It’s common sense. If you prepare for the worst, you’re better off in the long run.
Well, maybe not.
A few years ago, the American Institute of Certified Public Accountants (AICPA) suggested that every co-op and condo’s financial statement contain information about the remaining useful life of – and the replacement cost for – all the building’s infrastructure. Makes sense, right?
Not to some attorneys and accountants. “Very few buildings follow the AICPA recommendation,” says Rick Montanye, a partner in the accounting firm of Marin & Montanye. “They simply disclose in the financial statement that the [engineering] study [to determine remaining useful life] has not been done.”
We’re talking about liability. In a catch-22 situation, if a board is forward-thinking enough to commission an engineering report – which is the basis for a capital plan – and then doesn’t implement necessary changes before a capital-related accident occurs, the co-op could be liable. So, a lot of co-ops and condos simply don’t do them.
Still, not everyone is cowed by the specter of lawsuits. “We do long-range capital planning for all our properties,” asserts Michael Berenson, president of Akam Associates, which manages 135 of them. “A lot of buildings want to limit it to five years. When you go longer than that, you’re doing more of a ‘guesstimate’ of what capital expenses are going to be. With a five-year plan, it’s easier to predict rises in prices, the contractor climate, and material costs.”
Why should you go to the trouble – and possible liability – of crafting a plan? After all, long-range planning is never easy. Given such unpredictable recent history as 2007’s economic downturn and the costly rebuilding from superstorm Sandy, projecting a capital-expenses budget even five years out seems more a matter of crystal balls than of silicon chips.
The reasons for planning include:
No surprises. For Gary Mindlin, co-op president of the roughly 450-unit 150 West End Avenue, “it’s about control of money and responsible planning. If we’re doing our job really well, anticipating what expenses are coming and having the right capital to fund them, there are no surprises when we deliver information to residents,” says the 15-year board veteran. “We’re not saying, ‘Oooh, we didn’t account for this and now you’re getting hit for additional money.’”
You can refinance and better anticipate how much extra money you need to take out for capital work. A good way to get a cash infusion in your reserve account – in these days of low-interest rates – is to refinance your building’s underlying mortgage. Capital projects can then be funded from the reserves. “How do you as a board know the right amount to refinance if you don’t have a good plan?” Mindlin adds.
You can predict (and eliminate) special assessments, budgeting in maintenance increases instead. Deran Cadotte, a former board president who has worked on capital plans at the 76-unit co-op at 250 Cabrini Boulevard in Manhattan’s Hudson Heights, says you can “foresee any required assessments and, at best, maybe alleviate the need for assessments by regular proactive maintenance increases. Assessments have to be targeted to specific projects. Maintenance increases do not, and they allow you to build up funds for a capital project.”
And some lenders are instituting requirements that are easier to address if you have a long-range capital plan. “Some banks are now requiring that reserves be kept aside from specific purposes,” says Alvin Wasserman, director of asset management at Fairfield Properties. “In some instances, you can’t touch it without their permission, and you have to demonstrate that you’re going to use the money for what it’s earmarked. If, upon refinancing, the bank does its inspection [of your property] and notices that within a couple of years you’re going to have to replace your windows, they might require that the co-op set aside money each year for that capital project.”
As for condos, Fannie Mae – a.k.a. the Federal National Mortgage Association, which securitizes most co-op loans and condo mortgages – “requires condominiums to have a capital plan or to put aside 10 percent of the monthly common charges for future work, as a backup in case of default,” says accountant Stephen Beer, a partner at Czarnowski & Beer. “That’s not required of co-ops as yet.”
How to Plan
How do you lay out a five-year capital plan? The first step is to define a capital expense. Many people think of it as something that’s not recurring. But the Internal Revenue Service defines a capital expense as “something that would extend the life of a building component more than a year,” notes Beer. This includes windows, roofs, and asphalt or concrete structures such as parking lots and walkways.
The next step is to commission an engineering report. This covers the exterior envelope: the windows, fire escapes, bulkheads, sidewalk, and retaining walls. It also reviews the building mechanical systems, stairways, and elevators, and notes cracks in the interior walls and egress issues (are baby carriages blocking the exits?). Finally, there is a chart showing the useful life of all building parts.
Mindlin, the board president, stresses the importance of knowledgeable board members and others adding institutional history and their familiarity with a building’s quirks and “personality.”
“We had an engineering company come in and work with our super and our managing agent to put together the foundation for the plan,” he says. “The board then gave its input, which the engineer incorporated into a second and final draft. Once we had the report done, we knew the approximate dollars to assign to different components and build that into our budget. Then we started giving the appropriate information at appropriate times to the residents.”
Attorney Stuart Saft, a partner at Holland & Knight and chairman of the Council of New York Cooperatives & Condominiums, explains the problem with engineering reports: “They always come down and say, ‘These are the things you should do immediately, the ones you should do over five to ten years, and what you can do but isn’t essential.’ You distribute this report and everybody assumes you have to do all three, and it’s $10 million, and everybody freaks out. But in fact, the things that must be done may be only $1 million, and things that should be done over five to ten years may be $3 million over five to ten years.”
Eric W. Cowley, principal in Cowley Engineering, explains that the idea of the report is to help the building owners prioritize repairs. “It should tell you the first thing you should concentrate on,” he says, noting that the cost of such a report, which usually takes about a month to prepare, could run anywhere from $7,000 to $15,000 depending on the size of the building. Does having such a report increase your liability? Cowley admits that it could, but adds that is no reason not to do one. “It just makes sense.”
How to Implement a Plan
Should you share the plan with the shareholders/unit-owners? “[You] wouldn’t necessarily circulate any kind of formal plan unless you’re absolutely bound by the timing of it and the prices because you will have backlash from people if you decide not to proceed on something, or if prices change, or the scope of the work changes,” says Theresa Racht, a partner in the law firm of Racht & Taffae. “That doesn’t mean you don’t let shareholders know in very general terms that you have your eye on certain projects and ways to finance them and what the overall cost would be.”
She recommends being open with residents but not necessarily distributing documents. “If you’re getting an engineering report, people need to know you have it. But you have no obligation to distribute it to shareholders. If your shareholders ask if you’ve done evaluations and have an engineering report, however, you need to tell them whether you have or not. If they ask to see it, you have to make a decision if you want to let them or not.” Racht warns boards should understand the repercussions. “If you say, ‘We’re not going to tell you,’ the immediate reaction is, ‘You’re hiding something.’”
So what should you tell them? Notes Racht: “You can say, ‘Yes the board is working with the engineer and the managing agent, and we have a list of items that need to be addressed in the near future and in the distant future, but we have not done a rigid schedule of certain projects at certain times.”
“I have [board-member] friends in buildings who say, ‘We don’t want to tell the residents anything,’” says Mindlin, the co-op president, who takes the approach that if you educate your shareholders or unit-owners, you can stave off suspicions and problems. “At our meetings, we give a lot of information. You want to deliver it so that people are educated but not scared. The more you communicate, the better off you are – I really believe that.”
Cadotte, the former board member, cautions that you have to “market” information to manage residents’ expectations. “When you reveal things at a shareholders’ meeting, you are exposing the board’s take on the priorities of future projects,” he says. “Shareholders may have different opinions on those priorities once you open that door. I would recommend really cogent communication.”
Concludes Racht: “The big mistake is not doing any planning at all. Boards should have a good idea of what needs to be done in their buildings.”