In today’s piece, we take a break from the usual rant about no fee Manhattan rentals lists and focus on the sales market.
The Nasty Closing Cost: Flip Tax
After reading Teri Rogers’s article in the New York Times, The Downside of Condos in a Downturn, many co-op owners must be rejoicing their decision to forgo the subletting optionality and transferability of a condo. While we agree with the majority of the points in the article, there is a bit of a flip side to the story in which co-ops dependent on high transaction volume are encountering large budget deficits. Most co-ops impose some transaction fees on all parties during a purchase and sale of an apartment (technically shares of the co-op). These fees range from perfectly reasonable ($50 messenger service fee), to borderline justifiable ($1,000 in misc. administrative fees), to outright co-op profit (tens of thousands of dollars in flip tax).
What is a Flip Tax?
A co-op is not in the business of making money and paying dividends to its shareholders. A co-op is simply a legal entity that governs the building, the tenants, and the expenses. Under normal circumstances, the building expenses such as the doorman wages and common area maintenance are paid by the residents in the form of monthly maintenance fees. The fees each resident pays is proportional to the number of shares assigned to their unit, so while the fees can rise and fall each year, the ratio of fees an owner pays relative to his or her neighbors stays constant through the years.
In times of inflation and annual price increases for a basket of co-op expenses, we would expect the maintenance fees to increase each year. Fortunately, several boards discovered a seemingly innocent way to peg their revenues with inflation without charging the owners higher dues: the flip tax.
A flip tax is a fee, usually a percentage of the purchase price of the apartment, paid to the co-op during a purchase and sale of a unit. For example, a $600,000 apartment in a building with a 3% flip tax means the seller must pay $18,000 to the co-op at closing (some sellers will stipulate that the buyer must pay the flip tax in addition to their bid price, which of course must be negotiated prior to contract signing). Keep in mind that a typical monthly maintenance fee for a $600,000 apartment is about $1,200, or $14,400 a year, so co-ops that see a healthy turnover of units will collect lots of extra revenue per year.
Benefits of the Flip Tax:
During the Manhattan real estate boom from 2002 through 2007, the flip tax helped co-ops tremendously. First, the higher transactions costs discouraged home flippers from taking leveraged long housing beta plays (hence a widening of the co-op / condo basis). A stable community is generally desirable, as it creates more longer term residents who will likely participate in community activities and who may someday serve on the board. Second, for the units that do change hands, the co-op gains a nice revenue injection, often equal or greater than a year of the subject unit’s maintenance fee. Finally, the flip tax naturally tracks housing prices, which during the boom period more than beat inflation. The long-term shareholders get the biggest windfall, for their maintenance fees can stay low, subsidized by the investors and home-flippers who trade in and out of the community.
The Double Whammy:
Sadly, those good times came to a screeching halt in the Fall of 2008, as the housing downturn finally hit Manhattan full force. Now, the co-op owners will have difficulties selling their units without offering a deep discount from a few months prior. As buyers become scarce and sellers defiant, the bid / offer spreads widen, liquidity dries up, and transaction volume plummets. The end result, no one is buying or selling, meaning no flip tax revenues are collected.
For years, co-op boards have been able to budget in flip taxes from a reasonable turnover rate, and now all of those projections have fallen short. Any co-op that has mysteriously seen flat maintenance fees may begin to see rate hikes, and those with rising fees may see an acceleration. Until real estate transaction volume resumes, the gravy train of inflation-indexed subsidies have vanished, and the doormen won’t be happy to take a paycut.
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