Take a walk around the observation deck of the Empire State Building and put on your green eyeshades. If it’s a clear day, you’ll be able to take in a broad view of the biggest co-op and condo market in the U.S., one that has created a very special identity within the last 25 years. It is one with its own knowledgeable cadre of professional attorneys, accountants, managers, brokers, lenders, and other advisers to thousands of boards of directors. Fifteen to 20 years ago, when sponsor defaults were roiling the market, a financial “threat level” map would have colored many of those co-ops yellow, orange, or even red. Today, they’re in the black: income is back in balance with expenses. Five years ago, co-ops and condos felt another financial shock on September 11, when insurance rates began a dramatic rise – but that trend is now moderating. Mortgage refinancing is getting cheaper and more flexible, and new ways for buildings to earn money are becoming widely accepted, adding to the plus side of the ledger.
Revenues are up, with a third to a half of corporations now imposing transfer taxes. Most have mandatory sublet fees, and many are finding creative ways to increase income, such as selling storefront space, advertising, and air rights, and renting space for cell phone towers. And because boards are generally conservative, imposing steep financial reporting requirements on prospective purchasers, co-ops are especially likely to have tenant-shareholders with greater resources to weather tough times.
Building costs have not risen nearly as much as building values. The biggest-ticket recurring items on the expense side – real estate taxes, mortgage debt, payroll, energy costs, and insurance – are all things over which boards have a limited degree of control. Three of the five – real estate taxes, energy (home heating oil), and insurance – have posted sharp rises in the last five years. Labor costs have held to the rate of inflation, and mortgage refinancing rates have remained near historic lows, with total costs for loans actually going down.
Business and economic cycles will work their magic, for good or ill, and boards clearly have an acute responsibility to monitor the underlying fundamentals and adjust to them. But where boards have the most fiscal power and responsibility rests in how they approach repairs and capital improvements.
The co-op and condo board has become much more mature and capable over the past 25 years. Charting the financial path of this increasingly sure-footed, many-headed beast reveals a history of self-reliance and of building activism in which many board members have had to take on new and sometimes uncomfortable roles and learn new skills. And as boards have gained knowledge and experience, many officers have learned to think cyclically and budget for the long term. Valuable means of cost control have come about through court cases and state legislation, but the biggest deciding factor in the equation has been the actions – or lack thereof – of each individual board.
The co-ops, condos, and homeowners associations within the hundred-mile circle around New York City were not originally set up as redoubts of wealth and prestige. Even before the big wave of conversions in the last quarter of the twentieth century, co-ops like those owned by the Finns of Brooklyn’s Sunset Park – dating back to the early twentieth century – made a virtue of thrift, hard work, and cooperative living. Another small wave of cooperators arrived after World War II, but the largest group came later. Between 1980 and 1994 in New York State, 11,688 buildings containing 830,833 apartments were converted to cooperative ownership, according to the attorney general’s office. Co-ops and condos were becoming a rock for the middle class, providing secure value for the hundreds of thousands who made the transition from renting to owning.
That transition was rocky for some. If the new co-ops had birth pangs, they can be mapped on balance sheets, and the major trauma occurred in the late ’80s to early ’90s, with a real estate recession triggering a wave of sponsor defaults affecting about ten percent of all New York City cooperatives.
The worst of it happened in Queens. Claire Shulman, the borough president at the time, went to bat for a number of large buildings with thousands of units between them, like Hyde Park Gardens and the Acropolis, trying to stave off a disaster for the middle class. The crisis in Queens involved some 20,000 units, a quarter of the borough’s total cooperative apartments at the time.
“You only had to sell about 15 percent of the apartments, and you could convert,” she says of the non-eviction conversion plans offered at the time. “So you had a very small number of cooperators, and a very large number of rent-stabilized tenants. When the real estate market dropped, they couldn’t afford to pay the freight, and the banks began to start foreclosure proceedings. There were two issues for me: one was to save the homes of people who spent their last nickel on a two-bedroom co-op apartment, and the other was to stabilize neighborhoods. If middle-class cooperative housing went down, so would the neighborhoods.”
The workouts which Shulman engineered were complex, in the case of Hyde Park involving a consortium of 35 banks. “[Mayor Rudolph] Giuliani had his comp-stat meetings, in which he told police commanders exactly what he wanted. I did it with lawyers for the banks. I told them, ‘Guys, we have to work this out.’ The banks didn’t want to end up with all of this property on their hands. We lowered the interest rates so the cooperators could afford the monthly payments, and extended the time of the mortgage. In the end, the banks got their money – they just didn’t get as much as they wanted.”
Shulman and other public officials forced the state legislature to cut down on abuses in non-eviction plans, working with developers to bring Senate Republicans, initially skeptical, to her point of view. She credits attorney Stuart Saft, a partner in Wolf Haldenstein Adler Freeman & Herz, and Mary Ann Rothman, longtime executive director of the Council of New York Cooperatives & Condominiums, for their guidance throughout.
Susan Hewitt, president of the Cheshire Group, a real estate investment firm specializing in multi-family property, was one of those who acted as a “white knight” during that period, restructuring finances for co-ops with sponsor defaults. “Toward the end of the 1980s, sponsors were loading as much debt as possible onto buildings. They didn’t anticipate, in 1988 and 1989, that they wouldn’t be selling all the apartments. Once the real estate market screeched to a halt in 1990, most didn’t have the ability to keep paying the negative shortfall.”
The days of “low sold” co-ops now appear to be over. In 2002, a landmark decision, 511 West 232nd Owners Corp. vs. Jennifer Realty Co, stopped sponsors from accumulating apartments and operating them as rentals, a major source of instability. And cooperatives, themselves, Hewitt says, are different: “Now shareholders have more experience, and they have made the transition to – not just legally, but mentally and emotionally – running their buildings. The more mature the co-op, the less vulnerable they are to problems.” Owner occupancy, she notes, is a mainstay of financial stability, and in New York, it is now the rule. Even in the condo market, Hewitt says, “given where rents and sale prices have been lately, most aren’t buying condos to be in the rental business.”
The shock of the terrorist attacks on September 11, 2001, made itself felt in the co-op and condo market by temporarily holding down sale prices in the area around the World Trade Center and by causing a spike in insurance rates beginning in 2002. In some Manhattan buildings, particularly those near the United Nations and around Battery Park City, rates jumped by over 200 percent, before moderating in ’05 and ’06. In the outer boroughs, the rise was much less pronounced.
An analysis of 125 co-ops and condos, based on comprehensive spreadsheets provided by the accounting firm Kleiman & Weinshank and publicly available on its internet database, offers a good sketch of what happened to expenses in the years from 2001 through 2005. (Because only 14 percent of the co-ops and condos in the database are in the outer boroughs, adjustments should be made when considering the entire market.)
According to the analysis, average real estate taxes saw a steady rise of 69 percent over the five years, as building valuations soared and the city worked to keep pace. Tax certiorari lawyers have been kept busy saving co-ops and condos from gross overcharges. Staff payroll costs rose only 14 percent, reflecting the consumer price index during the period, and gas and electric outlays also rose by a relatively mild 17 percent. Heating oil, however, jumped significantly by 68 percent over the five years, reflecting the uncertainties brought on by the Iraq war and possible price gouging by the big oil companies. Costs for mortgages and loans actually declined by 12 percent from 2001 to 2005. Mirroring the fear caused by 9/11, and perhaps a cyclical adjustment as well, insurance rates for co-ops and condos rose 277 percent between 2001 and 2004, spiking in that year before declining slightly in 2005 to 256 percent of the starting figure. (These insurance numbers, it should be noted, will be much lower in the outer boroughs and surrounding counties, where rates increased but not to the same extent as in Manhattan.)
How fast will costs rise in the coming 25 years? As one financial analyst says: “My crystal ball is as cloudy as yours.”
Abe Kleiman, a partner at Kleiman & Weinshank, sees boards taking increasingly proactive roles to insure financial stability. “In well-to-do buildings,” he says, “what we see is a lot of restrictions on the amount [a prospective shareholder] can finance. Co-ops are insulating themselves from a possible crash [in the real estate market]. Some boards will restrict the amount they will allow you to borrow. They want the people coming in to have secure economic standing.”
Just as important as making sure of the financial strength of tenant-shareholders is sound long-term planning for capital improvements and repairs. New York housing stock is old, and major work in recurring cycles is a fact of life. So is adaptation to new technology, such as the need to wire buildings for the internet.
In a January 2007 analysis given to shareholders of 370 Riverside Drive, a 76-unit co-op on Manhattan’s Upper West Side, the board presented a capital funding plan projecting recurring building expenses out to 2090. Taking the long view, the spreadsheet calculates replacement cycles for building systems including boilers and elevators, as well as the roof, water tank, and sidewalk. Even the front door has a calculated replacement schedule. In an accompanying letter, Lynn Underwood, the treasurer, discusses the strategies that have allowed 370 Riverside to maintain good financial health: a capital funding contribution is part of the monthly maintenance, and tax abatement money is also earmarked for the same purpose. Three months’ worth of maintenance is maintained in the reserve fund. The co-op refinanced its underlying mortgage in 1992 through the National Cooperative Bank.
Indeed, in the future, mortgage refinancing is going to continue to be a fact of life at most properties, but it will become less painful, experts say. Co-op and condo boards now have access to a greater variety of financial instruments than ever, and the trend is going to continue.
“Another trend is the growing supply of money coming into the real estate investment market, and the birth of additional types of institutions to channel that money,” says Patrick Niland, president of First Funding, which has specialized in underlying mortgages for co-ops and condos for more than 20 years. These new investors are more aggressive, creating more competition and lowering interest rates.
Lenders have also become more savvy and flexible about the co-op market. “Twenty-five years ago, if you were underwriting a co-op, you were most concerned with the number of ‘good units,’” Niland says. “Units owned by the sponsor, an investor, or a former resident and even someone living in the building who owned multiple units were considered ‘bad units,’ along with sponsor-owned units. Then, Fannie Mae decided to count sublets – rented units owned by former residents – as ‘good units,’ and that was a dramatic change, because now you had buildings that were deemed less than 50 percent owner-occupied becoming 60 percent owner-occupied. Suddenly, those buildings got attractive financing.” Also helping co-ops is that, as time goes by, “the overhang of sponsor units has dissipated.”
“The efficiency of the marketplace is going to continue to improve,” Niland says. “It’s going to provide more and more specialized products. Twenty-five years ago, virtually all lenders offered the same product. Over time, different financial institutions entered the market with new products. Among those, the most significant were Wall Street firms that packaged different financial instruments in new ways that made them attractive to institutional investors.”
That change was perhaps the most dramatic increase in the availability of funds for co-ops, a process which Niland calls the “securitization” of the real estate market. “Over time,” he continues, “technology, understanding [of the co-op market], and financial philosophy will converge to provide uniquely tailored products for every borrower. In the same way you order your Dell computer – they don’t make it until you order it – you will be able to get tailored products from the financial markets. If a co-op wants a seven-year loan, and a 16 percent amortization and no prepay penalty in the last ten years, you’ll be able to do that – without paying an inordinate premium.”
Niland’s pet peeve is that boards often resist involving their professional advisors from the beginning, when they first begin to contemplate the need for an infusion of cash. “A board that tries to refinance without their managing agent, accountant, and attorney, and a good mortgage broker is nuts,” he says bluntly, “because this is the most important financial decision they will make during their entire tenure, and it affects the market value of everyone’s shares.”
Rather than being fixated on the rate alone, Niland says, “the total package of terms is what really makes the difference, and in order to make the best transaction, you need to have input from everyone. Frequently, I’ll meet with a board, and they’ll say, we want to borrow $2 million. I’ll ask, ‘What do you have in the reserve fund?’ and they’ll say, ‘Nothing. We don’t want to raise the maintenance.’ Then, either they’ll close the loan and six months later call and say, ‘We need more money,’ or they’ll get near the closing and then realize they need more money, and will have to re-do the transaction. If they had involved their professionals, they wouldn’t have made that mistake.”
The upside of co-op and condo finances doesn’t only rest in expanded possibilities for mortgage instruments. Fees for storefront spaces have the potential for major growth, especially in Manhattan, along with advertising signs and commercial garages. Some co-ops are even selling air rights. Tax attorney Joel E. Miller, a partner at Miller & Miller, says some cooperatives are already running into tax problems because of high income from commercial rentals that causes them to run afoul of the so-called 80/20 rule (meaning only 20 percent of a co-op’s income can come from non-shareholders). “A few cooperatives think they can run the whole building on outside income,” he says, potentially allowing them to eliminate maintenance fees entirely. Such an income stream, though, would radically change the co-op’s tax status, and members would no longer be able to deduct real estate taxes and interest or claim a $250,000 per person tax exclusion in the event of a sale.
Miller, along with many other co-op and condo tax advisors, would be happy to see Congress eliminate the cap on non-member contributions outlined in Section 216 of the Internal Revenue Code. With the recent elevation of Democratic Congressman Charles Rangel of Harlem to the chairmanship of the powerful House Committee on Ways and Means, a change in the 80/20 rule is possible (but unlikely), Miller says.
After the tough slog of the late ’80s and early ’90s, co-ops have emerged as one of the best places to put your money. Keeping your investment in your home secure, however, will continue to require personal dedication and sacrifice.
Now, is anyone interested in running for a board spot?