For many, it was like living in a nightmare.
Between 1989 and 1995, dozens of co-ops and condos faced severe financial difficulties because sponsors – who frequently still had a stake in the buildings they had converted – were defaulting. To get their buildings out from under onerous rent controls, sponsors had converted and borrowed heavily against them. But then they could not keep
up with maintenance or common charges on these unsold apartments. The reason? Money from their rent-controlled and rent-stabilized tenants was far less than their income.
Fortunately, in New York City, cooperative housing corporations and condominium associations rarely face this type of financial peril. In fact, during the last 50 years, less than half a dozen co-ops and condos have actually failed. The situation today is very different primarily because (1) there are a large number of market-rent apartments and (2) the rents under the rent stabilization laws are much higher than previously.
In dealing with a sponsor default, there are two primary ways of handling a co-op or condo: bringing in a so-called “white knight” to rescue the property, or utilizing self-help techniques. When my clients faced sponsor defaults, I advised them to use the latter choice. Although it was usually complicated, it protected the co-op or condo’s long-term viability.
(There were also a relative handful of co-ops that purposely defaulted on their mortgages in an attempt to “force” their lenders to renegotiate the debt. This was an absurd strategy and is not the subject of this article because the strategy always resulted in failure. Having spent more than decade on the board of the National Cooperative Bank with two terms as chairman of the board and six years as chairman of the loan committee, I can assure you that going to war with the lender is never a good idea; it is more akin to corporate suicide.)
The White Knight. Calling these investors “knights” is a misnomer. Certainly, like knights, they rescue people in distress, but the analogy ends there. Storybook knights typically act from a code of chivalry. But real estate “knights” act from the profit motive. They take ownership of the unsold apartments and pay the maintenance or common charges. Then they do anything required to get the rent-controlled or rent-stabilized tenants to leave the building, so they can fix up the apartments and then sell them for the maximum price. In the meantime, the knight/investor will try to control the actions the board may want to take in order to reduce costs or gentrify the building to make it more attractive to buyers. The knight/investor is typically more concerned about having the co-op or condo spend money on the lobby and the hallways than on making certain that the heating system works efficiently. The goal, always, is to make as much money as possible for the investor. I have nothing against making money, but the alternative makes money for the co-op or condo rather than an outsider.
Self-Help. The self-help method involves the following steps:
• The board obtains the unsold apartments from the sponsor by exercising its legal rights.
• The board negotiates with the building’s lender to split the debt on the building, placing a portion of the debt on the unsold apartments. That accrues until the apartments can be sold and then it is repaid with interest.
• The debt service paid by the corporation is reduced because the principal has been reduced, which brings down the building’s operating costs.
• If necessary, the board increases the indebtedness in order to pay unpaid real estate taxes. The interest on that accrues at 18 percent per annum. This has a higher priority than the mortgage, so it is to the lender’s best interest to keep payments current.
The philosophy behind the self-help alternative is that, as the economy improves or the co-op or condo’s other problems are dealt with, the value of the unsold apartments increases. The appreciation is then used to pay the lender everything owed, plus interest. The balance goes into the co-op or condo’s reserve funds. This money can then be used to pay the cost of long-term capital improvements, pay down the mortgage, or otherwise provide additional financial security to the shareholders and unit-owners. This turns a liability into an asset while enabling the shareholders and unit-owners to maintain control over their homes, which is usually their largest single asset. It is not as simple as turning the building over to a knight/investor. It requires a great deal of time and focus, but it preserves the element that attracts people to this kind of housing: control over their environment.
Does Self-Help Work?
To the question whether this structure actually works, I can respond with the following co-ops that today are strong, financially independent, and have apartments trading at all-time highs: Kings Village in Brooklyn (775 apartments), Hyde Park Gardens (650 apartments), Sanford Plaza (157 apartments), Hampton Court (316 apartments), and Boulevard Gardens (963 apartments) in Queens, and 35-unit buildings on Grove Street and West 64th Street in Manhattan.
This is the structure that Clare Shulman, the former borough president of Queens, found so helpful in keeping numerous large complexes solvent during the worst of the real estate collapse in the early 1990s. This is the structure that then-Congressman Chuck Schumer used in helping many co-ops in Brooklyn survive, and that he championed during a congressional hearing that he chaired in the Queens Borough Hall. This may sound like a history lesson, but it worked.
Utilizing a knight/investor in a commercial enterprise may make sense because the benefit goes to all the shareholders, however that is not the case with New York housing co-ops and condos. The financial benefit comes when you go to the outsider rather than to the shareholders and unit-owners. Simply put, self-help is a long-term solution that will make the commonly owned property financially stronger so that it can weather future storms without the need of another so-called white knight.