-op sublet policies. In that case, we have extensive experience working with buyers throughout the city and are familiar with most policies. Plus, all our buyers receive a commission rebate of up to 2% of the purchase price!
Georges has been working in Wall Street for the last 16 years trading derivatives with hedge funds. He has been an active real estate investor for over a decade. Georges graduated from HEC Business School in Paris and holds a master in Finance from ESADE Barcelona.
