Co-op subletting: the time to review is now.

Every indication suggests that 1994 is the strongest year of the decade so far for the cooperative apartment market. Spurred by the announcement late last October that Fannie Mae has significantly relaxed its loan qualification guidelines, thousands of studio and one-bedroom apartments in buildings owned by perfectly healthy cooperative corporations should once again provide a new generation of New Yorkers with their first chance at home ownership.

Many of these apartments have been occupied for years by subtenants, both legal and otherwise, as their owners were forced by a variety of circumstances to all but abandon them. The marked increase in the salability of these units now provides cooperative apartment co orations with the opportunity to review, codify and/or alter their subletting policies for the good of all concerned.

In this article, we will address what items should be included in any procedure adopted by the Board with regard to shareholders' applications for Board consent.

Any discussion about whether or not to permit the subleasing of Proprietary Leases by shareholders necessarily involves a broad spectrum of consideration and may invoke some deep emotional attitudes. On the one hand, the Board of Directors may legitimately be concerned with creating or maintaining that special atmosphere that seems to exist when all the residents of their building are owners as well. A building may be undeniably safer when the residents are owners with an extra degree of concern for who enters the premises. Owners are perceived to be more concerned about the physical condition of the building in which they live and may be prone to bring problems to the attention of building management more quickly. Transience can itself be a source of physical wear and tear on a property. Perhaps most importantly, economic stability is enhanced by a high level of resident shareholders in two ways - both because shareholders who have an ownership interest in their homes are often more responsible in making prompt maintenance payments and also because of the singular importance that financial institutions place on the percentage of occupancy as a criteria in evaluating whether or not to make a mortgage loan and at what rate. A high level of owner occupancy also increases the ability of a potential purchaser to obtain purchase money financing for a particular unit.

On the other hand, at any given time one or more individual shareholders in a building may have a change in circumstances that requires them to relocate - an increase in family size, a job opportunity out of town, an adverse change in economic circumstances like the loss of a job. The need to relocate may be temporary, with the shareholder desiring to return after a discrete period of time, or it may be permanent.

Prior to the change in Fannie Mae guidelines, a sale of the unit by such a shareholder may just not have been a viable option. Now, it should be.

It is obviously important that each Board of Directors seek to balance the equities involved in discussing and adopting a sublet policy. It is important that the policy adopted be fair, even-handed in its administration and that it be designed to maximize the flexibility of the cooperative corporation as well as the individual shareholders. In addition value of each shareholder's investment, a wise sublet policy may have some unanticipated benefits. First, there is usually a provision in Proprietary Leases permitting a Board to direct the subtenant of a defaulting shareholder to pay rent directly to the corporation. If you have a shareholder in extreme financial distress, a subtenant gives you a second source of income from the unit. Second, a sublet policy that requires not only the payment of application and review fees but also an ongoing monthly sublet fee during the term of the permitted subletting, can be a positive source of additional income to help defray the need for assessments and pay for building repairs. For those corporations that have a commercial income, the extra good news is that sublet fees paid by shareholders constitute |good' income under [sections]216 of the Internal Revenue Code. If your commercial lease requires rent that is a percentage or multiple of your gross income, the additional revenue derived from sublet fees will also serve to raise the rent of your commercial tenants.

Three main areas should be covered in a fair, even-handed and flexible sublet policy: (1) A clear statement 0[pounds] the restrictions promulgated with regard to subletting; (2) An application procedure with criteria for sublet candidate review; and (3) A fee structure that is workable and fair.

Having been guided, although not directed, by the thoughts of individual shareholders, the Board should draft and issue, in as clear and unambiguous a way as possible, a policy statement providing all shareholders with the basic guidelines of what is permissible and under what circumstances.

Does the Board consider sublets to be a necessary evil that it wishes to discourage and control, or as a potential benefit that merely will be aided by regulation? In addressing the issue of term, some Boards choose a minimum of six months to avoid seasonal subleasing and a maximum of two years to provide an opportunity for, and to encourage, sale of a unit rather than a repeated subleasing. In some co-op buildings, renewal at the end of a term is strictly prohibited.

Should a shareholder be required to establish either an intention to return and re-occupy or circumstances that constitute some financial or other hardship before the Board will consent? Evasion of the adopted policy should be discouraged, perhaps both by indicating that occupancy by a non-shareholder in the absence of the shareholder for a period in excess of 30 days shall be considered a de facto sublet, and also by establishing an economic penalty for violation of the published procedure.

The Board of Directors should next create a uniform application process and forms intended to elicit information relevant to the candidate criteria established by the Board. The questions posed by the application packet should not be overly broad or burdensome. It is important, however, to obtain information with respect to the proposed subtenant's financial condition, job stability, character, prior history as a tenant and size of family unit. The review process should also permit a necessary level of subjective judgment and the fair exercise of discretion by Board members.

The last issue for consideration is the establishment of a fee structure. At a minimum, an application fee to cover the actual cost of financial and character reference checks to be performed by the corporation's managing agent should be imposed. To compensate for any additional management involvement or wear and tear on the building premises, most Boards also adopt a sublet fee consisting of a flat annual charge and/or a monthly fee that is a percentage of either the sublet rent or the maintenance payable. A way of discouraging subletting might be to escalate either the flat fee or the annual percentage fee for each year after the first that subletting continues.

In summation, the newly revised Fannie Mae guidelines, by increasing the salability of many apartments no longer occupied by their owners, provide an opportunity to every co-op Board of Directors to review their current approach to subletting. The adoption of a fair and intelligent subletting policy may serve as a source of both economic and emotional stability for a cooperative corporation. With care, the policy can be administered in a way that does not compromise the building character and enhances the value of individual units both to resident shareholders and those who opt to move on.