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Special Purpose Condominiums: How They Can Help Building Owners and Investors Maximize Value in Today's Market

SPECIAL PURPOSE CONDOMINIUMS:
How They Can Help Building Owners and Investors Maximize Value in Today's Market

Condominiums were the rage in the most recent residential real estate development boom. This form of ownership, long frowned upon by New York City purchasers, became the norm, primarily because of the advantages of direct fee ownership, minimal restrictions on transfers and the seniority of condominium indebtedness.

In the current environment, conversion of buildings to the condominium form of ownership is continuing in New York but for completely different purposes. Well publicized examples of the use of condominium form of ownership are the sale of portions of Manhattan office buildings, comprising one or more condominium units, at 1540 Broadway and 666 Fifth Avenue and the sale and leaseback of the New York Times' portion of the New York Times Building.  In the case of other condominiums, making full use of the real estate tax exemption for not-for-profit entities[i] is a motivating factor.  The Park South Tower at 425 West 59th  Street, for example, was converted to condominium in 2007 in order to give St. Luke's-Roosevelt Hospital Center the benefit of the real estate tax exemption. The creation of condominiums is also often useful for special financial or income tax reasons, for example in connection with low-income housing.

Reasons for Conversion of Mixed-Use Property to Condominium Ownership

The underlying purpose for creating a condominium is to divide one or more buildings into several different parcels of real property that can be separately sold, transferred or financed.  An investor or owner-occupant might specialize in a specific type of real estate such as retail space, parking garages, community facility space or rental apartments. Targeted investing could be useful for REITs or other buyers that have narrowed the class of real estate which in their view is most likely to meet their objectives and to appreciate in the current market scenario. This type of activity also benefits the seller, enabling it to reduce outstanding levels of debt and leaving it in ownership of a more focused type of property.  

Condominiums are often useful today in the structuring of so-called "80-20" or other forms of mixed and moderate low income residential housing that qualify for low-income housing tax credits under Section 42 of the Internal Revenue Code.  The structures that enable such credits to be sold to an investor group frequently make use of the condominium form of ownership.[ii]  Even though the low-income apartments are generally not contiguous, they can be separated into a single condominium unit which can then be owned by the low-income housing tax credit investor independently of the rest of the building.[iii]

Office buildings that sell office condominiums rather than lease individual offices is a phenomenon which may also gather strength in this market.  Well-capitalized companies could benefit from purchasing their space and thereby establishing a permanent location that is not subject to the uncertainties of rent increases and the risk of the landlord taking back their space at the end of each lease term.

Control of Condominium Operations and Uses

Control of the Condominium's Board of Managers, veto rights of specific owners and permitted uses of units are often heavily negotiated issues in these transactions.  Some of the most important issues facing the Board are operating expenses and allocation of costs.  Reducing the amount of shared common elements and building equipment will help minimize disputes between different owners regarding expenses and capital improvements.  If a unit owner claims that the Board has exercised its power improperly as to specific items such as allocation of expenses, most condominium by-laws provide that such disputes should be resolved by arbitration.  On certain major decisions, the condominium by-laws can require the consent of some or all of the unit owners.   

Expedited Procedures for Special Purpose Condominiums

Special purpose condominium conversions can often be accomplished in a much shorter time frame than typical residential conversions.  This is because the New York State Attorney General's office has the authority to issue a "no-action letter" that exempts certain transactions  from the requirement of using a condominium offering plan.[iv]  Once a condominium is created pursuant to a no-action letter, generally, transfers of units in the condominium will also qualify for a no-action letter and no condominium offering plan will be needed. 

The Attorney General recently issued a position memorandum that has expanded the class of condominiums that are eligible to apply for "no-action letters" to include multi-use buildings that contain occupied residential space.[v]  Under that memorandum, the subdivision of a multi-use building into two or more condominium units, where the owner or an affiliate of the owner will retain ownership of all units and the reasons for the subdivision are financing, income tax, estate planning or government program purposes, will now be considered for a no-action letter. A sale to a party not affiliated with the owner may also qualify for a no-action letter, where there is no public offering involved and the sale is to a sophisticated party who does not require the protection of an offering plan. 

The Attorney General now requires that the affidavit submitted by the purchaser as part of the no-action letter application include a statement that the purchaser does not have any present intention to resell.  This has evolved from the more restrictive requirement in a 1987 Memorandum[vi] with respect to no-action letters for four unit commercial condominiums that the purchasers each agree not to resell the units for a period of two years.    

An application for subdividing a building into condominium units must also be filed with, and approved by, the New York City Department of Finance.  New procedures, effective June 1, 2009, have been instituted by the Department and are intended to streamline the application process.[vii]  A revised form of application is to be submitted to the Tax Map Unit of the Division of Land Records (formerly known as the Office of the City Register) of the Department.  A new condominium apportionment worksheet has been added to the application package, which is to be completed and filed electronically.  The Department of Finance expects to undertake only a limited review of the new application materials and thereby substantially reduce the time required for approval of a condominium subdivision.  Under the new procedures, floor plans for newly filed condominiums will be available for viewing on ACRIS, the Division of Land Records' automated information system.  Until now, only the condominium declaration and initial by-laws were available on ACRIS.

Given the many special purposes that can be served, from ownership of specialized real estate to utilization of tax credits, conversion to the condominium form of ownership continues to be useful, even in this economic downturn.  There may also be a resurgence in the creation of office condominiums.  The parallel changes in policy and practice at the offices of the New York State Attorney General and the  New York City Department of Finance are welcome developments that will facilitate and promote this expanded use of condominiums.

Elliot  E. Falk, a partner in the Real Estate Law Department, can be reached at (212) 841-0584 or efalk@phillipsnizer.comLonica L. Smith, an associate, can be reached at (212) 841-0567 or lsmith@phillipsnizer.com.   

An abbreviated version of this article was published by Real Estate Weekly in its Banking & Finance special section (p. 10) on September 2, 2009.

 


 

[i] New York Real Property Tax Law Section 420-a.

[ii] One legal issue that often requires attention in these special purpose condominiums is the restriction on blanket mortgages in New York Real Property Law Section 339-r.

[iii] See IRS private letter ruling 200601021, release date July 8, 2005, which confirms that an "80-20" or "60-40" building which is owned by more than one owner qualifies as a "qualified residential rental project" for purposes of tax exempt bond financing.

[iv] New York General Business Law, Sections 352-e subd 2 and 359-f subd 2(d); see also 13 NYCRR Section 23.9.

[v] NY Dept. of Law, Real Estate Finance Bureau Memorandum, Mixed Use Buildings Expanded No-Action Treatment, January 29, 2009.

[vi] NY Dept. of Law Memorandum, Granting No-Action Letters for Commercial Condominiums, July 24, 1987.

[vii] NYC Dept. of Finance, Division of Land Records, Finance's New Condominium Apportionment and Approval Process - Overview for Industry Representatives,  May 12, 2009.