Co-ops Should Ease Up A Bit & Shore Up Balance Sheets

Posted by urbandigs

Tue Oct 27th, 2009 10:59 AM

A: Before you mis-interpret the headline, please read on. Did you ever wonder what percentage of buildings out there may be financially mismanaged? I am of the belief that when things get euphoric, regulation of some kind should tighten to constrain risk taking and speculation. On the flip side, when things get too slow or facing a fierce downturn regulation of some kind could loosen a bit and encourage a more stable marketplace. All within limits and never incentivizing too much risk taking or buying something you can't afford. This is not the kind of market that co-ops should be tightening up in; yet today I am both hearing and seeing more talk of board turndowns without a reason provided. Lets assume for a moment that the main purpose of a co-op board is to efficiently and properly manage their building and to maximize value for the shareholders of the corporation. Lets also assume that the value of the shares owned in this corporation goes into a multi-year recession; and are worth less than it was at peak, trending lower, and seeking stabilization. Sounds like what we just went through. What is a co-op board to do? Well, one quick way is to use your powers to loosen up policy a bit without sacrificing future shareholder value? In a phrase, expand the target audience that is both willing & able to buy into your corporation!

Its funny, without naming building addresses I can tell you that I just experienced my 2nd board turndown in a co-op that was low on cash in reserves and set to make a huge chunk of change via a flip tax from an original shareholder from the 70s. I can also tell you the buyers were more than qualified to purchase this unit and secured a loan commitment. No reason provided. Make much sense? Not at all. I know that the building reserve fund would have surged 55% if they approved the deal. Yet it was not to be. Now future buyers in the building may adjust their bids or walk away after discovering a large building with such low reserves - how is that for maximizing shareholder value.

Some reasons I am hearing for recent board rejections include:

a) price being too low
b) buyers debt/income ratio being over 25%
c) aggressive accounting on tax returns shows a much lower Adjusted Gross Income
d) inconsistencies in the board package & financial statements provided
e) lack of liquid assets after closing
f) uncertain employment situation
g) inter-building conflicts

Co-op boards will always be protective of their shareholders and their building; as they should be. But often in crazy times the line gets crossed and decisions come down that makes even the most experienced brokers or managing agents scratch their heads. Co-ops that have a history of being tight & nitpicky should consider loosening up a bit; especially if the building just finished multiple assessments for major capital improvements and is facing a depleted reserve fund.

You see, I find that many buyer's generally want it all and who can blame them. They want low monthly expenses, but they want every amenity possible. They want the building to operate at a profit, but they don't want any flip tax. They want recent capital improvements but no assessments. You can't have it both ways and in the end every building must be managed properly to handle the work that needs to be done down the road. Every building will have leaks, need a roof repair, need a boiler, need a replacement of elevator relay switches, local law 10/11 facade inspection and pointing, and have to upgrade their hallways, elevators, lobby, etc.. at some point in time. No building is exempt from the effects of time so they should financially prepare for it today - call it the building's retirement account.

Start basic. This is the time where co-ops can loosen up a bit on house rules within reason. If the building has a high owner/occupancy rate because of a very strict subletting policy, perhaps the time has come to loosen that rule a bit and widen the target audience interested in your products. Add a fee for the owner or other revenue generator that goes directly to the building reserve fund for a 2 & 2 subletting policy - keeping in mind that you can't let the owner/occ rate decline to a level that adversely affects the entire corporation. If the building does not allow pied-a-terres, maybe now is the time to overturn that rule and reach out to a slightly wider audience? Other areas to loosen include allowing guarantors, co-purchaser's, or parents buying for their children; all within reason and board pre-determined guidelines.

Maybe the building has a loan tied to a very high interest rate? Perhaps a simple refinance at a lower rate and take out a bit more equity to the point where the interest payments are still the same, or only slightly lower - then deposit that extra money into reserves for future capital improvements limiting the need for more aggressive assessments? Buyers love reserve funds! Minimizing red flags may maximize transaction volume; especially for building's that utilize a flip tax as a revenue generator,

Shore up your balance sheet, add more revenue generating services to your business, expand your target audience, and increase demand to your product. Increased shareholder value + increased confidence in the product being purchased = stock goes up. At least in theory. Building's whose reliance for revenue is on flip tax only may see problems if the market goes into another freeze or sales volume dries up because of a lack of transactions in the building. Co-ops should try to spread out their revenue streams rather than rely only one main source! The goal is to minimize consistent rises in monthly maintenance that will constrain affordability for future sellers in the open market.

You can't change the market or the markets way of valuing your product due to general confidence, macro factors, and affordability. But you can enhance demand and increase the size of the buyer pool that views your building/unit as 'meeting their needs'! And that can go far in cushioning this downturn. Call it 'maximizing shareholder value'.

Where you don't ease up is financial qualifications for prospective purchasers. However, you can certainly loosen up on the "% DOWN" requirement if your building has enacted more stringent policy over the course of the past boom. I mean, do you really need to require 40%+ down right now to protect shareholder's interest against the likelihood of default? No, you don't. Rather that policy was intended to target a different end result; targeting a certain kind of buyer to 'join the club'. Lower it and ask the buyer to put 12 months of maintenance in escrow if they are borderline to meet pre-determined financial guidelines.

If your building has a 40% or more requirement for down payments and you are noticing a big dry up in prospective buyers given the nature of this slowdown, what will happen if you lower that restriction to 35% or 30% down? Does this really put the co-op at serious risk in regards to a buyer that can't afford the property? The key is maintaining tight requirements for employment situation, salary, debt/income ratio and liquid assets leftover after closing. By tweaking the percent down rule slightly, I don't think you risk a whole lot but your rewards could be a wider buyer pool that can now afford to purchase a unit in the building & pass your board! Today, I find banks to be more lenient than co-op boards; even with the tightening of underwriting standards.

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