BY DONNA KLEIN, nyarm

On Wednesday, September 22, 1999 the New York Association of Realty Managers (NYARM) resumed its monthly membership meeting schedule at Tavern on the Green. The special guest speaker at the luncheon meeting was Charles C. Dorego, special counsel to the prestigious law firm Stroock Stroock & Lavan.

In the past ten years, Mr. Dorego has almost exclusively devoted his law practice to tax certiorari, serving a roster of institutional and individual owners of large commercial properties. He is involved in every aspect of sophisticated tax appeals and property valuations — from assessment creation through final appeal. His resolution of tax appeal cases has resulted in tens of millions of dollars of refunds.

In addition to being a legal practitioner, Mr. Dorego has been a developer of garden apartment complexes and single family homes, both in New York and Arizona. As a result, he knows first hand the issues of property ownership and operation and the ramifications of proper property control. Mr. Dorego was invited to discuss the effect of rent destabilization on cooperative and condominium assessments.

ASSESSING APPROACHES

Assessors derive market value in essentially the same manner as appraisers. They use the Cost Approach when assessing new properties or specialty properties such as Yankee Stadium, museums or other properties that cannot be converted to other uses. Assessors employ the Income Approach to assess income or potential income-producing properties. The last approach used by assessors is the Sales Comparison Approach. This method is used most often when no cash flow exists, where properties are not rented and where there is a large number of similar sales.

After determining a property’s market value, the assessor "equalizes" the property by multiplying its value by a factor of assessment to value ratio, determined by the Department of Finance (DOF) for properties in the same class. The result is the property’s assessment for real estate tax purposes. Class 1 properties (one, two or three family homes) are equalized at a rate of 8% of market value. Class 2 properties (apartment houses, co-ops and condos) at a 45% rate.

REAL PROPERTY TAX LAW SECTION 581

In assessing individual residential cooperatives and condominiums one would assume that the best method to determine market value would be the Sales Comparison Approach. Co-ops and condos are, after all, single family homes set on top of one another. The majority of these apartments are very similar, are primarily owner occupied and possess no income stream to capitalize. In addition, there are many sales in the market place to serve as indicators.

However, back in 1980, a unique and comprehensive package of laws was passed, aimed at better defining the parameters of assessment practice by New York City and State in the wake of the Hellerstein case. The New York Court of Appeals threw the real estate tax world into disarray by directing that all properties be assessed based upon full value. Amongst the corrective legislative changes were the tax class system and the protective caps on increases benefiting certain classes, the transitional system of phasing in increases or decreases in assessments and Section 581 of the Real Property Tax Law which mandates that buildings converted to co-ops or condos continue to be assessed as if they were rentals, notwithstanding their converted status. Likewise, rental buildings could not be assessed based upon their potential as converted co-ops or condos.

Class 1 properties were granted protection by the legislature against severe increases in assessment by the creation of caps. No Class 1 property’s assessment may be increased more than 6% in one year nor more than 20% over five years. Class 2 and 4 properties were granted the lesser benefit of the transitional "phase-in" system, which postpones the effects of increases but does not cap them.

CONVERSION BOOM CHANGES EVERYTHING

The conversion boom threw a monkey wrench into the otherwise potentially smooth transition into tax classes. A large number of properties were changing their fundamental character at the same time that classes were being created allocating these same properties’ pre-existing tax burden. With the City assessor champing at the bit to use recently converted sales prices to his advantage, something had to be done to limit the increases on the newly converted apartments. Rather than place all converted or potentially convertible buildings into Class 1, Section 581 was enacted. The law was directly aimed at protecting apartment house owners and converters from severe increases in assessment resulting from rising sales prices.

FOR TWENTY YEARS 581 WORKED WELL

Over the past two decades, Section 581 worked fairly well for all concerned. The statute owed its success at keeping Class 2 on par with Class 1 due to the fact that, prior to conversion, a large majority of the converted properties were subject to rent stabilized rents. One issue the courts determined was that Section 581 required assessors to use these regulated rents in their computations. By imputing substantially below market rents into the economic model, the assessor was forced to limit assessment increases in direct proportion to rent stabilized rental increases. Similar to the caps in Class 1, rent stabilization worked to artificially suppress assessment increases. As a result, both renters and buyers enjoyed the benefits of rent regulations. But, while Class 1 properties rose by an average of approximately 4% per year, Class 2 properties rose closer to 6% each year.

This ever-increasing disparity between Class 1 and 2 assessments ultimately forced the City to establish a temporary program to bridge the widening gap. By passing the Co-op/Condo Abatement Program (which has been extended for 1999/00 at the current 17.5% rate) the City hoped to ease some of the pressure on Class 2 properties and continue to treat these two classes of homeowners relatively equally. However, according to Mr. Dorego, this program appears to not be enough to offset the impending problem, which is a direct result of a change in rent regulated rents.

LUXURY DESTABILIZATION

In the mid 1990s, at the insistence of landlords throughout the City, "luxury" rent destabilization became effective. At any time after April 4, 1994, an order may be issued by the NYS Division of Housing and Community Renewal (DHCR) to destabilize an apartment whose rent is greater than $2000 and whose occupant earns more than $175,000 for two straight years. In addition, any apartment whose rent was greater than $2000 on or after January 1,1997, is automatically eligible for destabilization upon vacancy. Ironically, in today’s healthy economy and climate of rising rents, when tenants may in fact need the help, landlords have finally achieved success.

Due to their increased revenues, landlords will feel the effects of higher assessments. As the apartments convert to market rents, the reported income will rise. That income will be capitalized to create the building’s assessment. The assessments of co-ops and condos will also rise with the increased rents collected by the landlords whose apartments have converted to market.

PROBLEMS

The mood at DOF is that luxury co-ops and condos have had a cushy ride for a long time. Now that the deck is stacked in the City’s favor, it is somewhat disconcerting that the limit on the game has been lifted. Co-op and condo owners need a real solution to this problem. Section 581 seems to have outlived its usefulness for tax years beyond 1996/97 as a protection for co-ops and condos. The co-op/condo abatement, while helpful, will do only so much and there are no assurances it will stay in effect. It is time to seriously revisit the fact that co-ops and condos are single family homes and should be treated as such.

According to Mr. Dorego, given the current co-op/condo assessment practices, it is extremely important for managers and boards to obtain good information, keep and report it accurately and share it freely with their tax professionals. Because if assessments rise as much as they can, the only way short of a major overhaul of the current system to reduce taxes, will be to show that the building does not or could not collect rents quite as high as the very rich landlord across the street.

Mr. Dorego can be reached at Stroock Stroock & Lavan, 180 Maiden Lane, New York 10038, 212-806-5472, cdorego@stroock.com.