Subletting Pros and Cons A Fair and Effective Policy is Good For All

Subletting Pros and Cons

The board of a co-op is required to perform an ongoing balancing act, weighing both the needs of the individual shareholders and the good of the whole. Nowhere is this more apparent than the controversial issue of subletting. While owners feel entitled to rent out their property as need dictates, the board must be concerned with the financial well-being of the building, questions of community, and quality of life. While a "no sublet" policy may create hardship for unit owners, too much undermines the building’s financial viability, establishing and enforcing a fair sublet policy can be crucial to keeping the peace.

Investors aside, people purchasing a co-op know that they are joining a community and expect the shared rights and responsibilities of ownership. "Boards don’t want people buying as investors," says property manager Gerard J. Picaso, president of Gerard J. Picaso Inc., a real estate management firm in Manhattan. "Originally, sublets were used when people went on a sabbatical." When the real estate market crashed in the late eighties, people began subletting apartments because they could not sell them at an acceptable price.

Varying Perspectives

Although the market is robust now, smaller apartments and those in certain areas of Manhattan and the outer boroughs are still selling at a discount. Owners who need to move for professional or personal reasons see subletting as the only way to recoup their investment. Conversely, resident owners are generally concerned that subtenants will pay less heed to issues of security and quality of life. Picaso says, "When you allow a lot of people to sublet, you take that many people out of the process of running the building."

While economic necessity drives a shareholder to sublet his or her apartment, it also encourages a board to deny the practice. Boards may find it difficult shopping around to refinance the buiding’s underlying mortage because banks consider heavily sublet buildings a risk. "Lenders are worst-case scenario thinkers, says Patrick Niland, president of First Funding Commercial Mortgage Brokerage in Manhattan. "They always assume sponsors or subtenants are going to have economic trouble or run-off." A high percentage of non-owner-occupied apartments may dictate what mortgage rate the building can obtain.

"The optimum profile for a co-op is 100 percent sold and 100 percent owner-occupied," says Niland. "The next best scenario would be 75 percent or above owner-occupied." Over 20 percent sublet, you start raising eyebrows." He adds, "Over 40 percent, you’ll be in trouble. It could mean an extra eighth to a quarter point on the mortgage."

Take, for example, a building that is 75 percent sold, 25 percent sponsored and 30 percent sublet. "At only 45 percent owner occupied, this looks like a rental building," asserts Niland. "The sponsor’s financial status becomes more important, and it’s a much more complicated underwriting."

Daniel J. Cunningham, a mortgage broker with Harvey P. Katz Associates in Manhattan, concurs, "Today we’re seeing buildings that have an average ten to 20 percent sublet. Beyond that, banks look at it with a jaundiced eye. They feel there are too many levels to deal with if we have to take this building to court."

While it’s tempting to deny subletting to maintain the building’s mortgageability, it is also worth considering the revenue which subletting can generate. Many buildings require an application fee from prospective subtenants, move-in and move-out fees, and a monthly surcharge to shareholders who are leasing their apartments. "Properly planned and budgeted," recommends Irwin Cohen, president of A. Michael Tyler Realty, a real estate management firm in Manhattan, "sublet fees can supplement the reserve or fund capital improvements." In addition, Cohen notes that tenants often use laundry machines more than established owners, adding to the building’s revenue.

Hammering Out

a Reasonable Polic

y

"It’s usually in the best interest of a property that subletting is allowed within reason but held to a minimum," suggests Cohen. "Policies can be unique and creative, depending on the needs of the individual building."

Attorney Douglas Heller, a partner at the Manhattan law firm Friedman, Krauss & Zlotolow, which specializes in co-op, condo and real estate law says, "The first thing to consider when determining sublet policy is the proprietary lease." He continues, "The courts look very closely at the language of the co-op documents." Sometimes, the proprietary lease will categorically deny subletting, but more likely it gives the board the right to set reasonable standards and procedures. If policy is not set in concordance with the proprietary lease, it can be subject to challenge later on.

"If you are consistent, the board has a wide range of policies they can set," says attorney Alan Fried, a partner at the Manhattan law firm Schwarzfeld, Ganfer & Shore, who handles co-op work and commercial litigation. "But they must adhere to the policy and fee structure as set out in the lease, or it can come back to haunt you."

A board can not refuse an application based on unlawful discrimination (race, religion, and in New York–occupation or sexual preference, etc.), act in bad faith by treating one shareholder differently from others, or engage in self-dealing (i.e. vote from the self interest of a board member).

"One legal reason to deny a sublet petition is when the bank says you’ve got too many tenants," says Heller. In addition, a board can deny an application based on bad references, inadequate financial means or an intended violation of house rules such as a "no pet" clause. Each board has to decide how much they choose to learn about a prospective subtenant.

According to Helene Rabinovitz, board president at a 37-unit co-op on the Upper West Side, "We do ask to see a curriculum vitae and meet with a prospective subtenant because our basic issue is to keep the building a community. We could be living with this person for the next three years." Rabinovitz adds that, in her experience, subtenants are just as respectful of the property and quality of life as owners. Sometimes, subtenants eventually become owners, and the sublet period is like living together before marriage.

In order to keep sublets within an acceptable range to the banks, most boards will enforce term limits. For example, the sublet cannot be for less than one year or more than two. Another formula may allow an owner to sublet for two years out of a five year period. Some buildings will require that an owner have occupied the apartment for a certain number of years before being eligible to sublet. In addition, boards can set certain criteria such as professional emergency or financial hardship as requirements for sublet approval.

Ideally, a board needs to set a policy that is stringent enough to protect the building’s interests, while not being so strict that it discourages subletting completely. Additionally, attorneys caution boards to check the corporation documents before putting any charges or policies into effect, otherwise the fee can be voided if the owner or subtenant contests in court.

Appropriate Sublet Fees

The application fee charged should compensate the building corporation for the time spent administering the sublet process. Other charges must cover any possible damage to common areas as a result of the moves in and out. A sublet fee charged either annually or monthly to the shareholder communicates that this is a temporary situation and ensures that the owner either resume occupancy at some time or sell the apartment. One way to discourage long-term subletting, is to require that the application be renewed each year with an escalating fee structure in place.

Cohen recommends setting the sublet fee per share. "A flat rate is inequitable," he says. "You need to take into consideration rent collected. There is a lot of difference in the share relationship between a studio and a three-bedroom." Doubling the fee for each year a sublet continues discourages long-term renting. "If they need to sublet for more than three years," says Rabinovitz, "they need to put the apartment up for sale."

All-in-all, a creative, and flexible, sublet policy can alleviate hardship for individual shareholders, while protecting the interests of the majority. In addition, when monitored carefully, sublets can generate capital for a building without undermining its mortgage viability. And that looks good on the balance sheet.

Ms. Mulhare is a freelance writer living in Queens.

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6 Comments

  • Is it common practice or within BCL for a managing agent to charge a perspective subletter a finders fee? I thought that the shareholder was supposed to satisfy that requriement to the managing agent.
  • What about a shareholder that rents out a room? They are not subletting the apt. but subletting a room.
  • If you obstruct the owners with stiff rules and regulations dictated by coop's nonvisionary and small minds, you are already crossing the border to communism and didctatorship!
  • As a cooperative owner and also on the BOD, I would like to ask if permitting subleasing should be presented to membership for their vote?
  • In a Co-op, can Board members decide that there are absolutely no short-term rentals allowed?
  • When you sublet, the coop looses the abatement and star award as the owner of the apartment gives up his laim as a perminent resident.