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Miracle Workers

I live in a lovely prewar building with 160 units. Unfortunately, a combination of age and neglect by previous boards has pushed many of our building’s major systems beyond their useful lives. A recent engineering report recommended a new boiler, upgraded electrical service, and a complete replacement of our failing galvanized iron plumbing system. It also noted that our elevators, roof, and windows would all need attention very soon. The estimated cost to complete all of this work took everyone’s breath away. And, to make matters even worse, our current underlying mortgage has a huge prepayment penalty, so refinancing is out of the question. As one of my neighbors said, “We need a miracle!”

Miracles are like winning lottery tickets: They happen, but not very often. They also tend to perpetuate the underlying problem of not planning ahead. But that’s a topic for another column.

Right now, you have two issues: which repairs to make and in what order and, then, how to pay for them? First, I would go back to the engineer and ask him to prioritize all of the work. My guess is that, given the time of year, and the relative impact of a failure in each system, the order will be plumbing, then electrical upgrade, then enough repairs to tide your boiler over until next summer, then the rest of the work. Your managing agent can help you develop a detailed budget, lay out a realistic schedule, and select qualified contractors to assure that you get on-time completion of high-quality work, at reasonable cost, with minimum disruption. No matter which way you cut it, however, you’ll be looking at some big numbers. But choosing the right funding plan can make them more palatable.

There are several ways to pay for this work. You could raise maintenance by an amount sufficient to raise the needed money over some period of time. The disadvantage to this method is that it takes a relatively long time to raise large sums, and it forces you to delay the work until you’ve collected almost all of the money needed for each project. Given the urgency of some of your repairs, this method doesn’t meet your needs. However, it may be something to implement now as a way to start raising funds for future projects.

You also could levy assessments. Large sums can be raised fairly quickly, but the practice tends to be burdensome to most shareholders. This would probably be the case in your building because your assessments will either be very large or continue for an extended period of time to raise the amount of money necessary to complete all of your work. Additionally, assessments have no short-term tax benefit since they get added to each shareholder’s basis instead of being deductible in the year paid.

Finally, you could borrow the necessary funds. The most obvious source is your existing lender. Since it holds your building as collateral for its loan, it has a vested interest in preserving that collateral. So, you might ask for a second mortgage and/or a credit line to fund some or all of your repairs. However, be prepared for some resistance because, in today’s economic environment, not all lenders are comfortable increasing an investment in real estate. If your existing lender won’t give you secondary financing, you can ask it to waive or reduce the prepayment penalty and give you a new underlying mortgage big enough to repay the existing loan and fund your needed repairs. Many lenders are more amenable to new first mortgage financing because those loans can be sold to Fannie Mae or Freddie Mac, recouping most of the lender’s capital.

If you can’t get a second mortgage, a credit line, or a new underlying mortgage, you can ask for permission to get subordinate financing from some other lender. Your lender does not have to grant you this permission, but most lenders will allow some subordinate financing if it is used solely for needed capital improvements. That said, finding another lender that is willing to provide secondary financing (either a second mortgage or a credit line) can be difficult these days.

And that brings us back to your existing lender and that onerous prepayment penalty. Sometimes the better, albeit initially more costly, solution involves paying a prepayment penalty in order to be able to properly structure financing that supports the long-term financial health of the cooperative. As difficult and painful as paying the penalty may be, try to view it as the price of correcting the fiscal mistakes of previous boards. Still, it will take courage to pay that price now. However, if you don’t, it only will grow bigger. And, sooner or later, that price must be paid.

Once you are free of your existing loan, you have myriad ways to fund your needs. One option is a new fixed-rate underlying mortgage large enough to fund all of the work recommended by your engineer. This has the advantage of tying up all of the money you need at today’s relatively low interest rates. However, since your capital improvement program will probably stretch over several years, you will be paying now for money that you won’t spend right away. Also, even at today’s rates, a loan that large probably will be too expensive for your shareholders.

Another alternative would be a loan large enough to complete the three critical projects (plumbing, electrical, and boiler) over the next three years, with an option to roll that into a larger loan to tackle the next three projects over the following three years. This structure would have a low interest rate and would guarantee funding for all improvements, but it would not burden shareholders with the entire bill up front. While this format does expose the cooperative to some interest rate risk in three years, that risk would be worth it for the flexibility of this structure.

A third option would be a construction-type loan at a floating interest rate that converts to a fixed-rate mortgage as soon as all of the work is completed. This structure matches funding to spending and minimizes interest costs. However, it also maximizes exposure to interest rate risk. That could cause budgetary headaches should interest rates start to increase dramatically before all of the work were completed and refinanced out into the fixed-rate loan.

You have a very difficult situation. Unfortunately, the solution will be neither easy nor painless. But with thorough analysis, determination, and sound advice from all of the cooperative’s professional advisers (your accountant, attorney, managing agent, and maybe a good mortgage broker), you will find your “miracle.”

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