Assess for Capital Improvements? Borrow? Do Both with "Split Funding"

Since 1997, though, condominiums have been able to borrow money for repairs and capital improvements. Borrowing tends to be a more equitable way to fund such expenditures because the interest cost and principal repayment occurs over an extended period of time, more in line with the likely lifespan of the building components being repaired or replaced.

Initially, very few lenders were interested in this type of business, and those that were did not offer attractive terms. Today, that's changed. But don't expect to find the 30-year, self-liquidating loan at a rock-bottom interest rate that your neighbor's co-op building just closed. 

Similar but Different

Condos generally are offered a 5-, 10-, or 15-year loan with amortization on a 10- or 15-year basis. These terms result in a monthly payment that is higher than you might expect, but much more affordable for the average unit-owner than a lump-sum assessment. Condo loans have shorter terms and amortization schedules because of the absence of tangible collateral that could be mortgaged as security for the loan (as is typically the case for cooperative apartment buildings).

Not many condominium loans closed during the first few years after the law changed. Boards were unsure of the process and just accustomed to levying assessments. Over time, however, more and more condos applied for loans, especially as their buildings aged and required more extensive — and expensive — work. Today, most condominium boards are aware they can borrow money for capital improvements and include that option in their funding discussions.

In almost every building, a certain percentage of unit-owners still prefer a lump-sum assessment to any increase in their monthly obligation. Most buildings also have a percentage of unit-owners who could afford an increase in their monthly common charges but who would find it difficult, if not impossible, to pay large assessments. In the past, these factions usually battled it out until one or the other prevailed.

Over the last several years, many boards have considered funding a large capital improvement project by allowing some unit-owners to pay their pro rata share of an assessment in one lump sum (or several installments over a relatively short period of time), while other unit-owners assumed financial responsibility for borrowing the remainder of the project's cost. However, this "split-funding" concept was just that — a concept — until a Long Island condominium I recently represented actually closed a loan on that basis.

Tiered for Success 

The first step in any such transaction is to calculate the total cost of the project being funded. Next, determine how many unit-owners plan to pay their pro rata share of the total cost up front. Subtracting the second number from the first tells you the net amount of loan you need. To that, I would recommend adding something extra to cover loan application fees and projected closing costs.

The mechanics of each split-funding transaction will vary from condo to condo, but the cleanest format for handling the monthly loan payments is to break the common charges into two tiers. Tier A covers the monthly operating expenses and is invoiced to, and paid by, every unit-owner according to their percentage ownership in the condominium association. Tier B covers the interest and principal payments on the condo loan and is invoiced to, and paid by, only those unit-owners who did not pay their pro rata share of the total project cost up front.

I would not recommend venturing into a split-funding transaction without consulting all your professional advisers. Many issues must be addressed in both the condo-association and loan documents to ensure each unit-owner is treated fairly; the condominium's attorney will know how to handle those. Your accountant will provide much of the financial information required by the lender and also will know the tax ramifications. Your managing agent will help determine the total cost of the project(s) being funded and, after the loan closes, will program and administer the two billing tiers.

As I noted earlier, borrowing is, generally speaking, a more equitable way of funding repairs and capital improvements. Split funding allows a condo board to satisfy its financial needs while accommodating the individual financial preferences of its unit-owners. It's a win for everyone. 

Patrick B. Niland, a mortgage broker, is the principal of First Funding of New York.

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