are shareholders aware when they reduce value?

anecdotes illustrate, MLG goes on and on
Interesting post last week by the ever-thoughtful proprietor of True Gotham, Market Heats Up? and Your Building’s No Pet Policy May Be Costing You a Fortune. I am most interested in the second part of the post (and title), about a specific listing in a specific Manhattan building that sold easily (and high) after the Board changed from a No Dogs policy. Doug thinks it was the change in pet policy that made the difference (my bold):

Let’s not quibble with The Heddings (yet), but consider his implied point: shareholders in Manhattan coops that have rules that cut down a potential buyer pool reduce the market value of their apartments. Period. That’s a fact.

How much of a reduction is a hard question to answer, but there is no question that the general principle is that anything that reduces the pool of potential buyers reduces value because a smaller pool means that simultaneous interest from more than one buyer is less likely and that days on the market should be higher.

The related questions are very interesting: are shareholders aware that their coop has policies that will reduce resale value, compared to coops with different policies? Are boards?

I started a draft of this post last Saturday, and have been back to it at least four times since then. It just kept going, and going, and …. Prepare yourself for a quintessentially rambling Manhattan Loft Guy journey in (and out?) of the weeds. I have to also consider how these policies "cost you" (in Doug’s terms), how these policies have benefits (as well as costs), and (finally!) whether Doug’s example proves his point. Freshen up that coffee, will ya?

what kinds of things do shareholders do to reduce value?
I want to focus on building policies, rather than the things that individual unit owners do that reduce the buyer pool for an individual unit, such as creating true One Bed Wonders that would cost a lot to turn back in to a multi-bedroom space, or bathroom or kitchen renovations that are so idiosyncratic that no one else will think that they add value (only demolition cost and bother). Instead of these individual choices, certain corporate decisions reduce the pool of interested and qualified buyers, such as:
 

• atypical down payment requirements or other ‘high bar’ financial qualifications
• prohibiting or restricting open houses
• sublet policies
• no pet policies
• miscellaneous (unaudited financials, atypical flip taxes, restrictive renovation policies)

exclusivity costs, of course
The top one in this list is most ‘effective’ in reducing buyer pools and is probably the most likely to be intended as such. Of course you have the classically snobby coops in this category, in which (at the extreme) buyers (a) must pay cash and (b) have some multiple of the purchase price in liquid assets after the sale. There is no question that there are fewer people with the $20mm it would take to buy a $5mm coop in such a building than could qualify to put down $1.5mm and borrow (say) $3.5mm, with $2mm left over liquid.

I usually explain such policies in terms of an apparent willingness to artificially reduce the value of one asset (a Manhattan apartment), by people for whom that asset represents a fraction of their net worth, in order to make it more likely that their neighbors will be People Like Us. Shareholders in such buildings willingly and consciously make that trade-off.

While this is obvious at the top extreme, it is also operative in reducing the potential market in ‘lesser’ buildings, in which it might not be so obvious to shareholders that that is what they are doing. In this category are buildings that (say) require 40% down when their truly comparable buildings require only 20% or 25%. Such buildings tend to get a who do they think they are? sneer from real estate agents. (Of course there are coops that ‘legitimately’ require 40% down; I assume these shareholders intend to restrict the market in order to accomplish other benefits from being ‘exclusive’, such as reducing the risk of a default from tiny to infinitesimal.)

not a very open house
A restrictive open house policy is probably less likely to be perceived by owners as reducing market value — at least until the "owners" become "sellers". The fact is that many Manhattan apartments sell because they were exposed to the greatest number of buyers at Sunday open houses. (This is not true of the mega-million apartments, but is probably true at least up to $3mm.)

Manhattan buyers tend to like to ‘tour’ on Sundays without the hassle of having an agent make a weekday appointment. If the 5 most directly competitive apartments to yours (same neighborhood, price range, size) have easy open houses, yet your building prohibits open houses, your listing will suffer in all but the frothiest of markets.

This one is interesting: many shareholders may be aware of this trade-off, and in favor. But some may not be.

Restricting open houses is a major lifestyle benefit in buildings in which a lot of shareholders are around on weekends and that have small lobbies and/or elevators. I.e., shareholders who are most likely to be bothered by swarms of people in and out of the lobby. This category also includes shareholders in buildings that are nervous (paranoid?) about security, who don’t like having people wandering the halls. (There are less restrictive ways to serve these goals, but not all buildings seem to realize that they can require that an open house agent always be in the lobby or that visitors be accompanied upstairs and down.)

sub-letting, or not
Many prospective buyers ask about sublet policies when they are shopping (is that in a popular on-line buyer’s guide?), but I am not convinced that this is a significant factor in resale value because (like some of these other policies; as discussed below) there are significant potential benefits to shareholders from such a policy.

On the one hand, prospective shareholders take comfort in the fact that there is a ‘out clause’ through subletting if they would otherwise be forced to sell into an unfavorable market (2009, anyone?), or that they can offset some cost if life temporarily moves them from Manhattan (the one or two year job transfer overseas being a classic example). On the other hand, some shareholders are in a coop precisely because they want some scrutiny of the financial qualifications of their neighbors, and the stability that often comes from a fully owner-occupied building.

As with the pet policy (below), I am skeptical that there are enough people in the impacted segment to make a difference in the Buyer Pool. (But, repeat after me: it only takes one buyer to sell an apartment.)

no "pets", or no "dogs"?
I have trouble coming up with principled reasons why a building would prohibit all pets, as opposed to a no-dogs (or one dog per unit, or a ‘small’ dogs rule). Unless there are noise or nose issues, any animal that (a) stays in the apartment always, or (b) enters or leaves the building in a container, is a pretty benign presence. If your neighbor doesn’t like your parrot’s caw, there can be rules crafted about that, if the normal rules are not sufficient. Similarly, if you keep your pets and their environment clean, you won’t bother neighbors (or live like the folks in one apartment I visited, in which all rugs and blinds had to be thrown out before listing because the [bunch? herd? crew? of] rabbits were … evident.)

Most pet-related trouble that I have seen in buildings (apart from noise) concerns dogs in the lobby or elevator. No surprise that families with small kids in strollers may be leery of a dog snout that is mouth-to-mouth with their bundle of joy. Other buildings don’t want to deal with the wear and tear from dogs on hallway carpets, or walls. Granted, there are lots of ways for reasonable neighbors to deal with other reasonable neighbors in this situation (and others, related), but some buildings simply ban dogs, or ban ‘threatening’ (large) dogs.

lesser restrictions
One building policy that is probably limited to small buildings (so may be particularly germane to small loft buildings) is that some boards choose not to have audited financial statements. I don’t know the ‘savings’ achieved by not paying for a full accountant sign-off, but I doubt that it is worth it. Simply put, there are enough financial / prudential concerns for a potential buyer in a small loft building (concentration of risk on few shareholders, principally) that adding another uncertainty seems penny-wise-pound-foolish. More to the point of this post, further reducing the pool of potential buyers by choosing not to pay for an audited financial statement ($200 per year, per shareholder?) is a gratuitous Red Flag. Yet, some small buildings persist in ‘saving money’ this way.

Other policies that are restrictive that impact the buyer pool are probably subsets of the ‘exclusive’ coop policies, above. Buildings with high down-payment requirements may also be very stringent about renovations (only in the summer, only a limited number at one time), such that owners should expect not to be ‘at home’ for significant periods. This is less of a problem if you can just go to The Summer House or your Other Condo, and more of a problem if you are relegated to a pull-out at the in-laws. (But shareholders in the buildings that are ‘exclusive’ tend not to have to crash with the in-laws.)

Other policies that get some attention probably don’t get enough attention. By that I mean that prospective buyers don’t seem to discount enough for the financial structure of a building with comparatively higher maintenance or a higher flip tax. I suspect this to be true, but cannot prove it. (But then, neither can you prove the opposite!)

My sense is that a buyer choice that comes down to Apartment A in Building Z or Apartment B in Building Y just has too many variables already that people (in my experience) tend to meld everything together to assess relative value for them. As a result, I suspect you won’t see (or can’t prove, if it is there) a market discount of 2% comparing two buildings in which A has no flip tax, and B taxes 2% of the sales price. The Market should apply that discount (or the present value??), but I am not convinced that it does.

a demand issue, not a discount issue
Let me be clear about one thing that has been implicit in this entire discussion. Each of these policies ‘operates’ to ‘reduce value’ not because a given buyer will pay less for an apartment with these policies; instead, fewer buyers are interested at all, so that there is less demand for apartments in these buildings. Buyers for whom these things are important will simply buy elsewhere, and will not even consider these buildings (unless they were at a large discount to comparable buildings with different policies; an unlikely scenario).

In market conditions of relatively great demand, the impact of these restrictive policies on value is probably impossible to even find (think 2007). In thin markets, such as early 2009, there is likely to be the greatest impact (when any buyer reduction is painful) but, again, it may be heard to prove this effect through precisely paired sales.

difference between market value and value
For many shareholders in many buildings with these policies, these policies are ‘worth it’. The shareholders derive significant benefit from these policies.

Most obviously with financially ‘exclusive’ buildings, high (or no) down payments are associated with high income and net worth restrictions, which not only (a) dramatically reduce the Buyer Pool, but (b) reduce the Buyer Pool in ways in which shareholders approve. Note that the financial requirements for (nearly) all coops are more restrictive than for (nearly) all condos, which is one reason condos enjoy a structural value benefit vis-a-vis coops. I assume that everyone knows this, but it illustrates that these things are always a matter of degree.

I put the open house and pet restrictions in a life-style category. If these rules make sense at all (something that may change over time), they make sense because shareholders benefit from not having open house throngs in the lobby, and in not worrying about baby-snacking dogs in the elevators. Again, I doubt that you could prove that some people will pay a premium for such policies, if for no other reason than that any Pay A Premium buyer segment may be similarly small as (and canceled out by) the Won’t Even Consider buyer segment.

what really happened with that apartment and the dog policy?
The premise of the True Gotham post from May 7, Market Heats Up? and Your Building’s No Pet Policy May Be Costing You a Fortune, is that The Apartment couldn’t sell until the Board loosened the pet policy. Maybe. But I don’t think the data support that conclusion.

First, The Apartment had only been on the market "a few weeks" and I don’t know if all five of the bids that came in after the change in policy are from dog owners. Second, the agent responsible for the change in policy has not updated the listing description to reflect the new policy (maybe because they have a deal that has not yet been signed, but you’d think if it was a key driver on value the listing description would be updated). Third, none of the three ‘experts’ on television who valued the apartment mentioned the dog policy in valuing The Apartment.

As one of those TV experts (the one with the very recognizable name) noted, there had been a recent sale in the building of a similarly sized unit, which also had outdoor space. That #5A has some evident similarities to The Apartment (#1D), in that both are 3 BR + 3.5 baths, and it cleared on September 10 at $1.825mm. That one was a triplex with "500 sq ft" terrace; The Apartment has one bedroom on a lower level and has a "938 sq ft" garden; both are said to have high-end renovations.

comping is, as always, hard
Assuming these two units are of comparable size and condition, how to account for the fact that one cleared at $1.825mm and the other "will sell" (assuming the deal that Doug knows about goes through) above $2mm? Apart from the Great Dog Shift, there are two relevant valuation factors: timing and space. The other apartment was marketed toward the end of the post-Lehman nuclear winter, from May 27 to a contract on July 31. I suspect that July 2009 values were lower than April 2010 values for ‘unique’ apartments (both of these being Real Estate Unique).

Second, the garden is nearly twice as big as the terrace. If you remember my May 6 post, riffing with The Miller on the value of Manhattan terraces, decks + balconies, you know that baseline values for outdoor space are in the 25% – 50% of per-square-foot for interior space. You also know that there are widely divergent valuation factors.

Might the differences between July and April, and the terrace and garden account for the apparent difference in value between #1D and #5A? Maybe. Might the dog policy be a factor? Maybe. But it is awfully hard to say.

For fun (?), let’s assume the #5A terrace is equivalent to interior space values at 25% (great sunset views, but entry is through a bedroom) and the garden of #1D is equivalent to interior space at 50%. Assuming #5A is also "1,500 sq ft", that makes #5A a July 2009 $1,123/ft value ($1.825mm divided by 1,500 sq ft plus  25% of 500 sq ft = $1,123). In contrast, at $2mm or more, #1D is shown to be worth at least $1,105/ft in April 2010 ($2mm divided by 1,500 plus 50% of 938 = $1,015/ft). Of course, you could quibble that the garden is too big to get full 50% treatment. Or you could quibble about a lot of things.

My point is that it is very much not clear that — absent a huge premium over the $2mm ask for #1D — you can find any value here due to the change in dog policy. It is a great anecdote. It might even be true.

But looking at the July 2009 value of #5A at (more or less) $1,123/ft and the April 2010 value of (more than) $1,105/ft for #1D, I am hard pressed to assign any premium to the dog policy, as opposed to the timing and the outdoor space. And that is without knowing if the #1D bidders own dogs.

For more fun (???) if you count the two outdoor spaces as equally equivalent to interior space, the notional differences are $1,123/ft for #5A and (more than) $1,153/ft for #1D at 25%, and $1,042/ft for #5A and (more than) $1,015/ft for #1D at 50%. This ‘proves’ a couple of things: that the assumptions drive the result (d’oh!), and that it is still very hard to prove that the dog policy has had any impact on value.

Department of Redundancy Department
Great anecdote. Indeed, The Heddings makes a great point that shareholders should pay attention to building policies because they may impact resale values. I would add that the logic is inescapable but difficult to prove in the lab. Also, that some of the policies that ‘cost’ value are of some benefit to some shareholders at least some of the time.

Memo to owners: read the fine print; talk to board members; agitate so that the building is run for your benefit, not just because ‘that is the way we have always run’.  How was that coffee?

 

© Sandy Mattingly 2010