Legal decision intended to protect co-op may backfire.

In December of 1995, the New York State Court of Appeals issued a ruling which will affect how cooperatives are valued. The court, in its ruling, has asked the New York State Division of Housing and Community Renewal (DHCR) to develop new rent regulations for "deconverted" buildings. DHCR is expected to issue these new regulations shortly.

What could this mean for New York cooperatives? At first glance, it appears that the court's decision is beneficial to co-op owners. It seeks to protect cooperative owners from the effects of foreclosure. But, the reality is, if DHCR does not set rents close to market rate, then the ruling could eventually hurt the very people it set out to help.

When coop buildings are appraised for financing, they are generally valued as if they were rental properties. Lenders tend to calculate values based on a "worse case scenario" or as if the building could at any point default. If a cooperative defaults on its loan, the lender has the right to foreclose, thereby becoming the new owner of the building. In effect, the cooperative's stockholders become renters, and their new landlord is their former lender. If the building has been rent regulated prior to its cooperative conversion, the building "deconverts," and returns to its original status as a rent regulated building.

Suppose DHCR sets rents at a level below market rate. Only a small percentage of coop owners would actually benefit from such a move. These are individuals who reside in failed co-ops - or approximately .005 percent of the total cooperative housing population. This estimate is based on past co-op default rates equal to one tenth of one percent of all the co-op buildings in New York City. And, the number of failed co-ops will be even smaller in the future with many new legal safeguards in place.

Who potentially could suffer?. An estimated two million coop residents - especially owners in the moderate to middle-income range. With rents set at a level below market rate, the larger implication is that coops would have a tougher time accessing financing so critical to their health, as well as the health of the housing market overall. Why?

If DHCR sets rents at levels much below current market rents, a co-op's appraised value, as determined for financing purposes, could be lowered dramatically. With such a regulation in place, analysis suggests that the values of many buildings could fall to as little as half of their current worth.

And, lower appraised values will only snowball. First, values impact financing. With a lower value, obtaining or refinancing a cooperative's mortgage could be that much more difficult, and interest rates could be that much higher. The higher the interest rate, the higher the maintenance charges for the cooperative owners' unit, which can only mean slower sales and lower sales prices.

In addition, if coop owners need to raise money for capital improvements, whether it may be a new roof, furnace, boiler or elevator, the building, because of its lower appraised value, would be considered fully financed. Without the ability to obtain additional outside financing, cooperatives will be forced to assess members for such costs, which for many middle-income owners is a great hardship. At the same time, assessments are not tax deductible, adding to the after-tax cost for individual homeowners.

The consequences of DHCR's decision will have significant impact. And, now is not the time for any action that might weaken the co-op market. If DHCR does not issue regulations which set rents close to market rates, the consequences could be detrimental, reversing the progress made by cooperatives so soon after the market has begun to stabilize.