Buying From a Sponsor--The Basics
How are Coops and Condos Born?
In New York, the creation of a cooperative or a condominium is a regulated process under the jurisdiction of the Real Estate Financing Department of the New York State Attorney General's Office. Various documents are filed by one or more individuals or entities known as a Sponsor seeking approval to create a new co-op or a condo (that is, where new construction is involved) or to convert an existing rental building to co-op or condo status. This filing process can take up to a year or more to complete and the Sponsor is prohibited from offering apartments for sale to the public until the Attorney General has given its approval.
How Are Sponsor Sales Different?
Sponsor sales are quite different from purchasing an apartment from an individual owner since the sales are regulated. The offering of apartments by a Sponsor is made through the delivery to potential buyers of a prospectus called an "Offering Memorandum." In this document, which is actually a series of documents, the Sponsor discloses all of the terms of the offering as well as material information about every aspect of the offering and construction or condition of the the building. The Offering Memorandum is updated by amendment whenever there is a change in the terms (e.g., a change in pricing of apartments or any other material change in the offering). A purchaser of an apartment is bound by the terms of the offering as approved by the New York State Attorney General although changes to the contract for a particular apartment may be negotiated based upon your bargaining power. The Sponsor likes to make as few changes to the contract as possible because there may be many deals being negotiated simultaneously. Further, your ability to obtain concessions from the Sponsor and changes to the contract will relate directly to the degree of interest in the apartment you wish to purchase and in the building in general. If there is great interest in the Sponsor's offering, the chances are you will have to purchase the apartment on the terms desired by the Sponsor.
Due Diligence
The Offering Memorandum should be reviewed carefully to make sure there are no surprises lurking relative to the financial or physical condition of the building. If it's a newly constructed building, there won't be any building history to investigate. Nevertheless, investigate your Sponsor's track record with other projects. To the greatest extent possible, make sure you're comfortable with the way the construction will be completed. Although a Sponsor can be held liable for material misrepresentations in, or omissions from, the Offering Memorandum, once the majority of apartments have been sold, it's not that easy to hold the Sponsor responsible for construction defects and other problems. When the market goes in the wrong direction, and units aren't being sold, Sponsors are stretched to the limits financially and projects can suffer in many ways. If the owner occupancy ratio in a new condo is low (as it is in many condos these days), financing may be very difficult to come by. Again, knowing who you're dealing with is essential.
Pay Attention to Technical and Financial Disclosures
The Offering Memorandum will disclose all of the financial terms of the offering (including an estimate of operating costs for the first year of existence) as well as technical information relating to the "build-out" of the construction and mechanical systems located in the building. It doesn't hurt to run the financial disclosures by your financial advisor, as your monthly share of building expenses is determined by the Sponsor's initial estimate of operating costs for the building. If the Sponsor's estimate is wrong, your carrying costs could go up. Further, it's a good idea to have an engineer review the technical parts of the Offering Plan and visit the building and your proposed apartment, if that's possible.
Is Your New Building Solid as a Rock?
When a buyer visits the model apartment, things always look good. Staging apartments is an art and there are folks out there who can make almost any apartment look appealing. The truth is, that until a building has an operating history of two or three years after construction has been completed, a buyer will not know exactly how well the building was constructed. Problems with new construction occur all the time and the unit owners find themselves fighting with the sponsor, who often is reluctant to lay out the funds to make things right. Particularly with the financial stresses that many developers are experiencing at the moment, there has never been a time when due diligence has been more important than when a buyer purchases an apartment in today’s market.
Residential Realty: The Financial Shake Out
When I first wrote about this topic a number of years ago, the landscape of a purchase from a sponsor was remarkably different. Brand new apartments, with high end features, were coveted by potential buyers and folks literally lined up to sign purchase agreements. Sponsors were unwilling to negotiate the terms of the purchase agreement and many sales were made on a “take it or leave it” basis. Well, things have changed. Yes, there are still many situations where high end developers will not materially change the terms of the offer as stated in the Offering Plan. On the other hand, there are many, many developers out there who are sitting with an enormous amount of inventory and they are ready to make deals. A year or two from now, things may change, but for the moment, it is still a strong buyer’s market.
For more on what to look for when purchasing from a sponsor, See “Life Is Not Fair—More on Purchasing an Apartment from a Sponsor”.
