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How to get money to start a new co-op residence

by Michael Bluejay • 2007-2020

Check local laws first

Before figuring out financing, first figure whether a co-op is even allowed in your area.  Local laws in many (most?) areas limit how many unrelated people can live in the same house.  For example, in Austin, the limit is 3 to 6 depending on the circumstances. (ordinance #20140320-062, source 2)  Apartments, of course, have no such limits, but you can't just call your house an apartment; the property has to be zoned as multifamily.

If local law prevents as many people as you want to have in your house, then you can ask your City to grant a variance (an exception) to the occupancy limit, though there's no guarantee they'll agree to it.

You're wondering how co-ops exist when they have more people than allowed?  They're generally either grandfathered in (the city allows it because the co-ops have been operating for decades, often prior to the occupancy law being established), or they're operating illegally, under the radar.

Don't expect that your new co-op can operate under the radar.  Lots of people, cars, noise, and trash in a house is a recipe for a neighbor to call the city to complain.  The city could then force the co-op to evict several members to comply with the occupancy limit, at which point your co-op won't be financially viable.

If you've got the occupancy thing handled, then you can proceed to work on financing.

Various ways to get money for a new co-op

Nobody pays cash when they buy a building.  Instead, you make a down payment (1% to 30% of the purchase price), and get a loan for the rest.  There are three ways to get that loan:
  1. Get the loan from a bank.  This one is easier said than done, because you usually need a big down payment (20%+), and because of other catches that come with commercial loans.  We'll cover these in more detail below, but for now, just know that getting commercial loans often isn't easy.
  2. Get the seller to finance the property.  This means making monthly payments to the seller rather than to the bank.  Most sellers won't want to do this, because it will take them 30 years to get all the money.  They'll usually prefer you get a bank loan so they can get a big lump sum all at once.  There are other obstacles as well.  We'll cover those below.

  3. Borrow through microloans.  With microloaning, you raise the money by soliciting small loans from hundreds or even thousands of people.  The lenders like it because it's real community investing and because they can get a better interest rate than they're getting from their savings accounts.  You'll like it because you can raise the money even if a bank turns you down, and you'll pay less interest than you would to a bank.  The downside is that there's a lot of paperwork involved — you've got to get a loan agreement signed with every lender, and you have to mail out repayment checks every year.
  4. Develop as a NASCO Properties co-op.  One arm of NASCO is NASCO Properties, which is a co-op of co-ops.  NP might be able to finance your project, in which case your co-op would be a member of the NP family.  You wouldn't own your own building independently, you'd own it collectively along with all the other co-ops in the NP family.

  5. Borrow from me.  [Update: I'm no longer loaning money for co-op starts.]  When my cash isn't currently invested, I loan money to groups trying to start co-ops.  The pro is that this is the easiest way to borrow the money.  The cons are that my money is usually already tied up in co-ops so I don't have free cash to loan, and when I do, I charge a higher interest rate than you'd pay to a bank or to microloan lenders.

Let's look at each of these options individually.

(1) Getting the loan from a bank

Getting a loan from a bank to buy a co-op property is easier said than done.  You might be familiar with personal loans to buy a house, but commercial loans are a whole different animal.  (And a loan to buy a co-op is indeed a commercial loan, because a co-op is a business.  Even if the co-op is a nonprofit, it's a nonprofit business.)
  1. Higher down payment.  Most commercial loans require a down payment of 20% to 30% of the purchase price.  Ouch!  If you're lucky, you might be able to find a bank that requires only 10% down, but even then, coming up with $50,000 for a $500,000 property isn't exactly a walk in the park.  You might be able to borrow the down payment money from another source, such as through a microloan program, but that might not be kosher with the bank:  The bank might be willing to loan only if you've got your own money saved up for a down payment.

  2. Higher interest rates.  A commercial loan is 1 to 3 percentage points higher than a private home loan.

  3. Shorter amortization.  When you buy a house, you can spread your payments out over 30 years.  But with some commercial loans, the repayment schedule is for only 25 years, which makes your monthly payments higher.

  4. Balloon notes.  When you buy a house, your loan lasts the whole 30 years.  But with many commercial loans, after 3, 5, 7, or 10 years (depending on the loan), the entire remaining balance on the loan is due.  Since you won't have the money to pay it off, you would hope to just refinance.  But if you can't get another loan from a bank at that point, then you lose your building.  I know of one co-op that nearly went under because of this very problem.  Next, even if you can refinance, the interest rate might go up when you do.

  5. More paperwork before you get the loan.  Banks require reams of data before they'll loan.  Here's a list of what they require.

  6. More paperwork after you get the loan.  From Real Estate ABC:  "[Even after you get the loan,] many banks will ask you to provide quarterly or annual income statements, balance sheets and tax returns. Some loans will require covenants—promises that your business will meet certain tests in the future. They may require a certain positive cash flow, or a certain debt-to-cash-flow ratio, or other financial criteria.... If your business falls short of the terms and conditions contained in the loan covenants, your bank may deem that your loan has entered into default. Default triggers numerous penalties. It may require that you pay back the loan immediately. This can cause you to have to find another lender very quickly, or face foreclosure on the property."  Ouch.

(2) Seller-financing (aka owner-financing)

With seller-financing, you make your monthly payments to the seller.  No bank is involved, and it's simple.  But sellers usually can't or won't seller-finance.

Imagine a property being sold for $500,000, where the seller has $200,000 left on her own loan.  If you got a bank loan to buy the property, $200,000 of your money would go to pay off the seller's existing loan, and the seller would net $300,000.  But if the seller were seller-financing, first she'd have to pay off the $200,000 herself, and probably doesn't have $200,000 lying around to do so.  So, in most cases, it's just not possible for the seller to seller-finance.

Even if the seller's property is already paid off (or the seller has the cash to do so), sellers usually don't want to seller-finance because doing so means they get their money slowly, one month at a time, over 30 years.  With a traditional sale via a bank loan, the seller gets the huge lump sum all at once, which is probably what the seller wants.

But improbable doesn't mean impossible.  If the seller owns her property free and clear, you can entice the seller by offering a higher interest rate.  Start with at least three points higher than current mortgage rates to get the seller's attention, though you might have to go higher at which point the property is unaffordable to you.  Also, you can offer to have the loan be a "two-year balloon", which means that in two years you have to pay off the entire remaining balance.  The way you'd do that is to get a regular bank loan after two years.  It's hard to get a brand-new loan, but it's easier to move an existing loan to a bank when you already have one, when you have two years of solid payment history on your existing loan.  You'd want to move your loan to a bank in the future anyway to save on interest, because you had to offer a higher-than-normal interest rate to get the seller-financing in the first place.

A combination of a high interest rate and a short balloon might get the seller to finance when she wouldn't do so otherwise.  The downsides are the higher payments for the first couple of years, and the risk of not being able to secure a new bank loan after two years, in which case the seller could foreclose and you could lose the property.  Ouch.

(3) Borrow through microloans

Rather than getting one big loan from a bank (or from me), with microloans you get hundreds or even thousands of small loans from individuals.  That's often locals in your community, but with the Internet, you can solicit investors from anywhere.  The lenders earn a better interest rate than they could get from a savings account, and you pay a lower interest rate than you would to a bank (or to me), so it's a win-win situation.  Lenders also appreciate the ability to invest directly into their community.  Here are some examples of groups who raised funds through microloan programs:
There are a couple of downsides to microloan programs, though.  The first is that there's a lot of paperwork (or electron-work, if you can do it online).  You have to sign a loan agreement with every lender, and there will be hundreds or thousands of them.  You'll also have to cut checks and mail them to all those lenders once a year as you pay back the loan.  The other downside is that you might not be able to find enough lenders.  If you want to buy a $500,000 property, that's 1000 lenders at $500 each, or 5000 lenders at $100 each.  It's possible to land big investors, but don't count on it:  When Wheatsville raised over $700,000, I was their biggest lender, and I loaned only $41,000.

Check out the Yellow Bike Project's writeup about how their microloan program worked.  It includes a copy of the contract they used, too.

If you go microloan, how much interest should you offer to lenders?  That's a hard question to answer, but I suggest somewhere in the range of 3% to 8%.  You wouldn't go lower than 3% because it will be hard to get people interested in loaning to you at a rate that low.  The higher you set the rate, the higher your loan payments will be (and thus the more your members will have to pay for rent), but the higher you set the rate, the easier it will be to get people to loan money to you.

(4) Develop as a NASCO Properties co-op

(5) Borrow from me  I'm no longer loaning money for co-op starts.  I'm leaving this section here for historical purposes.

I loan money to groups trying to start co-ops.  The pro is that this is the easiest way to borrow the money.  The cons are that my money is usually already tied up in co-ops so I don't have free cash to loan, and when I do, I charge a higher interest rate than you'd pay to a bank or to microloan lenders.

This loan is available to any group of people anywhere in the U.S. who are starting either:
and who can afford to make:
and where I will be either:
The first lien holder is the person first in line to get paid if the property is foreclosed if you fail to make your monthly payments.  If you're doing a deal with multiple lenders, then I'll agree to that only if I'm first in line to get paid if you default.  It is difficult to get loans from multiple sources, because each lender (including me) will generally require that they be the first lien-holder, but only one lender can be in that position.

This offer is not available to anyone else, period.  For example, I won't help you if:
If the property you want to buy is outside of Austin, Texas then I will require you to put up a deposit of $1000 since I will have to travel to your location to meet your group and to check out the property.  If the deal goes through you'll get the $1000 back, by having it applied to the loan balance.

Please understand that my motivation isn't completely altruistic. Loaning to a new co-op is an investment for me, from which I expect to make a fair profit.  I don't have to help co-op founders, I could invest in lots of other things which are decidedly more hassle-free (and more profitable) than trying to help finance co-ops.  I'm willing to take on the extra hassle and decreased profit, but I still consider this an investment.

How do we set up and manage our house after we buy it?

  1. Solicit help from NASCO.  Your co-op should join this association of co-op groups to become part of the family, and to have access to its resources.  Take advantage of this.
  2. See my articles.  I have a plethora of articles about managing co-ops.  Most of them are written for multi-house student co-ops, but you'll likely find some things that are useful.
  3. Sample house manuals.  Especially see the sample house manuals I put together for House of Commons (PDF, Word) and Royal (PDF, Word) co-ops.

Thanks for reading this far, and thanks for your interest in expanding the idea of co-ops!