Co-ops Should Ease Up A Bit & Shore Up Balance Sheets
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.
Comments (10)
Noah Noah Noah,
While these all sound well and good, they also sound like the kind of "when I am king of the universe I can cahnge things for the better" type of thinking.
The problem with these suggestions to boards lies in boards made up of the very people who make up the board, those who have chosen to stay in the building. While they SHOULD want to improve the situation of the building, to get there implies changing the rules, which would also increase the pace of change in the building itself. AND MOST PEOPLE DISLIKE CHANGE! The people who make up boards more than most.
If a human can postpone change (the emotional driver) then they will, even if they intellectually understand that this is not the optimal course of action.
You can see this everywhere, including our country's debates on healthcare/medicare/soc. secutiry, etc.
Posted by AvUWS | October 27, 2009 11:27 AM
AvUWS - its funny, I originally wrote this 4 months ago and didnt publish because it is a topic I usually like to stay away from. Since most of my time now is development of UD 2.0 and spot checks of data feed for inconsistencies, I had a blank on what to write. So, I went back and figured to publish this today. A bit less timely given the stabilization of the market from 4 months ago.
I expect a wide range of opinions on this topic!!! Many of which will disagree with me. You are 100% right, people fear change and the board members are likely older school shareholders that have been in the building a long time. But does this mean they are the most qualified of all residents to be a member of the board? Its not easy for new members with fresh ideas to get enough votes and support to uproot a long standing existing board member. And perhaps that is the obstacle that must be overcome to get change. I only owned a condo and was never on the board. I rent now. So I dont know all the intricacies of board meetings and how members view the talent that was elected to make decisions for the corporation's shareholders.
I do know that many buildings are financially mismanaged, and that change is sometimes hard to come by. So what do you do?
Thanks for comment AvUWS!!
Posted by Noah | October 27, 2009 11:41 AM
PS: I would like to add that condos are more clearly showing the fierceness of the wave down we had..coops seem to have been more protected from speculation and buyers that were borderline to afford what they were purchasing.
This was because of coop policies during the boom. Just dont want people to mis-interpret. In boom times, coops should be tight, especially during euphoria phase of the cycle near peak. Its during the slow times and bust marketplaces that I think coops could ease up a bit on policies outside of predetermined financial guidelines. Those should always stay in place
Posted by Noah | October 27, 2009 11:53 AM
I know you see stabilization in the sales market, but I have just started a search to rent a 2BR and I think the signs all point to another leg down soon in rentals.
- All the apartments I am seeing (low end of the market) are recently renovated (including redone bathrooms, floors, moldings, rails, etc).
- The listings are up for weeks, sometimes a few months.
- Brokers end each showing with the words "make an offer".
- Each broker has at least some inventory in each category.
For others reading, this is not the normal NY rental market (at least "normal" in regular times). Here little was needed to freshen up an apartment besides repainting and cleaning and they seldom were on the market more than a few days or a couple of weeks.
Posted by AvUWS | October 27, 2009 1:54 PM
For me, co-op board's are like umpires or referees - its only when they do something wrong that you take notice of them. However, unlike umpires or referees, there are no strict set of rules (aside from the by-laws) which a co-op board must abide. I can't think of a more thankless position where you have to spend a fair amount of time working (without pay) to help your building, only to get excoriated by some fellow shareholder for voting to increase the maintenance by whopping 1% that year.
There's no real upside for co-op board members to push for a change in the standards for admitting new shareholders, allowing pied a terres, etc. because (in addition to the fact that people dislike change), because if it doesn't work out, they will just get hammered.
Despite the fact that the co-op board in my building is borderline competent, I'd rather grin and bear their medicocre ways, than get involved and have to listen to some idiot tell me what I am doing wrong. There is no getting around the fact that even if 90% of the shareholders agree with an idea, that the remaining 10% will let you have it.
So while I agree with some of what you are saying, its not going to happen.
Posted by jn | October 27, 2009 3:06 PM
"There's no real upside for co-op board members to push for a change in the standards for admitting new shareholders, allowing pied a terres, etc. because (in addition to the fact that people dislike change), because if it doesn't work out, they will just get hammered."
its just a solid point...the changes I discuss I think have limited downside, but yes, its a downside risk in general.
But do you immediately discount any upside risk?
What if you have a 50% down building, that is 100% owner occupied, sees 3-5 transactions a year, has a flip tax policy, doesnt allow subletting or pied-a-terres at all. The board is made up of existing shareholders that have been in the building for 25+ years.
What if you change:
1) 50% down to 33% down
2) Allows a 2/2 sublet policy - live in 2 years, you can sublet for 2 years...then you must move back or sell. Fee for owner.
3) Allow pied-a-terre.
Lets just assume for a moment that these changes make it through - who knows, maybe some newbies made it to the board and voted to ease up a bit. No other purchasing guidelines are changed (still require 25% d/i ratio + say 3+ years of maint + mortgage in liquid after closing)...
In regards to the buyer pool that can now afford this property, you don't think there could be an upside for shareholders in terms of the market value of those shares on the open market?
Your point is a good one though, just playing the other side for a minute. thanks
Posted by Noah | October 27, 2009 4:09 PM
Does easing up, and expanding the pool of potential buyers, necessarily increase the value of the building/apartments? And even if the answer is yes, shareholders often vote against things which may make fiscal sense but don't appeal to them personally, myself included - I am opposed to subletting despite the potential benefits. Getting shareholders to unite behind something is like trying to herd cats - its impossible - especially in NYC where 15% of the population is outright nuts.
Posted by jn | October 27, 2009 4:40 PM
is it only 15% that is nuts? i would have thought it was a bit higher
Posted by Noah | October 27, 2009 5:35 PM
Speaking value to someone who is only concerned with maintaining a comfortable living situation is like talking about giving up your favorite glove just because new ones might make you grip the bat better. So what? You like your gloves. Same can be said of your building and the people who live in your building. You may generate more income for your building if you allow people to trade in/out faster but at what cost? You might not like that cost.
Posted by MeekSheep | October 27, 2009 7:57 PM
true, but what one may view as a comfortable or improving living situation, another may view entirely different. also, what one may view as a negative cost in exchange for an improvement, another may view as not negative at all. its all so individual. which is why we can have these discussions. I never would suggest any change that would jeopardize the integrity or essence of any one building.
with that said, i know of boards that have badly mismanaged their buildings, even if their heart was in the right place
Posted by Noah | October 27, 2009 8:40 PM