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Habitat Magazine Insider Guide



Making the Choice

For several years, the shareholders at a 74-unit, World War I-era co-op on the Upper West Side have been talking about the need to replace the building’s 600 windows. Today, after tackling several more pressing projects, the board is finally getting ready to work on the windows – at an estimated cost of just over half-a-million dollars.

Much as they might like to, boards in such situations often do not have the financial luxury to consult with more than one financial advisor or management firm about a potential project. But what if they did? What alternative realities would they have to explore?

To answer that question, Habitat offers a special report examining the additional choices a board might make. For the story, we reached out to a medium-sized Upper West Side co-op in Manhattan, which graciously agreed to let its building be a case study. Then we selected a panel of financial and management experts to examine the facts at this co-op and offer possible alternatives into what this particular building – and others in similar situations – might do. We think the answers are illuminating.



Chuck Wall, a publishing executive, has served on the Upper West Side co-op’s board of directors for 15 of the 17 years he has lived in the building. For years, he’s been hearing shareholders talk about the need to replace the building’s windows.

“A couple of years ago, we polled them and asked them to rate projects based on their personal priorities,” says Wall, who is now the president. “Windows actually came in third or fourth. The most recent [window-replacement] estimate we had was for $600,000. We didn’t have the money, so consequently we tried to make the windows last a few more years.”

The board is finally ready to tackle them. There is pressure to live up to some precedents. “We’ve kept maintenance increases down to two or three percent a year and we’ve never had an assessment,” he says. “We’ve managed to make major improvements without resorting to those measures.”

The co-op’s flip tax – 1.75 percent of the sale price of all apartments – financed the renovation of hallways three years ago. The board replaced both elevators, at a cost of $250,000, by selling its meeting room, allowing a shareholder to expand his apartment and, in the bargain, increasing the corporation’s income from monthly maintenance.

Can the board make it a trifecta – and complete the window project without levying an assessment or a major bump in maintenance? “We’re looking at various options,” Wall says, adding that the picture is complicated by numerous factors. The building has a reserve fund of $240,000, which is healthy but would not cover half of the window project. And the board is not inclined to drain a fund that is there specifically to meet unforeseen expenses. The board also has a $500,000 line of credit.

The co-op’s 10-year underlying mortgage comes due in August 2012, and the board had assumed that a refinance would be the logical place to get the money to do the windows. “At the moment, though, we’re not inclined to refinance ahead of the deadline because the prepayment penalty is so large – about $60,000 – and we can’t refinance before February of 2011,” Wall says.

Should the co-op refinance at the current level? Should it take out a larger loan because rates are so favorable – and use the difference to pay for the windows while still paying the same maintenance? Should it use the line of credit and pay it back through a maintenance increase?


CASE STUDY comments: a selection of solutions

A number of professionals – who had no connection to the window project – offered their analyses of possible solutions for Wall’s building and properties facing similar challenges. Among their suggestions: raising maintenance, taking a line of credit, assessing the owners, refinancing the building’s underlying mortgage, and withdrawing money from the reserve fund.



One option is to raise maintenance. This is a viable option, of course, but most would probably agree with the board member who says: “Increasing monthly maintenance doesn’t seem like a good idea, if you can avoid it. Capital improvements are a one-shot challenge while maintenance is forever.”



Rosemary Paparo, director of management at Buchbinder & Warren notes that the board “can take out a line of credit or tap into an existing line of credit. The upside is that you get immediate financing without an assessment. The downside is that the line will have to be paid back, either when the underlying mortgage comes due or earlier, depending on the terms of the loan. And the co-op will have to pay interest on the money borrowed, which will raise operating expenses.


Assessments: a real option?

“You can assess shareholders,” Paparo says. “The upside is that each shareholder can add his or her portion of an assessment to the base price of the apartment when they sell, which will decrease any capital gains tax due upon sale. And depending on the terms of the assessment, the co-op can have cash in hand rather quickly. The downside is that shareholders have to ante up their assessments, and they may be stretched to do so.”

Arline Kob, director of management at Key Real Estate, manages a building that also wanted to modernize its three elevators through an assessment – but raised the money before work had begun.

“Five years ago, we had an elevator consultant inspect the elevators,” Kob recalls, “and he said we would need to modernize in four or five years. So, the board put in a six-year assessment, running from 2005 to 2011. We’re going to start the preliminary work in early 2011, and we have the money in hand. It was a very conservative way to go. It was good fiscal planning.”

Richard Montanye, an accountant and principal at Marin & Montanye, agrees, but he’s quick to add that the board must be sensitive to the shareholders’ willingness and ability to pay any assessment. “The board has to determine the composition of the building,” he says. “In the majority of buildings, even very well-to-do ones, people don’t like major assessments. Smaller assessments spread over a longer period of time are more popular.”

Some boards, Montanye adds, will impose an assessment before a project beings, use funds from a line of credit to do the work, then leave the assessment in place until the loan is paid off. Others impose a long-term assessment, use the reserve fund to do the work, then leave the assessment in place until the reserve fund is replenished. If the reserve is replenished before the assessment expires, the board can always terminate the assessment.


Refinancing: take more than you need

“If you can refinance the underlying mortgage without any prepayment penalty,” Paparo says, “you may be able to raise the extra cash without increasing maintenance because interest rates are so low. On the other hand, the interest rates may be substantially higher for the next refinancing of the mortgage, and shareholders will have to pay that higher interest on the window money.”

“If you can afford to bring in some extra cash, that’s optimal,” adds Kob of Key Real Estate. “If you can afford to take out, say, an extra $1 million – and pay off the loan without raising maintenance – you’ll have a reserve for future projects. Older buildings have problems with plumbing and façades. But, remember, that money’s not free. It might make better fiscal sense to take out a line of credit so that if they have future projects, they will have the funds.”

Montanye, the CPA, agrees that taking out extra money is a good idea. If you are going to do all the work to refinance, you might as well get the maximum benefit. To do that, “It’s necessary to look at all building systems to see what their life spans might be,” he says. If you’re raising money to do the elevators now and your engineer tells you the roof will need to be replaced in five years, for instance, Montanye advises you to raise more money than you’ll need to do the imminent elevator job.

“That way, you’ll be funded even if the roof doesn’t need to be done in exactly five years. Maybe it holds out a little longer. At least the funds are there to handle another project.”

Barry Korn, managing director of Barrett Capital Corp., advises co-op and condo boards that, if they are willing to incur debt to cover a project, they need to pay particular attention to the amortization schedule.

“Some co-op boards say, ‘Since the interest expense on a loan is [tax]-deductible, we as a corporation should maintain affordable debt,”’ Korn says. “Other co-ops take a more conservative approach, making sure the term of the loan matches the projected life of the improvement to the building. Since elevators have a life span of roughly 30 years, any loan – a mortgage refinance, a second mortgage, an unsecured loan, a line of credit – should have at maximum a 30-year amortization. If you continue to have debt after the elevator wears out, you wind up double-paying. Like the federal government, your building has debt that’s going to affect maintenance in the long term.”

“The only two right ways to do it are refinancing the underlying mortgage or taking out a second mortgage – because that way you’ve got a fixed-rate loan paying for a long-term fixed asset,” observes Patrick Niland, president of First Funding of New York, a mortgage brokerage

If you decide to refinance, he adds, you must take out a large enough loan to cover your outstanding debt, closing costs, prepayment penalty, and the cost of the capital improvement. You should also take out money to replenish the reserve fund if you tap into it, and a little extra for unforeseen expenses.


The reserve fund: how much should we use?

“You can tap into the reserve fund for all or part of the costs,” Paparo says. “Then, to replenish the reserves, you can assess shareholders over a period of a few years, so that monthly payments are lower. The downside is that the reserve fund will be short if an emergency hits, such as an unexpected boiler replacement.”

Most co-op lenders require the building to keep a reserve fund equal to at least 10 percent of the annual operating budget. Montanye, the CPA, advises boards to keep more than that in reserve and, even more importantly, to have a stream of income that constantly replenishes the reserve. Some common revenue streams are a flip tax and sublet and storage fees; some boards have a line item in the budget that imposes an assessment when the reserve falls below a prescribed minimum level.

“You can use the reserve for any capital improvement or repair,” Montanye says, “but the bottom line is that you need a constant flow of funding to keep it at a certain level. You may have to have a combination of using the reserve and having an assessment at the same time. But if there’s a stream to replenish the reserve fund, you’re in much better shape.”

And keeping in sound fiscal shape is part of what cooperative and condominiums are all about, right?

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