Split Funding: The Everyman Solution for Condos

Since becoming a condominium, our building has needed a seemingly endless series of repairs, most of which have been funded with special assessments. Now we desperately need a new roof and major work on our elevator. The board is divided between another assessment and a loan of some sort. I recently read an article about something called “split funding.” Is that something we could do? If so, how would it work?

Special assessments have been the traditional vehicle through which most condominiums have raised money for repairs and capital improvements. While relatively simple in concept, assessments have two drawbacks in practice. First, they usually take a fair amount of time to collect since most unit-owners don’t have a lot of idle cash available. Second, most assessments place the entire financial burden of capital improvements on current unit-owners instead of spreading it over the useful lives of those improvements.

Since 1997, though, condominiums and homeowners’ associations have been able to borrow money for repairs and capital improvements. Borrowing tends to be a much more equitable way to fund such expenditures because the interest cost and principal repayment occurs over an extended period of time, more in line with the likely lifespan of the building components being repaired or replaced. Initially, very few lenders were interested in this type of business, and those that were did not offer very attractive terms.

Today, however, there is a reasonable selection of lenders with somewhat friendlier terms.

Similar but Different

But don’t expect to find the 30-year, self-liquidating loan at a rock-bottom interest rate that your neighbor’s co-op building just closed. Condo loan terms would probably be a 5-, 10-, or 15-year loan with amortization on a 10- or 15-year basis. These terms will result in a monthly payment that is higher than you might expect, but which will be much more affordable for the average unit-owner than a lump-sum assessment. Condo loans have shorter terms and amortization schedules because of the absence of tangible collateral that could be mortgaged as security for the loan (as is typically the case for cooperative apartment buildings).

Not many condominium loans closed during the first few years after the law changed. It seemed that boards were unsure of the process or just accustomed to levying assessments. Over time, however, more and more condos applied for loans, especially as their buildings aged and required more extensive – and expensive – work. Today, most condominium boards are aware that they can borrow money for capital improvements and include that option in their funding discussions.

In almost every building, a certain percentage of unit-owners still would prefer a lump-sum assessment to any increase in their monthly obligation. Most buildings also have a certain percentage of unit-owners who could afford an increase in their monthly common charges but who would find it very difficult, if not financially impossible, to pay large assessments. In the past, these two factions usually battled it out until one or the other side prevailed.

Over the last several years, many boards have considered funding a large capital improvement project by allowing some unit-owners to pay their pro rata share of an assessment in one lump sum (or several installments over a relatively short period of time), while other unit-owners assumed financial responsibility for borrowing the remainder of the project’s cost. However, this “split-funding” concept was just that – a concept – until a Long Island condominium I recently represented actually closed a loan on that basis.

Tiered for Success

The first step in any such transaction is to calculate the total cost of the project being funded. Next, determine how many unit-owners plan to pay their pro rata share of the total cost up front. Subtracting the second number from the first will tell you the net amount of loan you need. To that amount, I would recommend adding something extra to cover loan application fees and projected closing costs.

The mechanics of each split-funding transaction will vary from condo to condo, but the cleanest format for handling the monthly loan payments is to break the common charges into two tiers. Tier A covers the monthly operating expenses and is invoiced to, and paid by, every unit-owner according to their percentage ownership in the condo association. Tier B covers the interest and principal payments on the condominium loan and is invoiced to, and paid by, only those unit-owners who did not pay their pro rata share of the total project cost up front.

I would not recommend venturing into any split-funding transaction – or any significant financial transaction, for that matter – without consulting all of your professional advisers. Quite a few issues must be addressed in both the association and loan documents to ensure that each unit-owner is treated fairly, and the condominium’s attorney will know how to handle those. Your accountant will provide much of the financial information required by the lender and also will know the tax ramifications of such a transaction. Your managing agent will help determine the total cost of the project(s) being funded and, after the loan closes, will program and administer the two billing tiers.

As I noted earlier, borrowing is, generally speaking, a more equitable way of funding repairs and capital improvements. Split funding allows a condo board to both satisfy its financial needs and accommodate the individual financial preferences of its unit-owners. It’s a win for everyone. Good luck!