When he was New York City's mayor, one of Ed Koch's most effective ploys was to ask, "How am I doin'?" With his boyish grin and puckish charm, he disarmed any potential adversaries in a room and got at least one good sound bite on the evening news.
Most co-op board members have neither the charisma nor the battery of spin-doctors needed to pull off such a coup. Quite often a board's performance is either scathingly condemned in the annual meeting or blithely ignored throughout the year. In fact, the true test of a board's performance could be the quality of the flowers planted in the tree pits in front of the building just as easily as it could be whether or not there will be a maintenance increase in the coming year.
Wouldn't it be nice, though, if there were an objective measure by which to evaluate the performance of a board? After all, baseball players have their batting averages and corporate CEOs are measured by their companies' earnings per share. So, can there be a quantitative standard for co-op boards? And, if so, what is it?
FINDING A STANDARD
There is a number that represents how well a board has managed its operations for the year and it is net operating income per square foot. This is the amount of money left over after all the income is collected and all the operating costs of a building (which excludes mortgage and tax payments) have been paid, divided by the total square footage of the building.
The logic behind using this number? Boards are responsible for the money that is spent to heat the building, pay the staff, repair the elevators, decorate the lobby, and so on. Even though many costs, such as payroll (which is dictated by union contract), have more of a fixed than variable nature, they can be managed. An inefficient boiler can be repaired or replaced, staff overtime can be reduced (a union position can even be eliminated through negotiation), and administrative expenses can be controlled. Real estate and corporation taxes are not directly within the control of the board (although, through the tax certiorari challenge process, real estate taxes can sometimes be reduced). Also, the mortgage is a fixed cost that cannot easily be changed. Many co-ops are locked into lengthy mortgages with onerous early repayment penalties.
Getting to a square footage number can entail combining data from different sources. Kleiman & Weinshank, an accounting firm with a large number of co-ops among its clients, has been publishing an annual database of information on co-ops and condos for the last few years. The Cooperative and Condominium Database for 2001 reports the complete income statement information and selected balance sheet accounts for 131 co-ops and condos in the metropolitan area. The 2001 data, as well as similar data for years back to 1999, is available on the firm's website, www.kleimanweinshank.com (click on the section labeled "Internet Links") and can be downloaded in either Excel or Lotus (the information presented here came from the Kleiman & Weinshank 2001 database for a handful of buildings).
Table 1 (p. 27) shows the data from a group of buildings, ranging in size from 96,379 to 870,000 square feet. The data has been adjusted to move taxes and mortgage expenses out of operating costs. The resulting net operating income (NOI) shows how much money is left over after all the income is collected and all of the operating expenses have been paid. Immediately below it, this NOI number is expressed as a percentage of total income.
As a benchmark by which to evaluate this number, consider the rental industry. Private owners of residential apartment buildings look at similar calculations in evaluating management of their properties. They do include real estate taxes as operating costs and still expect the resulting free funds from operations (FFO) as a percentage of total income to be above 50 percent. Financing costs are taken out of the remaining 50 percent, and whatever is leftover is the owner's profit. Granted, co-ops are not-for-profit entities and the 50 percent target may be too high. Just remember, though, that the more that is spent on operations, the less there will be for taxes, financing, and any excess funds generated by the building.
After NOI taxes and mortgage costs are included with operating expenses to calculate total expenses. Total expenses are then subtracted from total income to result in an excess or deficit. The final three lines show the building's debt, its working capital (calculated from two balance sheet accounts, current liabilities less current assets, and approximates the level of the reserve fund), and the percentage of maintenance deductible from shareholders' taxes.
The buildings in the table are arranged from left to right by number of units from smallest to largest (the order used in the Kleiman & Weinshank database). It is clear that each building has a unique set of circumstances. "Buildings are like fingerprints," says Kleiman. "They are all different, and, depending on what the shareholders want, the numbers will look different from one building to the next. The square footage measure allows for a lot of interesting comparisons."
Total income can be dramatically affected by accounts other than maintenance (such as commercial rent and income from parking). Cable TV and electric charges appear in some building with umbrella contracts and submetering programs.
The pattern of operating expenses varies across this sample. Within each building, the size of each expense relative to the other expenses is easily seen. With the number of units reported for each building, the revenue and expenses can be divided by units to come up with a per unit figure. Nonetheless, units will vary in size (think of a one-bedroom apartment versus a three-bedroom unit), and the value of the per-unit figure is limited in its usefulness.
Calculating expenses on a per-square-foot basis creates a number that is expressed in a meaningful unit of measure. To do that for the sample group in Table 1, it is matched to the square footage measures available from the city tax assessor's office for Manhattan. To get the square footage for a building, go to the office at 66 John Street (212-361-7660) with your block and lot number. The clerk will provide you with a print-out of the building that will include the square footage.
Table 2 (p. 29) starts with the same information as Table 1 but all the income and expense numbers are divided by the total square footage of each of the buildings. Disparate costs, such as legal fees and heating expenses, can be compared and assessed more easily. Another benefit is that a per square footage number allows for meaningful comparisons of one building's operating performance with others. Also, it is akin to the FFO measure that owners of rental apartment properties use to assess the performance of management they hire to run their buildings.
With this common unit of measure, we can look at costs within a building and compare them much more productively. For example, Building 2 had an excess of one cent per foot in 2001 (a total of only $887), not much above the breakeven level. Should any one of the major operating costs increase the building would have a deficit. The building's NOI as a percentage of total income is 34 percent. There is nothing wrong per se about that level of performance (even though it is way below the heady 50 percent standard rental property owners demand), but given the fact that the building is on the verge of a deficit. It would seem appropriate for the board of Building 2 to start looking at cutting operating costs before even considering a maintenance increase or refinancing.
Another interesting example is Building 4, which has a deficit of 67 cents per square foot. Part of its problem is a high mortgage cost $2.79 per square foot. This negative is compounded, however, by a NOI percentage of only 40. Given that refinancing the mortgage was probably not an option during the year, the high level of operating costs contributed to the deficit. In analyzing operating costs, it is apparent that payroll costs are nearly half of the total operating expenses. When the related payroll taxes and pension and benefits expenses are added in, total staffing goes up to $5.53 per square foot, which is 63 percent of total operating expenses.
Certainly, the shareholders may demand a high level of staffing. However, if deficits are not going to be continued, something will have to give, and the issue for the board to tackle will be whether to raise the maintenance, find cost savings elsewhere, or begin to look for a way to reduce staff, which involves coming to terms with the union and can take years to accomplish.
Although this sample group is limited, it does reflect a cross-section of the Kleiman & Weinshank database and enables co-op board members to look at other buildings' performance and make meaningful comparisons. For example, a comparison of Building 5 to Building 4 highlights dramatic differences in management between the two buildings. Even though Building 5's income per square footage is only two-thirds that of Building 4, its NOI as a percent of income is 58 percent. Payroll in Building 5 is less than 50 percent of the same cost for Building 4 and virtually every other expense item is lower in Building 5. With this level of operating performance, Building 5 could increase its mortgage expense to the group average level of $1.54 per square footage and still have an excess of 70 cents per square footage. That's the kind of performance that anyone could learn to love.
For board members who reject the idea of their performance being summed up with one number, there are kinder, gentler methods by which to assess their efforts on behalf of the cooperative.
THE PEER GROUP METHOD
Another way to look at how well a board performs is to compare it to a group of other buildings with similar characteristics for which consistent data is available. In Table 3 (p.31), an Upper West Side co-op, Building A, is compared to a group of its peers, Buildings B-H, selected from the Kleiman & Weinshank data. The selection of peer group members is based on such similarities as type of neighborhood, location, number of units, and size of the maintenance income. Without square footage information, this analysis depends on comparing a single building to the composite performance of its peers. An average for each line item is derived for all members of the group (including Building A). In the final two columns, Building A's variances to the peer group average are expressed in whole numbers and in percentages.
By studying these variances, the board of Building A can see where its performance exceeds or falls short of the group composite. Building A's maintenance income exceeds the group's by 4 percent, yet its total income is 10 percent below the peer group average. This is the result of Building A not having any income from commercial rent, which four of the other buildings in the group have.
Running down the expense items, the board of Building A can again look at the variances to determine how well they are doing relative to the group. Here, a negative variance is desired as it indicates that an expense for Building A is less than that of the peer group average. Many of the Building A operating accounts are significantly below the peer group average and its resulting total expenses are 12 percent below those of the group. Its excess of income over expenses is 35 percent above the peer group average, an extremely good performance.
Building A's performance "below the line," however, is not as good as some people might expect. Its debt per unit is 29 percent above the group average and its lack of working capital (current assets less current liabilities) of $97,958 is way below the group average of $747,639.
So, what can be said about the financial performance of Building A? On the surface, compared to a select peer group, it is performing well in the area of operations. There is marked difference between this building's level of debt and level of working capital and that of the others in the group. Whether this is a problem or not cannot be determined from the data, but it seems as though the working capital situation should be studied and addressed by the board.
The Council of New York Cooperatives and Condominiums also does a study of building operating costs. The organization's data is collected from over 700 buildings. The data also includes the number of rooms in each building and income and expenses in per-room terms. The data is coded to each building and council members are given their code numbers so that they can identify and compare their buildings to the others in the database. For more information, see the council's website, www.cnyc.com. The study is available free to council members and for a nominal charge to non-members.
AN EMPHASIS ON QUALITY
Co-ops are not-for-profit entities. The board is charged with (1) increasing the value of the shares (or, at the very least, not letting the value of the shares go down) and (2) ensuring that the shareholders can partake of a satisfying lifestyle as tenants in the building. Norman Prisand, CPA and partner in the firm of Zeidman, Lackowitz, Prisand & Company, believes that it is impossible to assess a board's performance with a single number. "Every building is unique. The satisfaction of the shareholders with the lifestyle of the building and the long-term stability of the building are what matters," he notes.
To illustrate his point, he cites an example of the two sister buildings that are clients of his firm. The first, because of its location, is unsheltered by any other buildings and is exposed to the strong winter winds. The second is almost identical to the first yet it is sheltered from the winds and consequently has much lower heating costs. "If you just look at the numbers on the income statement, you would say that the board in the first building is doing a bad job. But that doesn't capture what is really going on," says Prisand.
For him, though, there are a number of quantitative factors to be included in the mix along with the qualitative ones. "Current assets should exceed current liabilities with a ratio of at least 1.5 to 1," says Prisand, which indicates that the building can generate enough cash to meet its current obligations. He also recommends looking at the trend in maintenance increases over the last several years as runaway maintenance increases my signal that the board is unable to get control of its costs. At year-end, he suggests comparing the actual income and expense line items to the budget for the year. If there are a number of major variances, then either the budgeting process has not been effective or the board is not executing its own plan effectively.
Prisand also encourages buildings to hire an architect or engineer to do a long-term study of capital improvements that will need to be undertaken over the next five years. Although this plan should be restricted to the board level and not made public, the board should use it as a guideline in managing the reserve fund. "The reserves should be large enough to fund the capital projects in the plan as they come up," notes Prisand.
How good are you? Take a look at the numbers and figure it out.