Spekulation på andelsboligmarkedet

Speculation in the cooperative housing market

Quite contrary to intention, antiquated lease legislation opens up for speculative capital gains when dissolving the housing society and selling the property.

By Peter Winther, Partner and CEO, and Ole Hjorth, Director, Sadolin & Albæk

In recent years, the Danish private cooperative housing sector has been the object of quite a bit of negative press coverage caused by the valuation problems inherent in this form of ownership. The combination of a maximum price system and complex rules produces major valuation uncertainty to the disadvantage of both residents and investors.

Cooperative housing as a form of ownership has existed for more than a century and is an offshoot of the cooperative movement. The form of ownership has evolved markedly from the emergence of the very first housing societies at the end of the 19th century to the private cooperative housing societies of today. Like owner-occupied dwellings, private cooperative housing societies account for about 30% of the housing stock in Copenhagen and Frederiksberg, making them a key component of the overall housing supply.

However, cooperative housing has in recent years drawn quite a number of negative headlines in the media in connection with ailing societies, interest rate swaps, bankruptcies, under-the-table money and major uncertainty about valuations made by real estate appraisers. A lot of the problems are associated with cooperative housing societies established in the period up to the financial crisis when the combination of high prices of residential rental property and complex financial products resulted in unviable societies. However, it hardly evokes sympathy that the members of such cooperative housing societies have specifically targeted bankruptcy, inflicting substantial losses on the loan providers while enabling the members of the society to continue as tenants.

Valuation uncertainty
Ailing cooperative housing societies aside, the challenges presented by this form of ownership are mainly rooted in the problems inherent in the combination of a maximum price system and uncertainty surrounding the valuation of the society’s prime asset – the property. 

The maximum price system is generally based on the provisions of the Danish Cooperative Housing Act governing the transfer of a unit in a cooperative housing society. The Act prescribes that the price of the unit cannot exceed a price reasonably justified by the value of the unit relative to the society’s assets, improvements made to the unit and the state of repair of the unit.

The maximum price system gives rise to problems when the price difference between a cooperative housing unit and a comparable owner-occupied dwelling exceeds a level explainable by differences in financing options and taxation. 

A housing cooperative is free to use the purchase price, the cash market value as a rental property or the most recent official property valuation for a property valuation. 

If a housing cooperative opts for the approach providing the lowest value, the units become assets sold substantially below the actual market value. Such a situation would foster nepotism, with the friends and family of housing cooperative members having a first claim to units for sale, and may lead to demands for money under the table or demands on buyers to pay unreasonably high prices for furniture and equipment.

Increased use of valuations made by real estate appraisers
The inherent imperfections of the maximum price system support the use of valuations made by real estate appraisers, as these would be more likely to ensure that current conditions in the investment and housing markets are factored into the valuation, but the valuation is subject to unacceptable uncertainty as a result of complex legislation.

Valuations made by real estate appraisers must be based on the cash market value as a rental property. This means that the appraiser will need to take into consideration the legislation that the property would be comprised by had it been a rental property. Accordingly, the applicable legislation is determined by the year of construction of the property and whether it is situated in a regulated or unregulated municipality. These factors determine whether market rent can be charged or whether rent is to be determined in accordance with the utility value or cost-related rent.

If valued as a rental property subject to cost-related rent, the property will be valued substantially below the actual market value of the individual units combined. This is due to the fact that cost-related rent is generally much lower than the rent that a house-hunter would be ready to pay in a free market.

However, the members of the cooperative housing society will have a direct financial interest in achieving the highest possible valuation price as it makes it possible for the unit owners to realise substantial tax-free gains. As a result, we often see an unhealthy scenario where the housing cooperative is incentivised to pick the real estate appraiser prepared to value the property at the highest amount – not the appraiser providing a correct value of the property as a rental property.

Complex and antiquated legislation
Most of the properties owned by private cooperative societies in Copenhagen, Frederiksberg and Aarhus were built before 31 December 1991 and comprise more than six units. As these three municipalities are regulated, most of the properties are to be valued on the basis of the provisions of the Danish Housing Regulation Act and in practice pursuant to extremely complex and antiquated legislation.

Accordingly, a correct valuation of a property comprised by the provisions of the Housing Regulation Act on cost-related rent must comprise a determination of the rent that may lawfully be charged, improvements made to the property in relation to section 5(1) of the Housing Regulation Act and the maintenance history of the property in relation to provisions under sections 18 and 18b of the Housing Regulation Act, etc. In a correct statement of the property’s current income and operating expenses, the valuation should also take into account any optimisation potential currently factored in by the market for traditional rental properties.

In a joint effort, the Danish Ministry of Industry, Business and Financial Affairs, the Danish association of private cooperative housing, ABF, and Finance Denmark have listed 13 recommendations to safeguard responsible operations in the cooperative housing sector. The 13 recommendations pertain mainly to formation, financing and the transition from unit owner to tenants, whereas the valuation is only touched upon very lightly, because of concurrent efforts presently undertaken by the Danish Association of Chartered Estate Agents and the Danish Property Federation. These two organisations are in the process of updating the guidelines and norms for real estate appraisals, including ways of ensuring that the appraisers have the required qualifications.

However, updated guidelines and norms alone are not enough to reduce the uncertainty associated with valuations made by real estate appraisers as the valuation basis remains an antiquated and complex body of laws.

Speculative dissolving of housing cooperatives
Serving as a current example of the consequences of the challenges posed by the maximum price system, several old and well-run cooperative housing societies are being liquidated, guaranteeing the unit owners a profit that substantially exceeds the value of the property had it been valued on the basis of continued operation of the cooperative housing society. 

As a result, it does not seem fair that tenants, who are often long-term residents at very low rent levels, pursuant to the mandatory pre-emption rights of tenants as set out in the Danish Rent Act may take over a rental property by forming a cooperative housing society, subsequently realising substantial tax-free profits when dissolving the very same society and selling the property as an untenanted rental property and therefore with a significant immediate upside potential for a buyer.

The underlying philosophy of cooperative housing was to establish a type of housing that would offer reasonably priced dwellings free of any speculative element. By dissolving a cooperative housing society and selling the property, however, the unit owners precisely do speculate in achieving tax-free capital gains.

Valuation basis remains antiquated
Like the maximum price system, cost-related rent was introduced in a statute passed as a temporary measure by the Danish Parliament, Folketinget, in 1937.

The statute entails that the income basis of a rental property is artificially low as the rent is often much lower than the real value of the asset as warranted by the right of disposal of the unit. As a result, the correct valuation by a real estate appraiser of a cooperative housing property will often be substantially lower than the actual market value of all units combined.

The Danish Parliament hardly intended for members of housing cooperatives to realise tax-free capital gains by dissolving cooperative housing societies. However, this option fundamentally continues to co-exist with the effective unhealthy maximum price system.