Between high inflation, rising expenses, and the lingering effects of the pandemic, it’s never been harder for co-op and condos to balance their budgets. Carl Cesarano, principal at the accounting firm Cesarano & Khan, explains how boards can navigate today’s challenging landscape — whether negotiating commercial leases, refinancing the mortgage or trimming expenses — by evaluating and readjusting their options in real time. Carl Cesarano is interviewed by Paula Chin of Habitat Magazine.
Thanks for listening. Subscribe to this podcast for more stories on how New York co-ops and condos have solved a myriad of problems. Brought to you by Habitat Magazine, the "bible" that hundreds of board directors turn to every day!
Between high inflation, rising expenses, and the lingering effects of the pandemic, it’s never been harder for co-op and condos to balance their budgets. Carl Cesarano, principal at the accounting firm Cesarano & Khan, explains how boards can navigate today’s challenging landscape — whether negotiating commercial leases, refinancing the mortgage or trimming expenses — by evaluating and readjusting their options in real time. Carl Cesarano is interviewed by Paula Chin of Habitat Magazine.
Thanks for listening. Subscribe to this podcast for more stories on how New York co-ops and condos have solved a myriad of problems. Brought to you by Habitat Magazine, the "bible" that hundreds of board directors turn to every day!
Paula Chin: Welcome to Problem Solved, a conversation about problems that have been solved in New York co-op and condo buildings. I'm Paula Chin, and my guest today is Carl Cesarano, principal at the accounting firm Cesarano & Khan. Welcome, Carl.
Carl Cesarano: Well, thank you very much, Paula. And thank you to Habitat. You guys are certainly doing a great service to the common interest real estate community.
Paula Chin: Thank you. After two years of living with COVID, co-ops continue to face challenges managing their finances, especially buildings with commercial tenants.
Paula Chin: You've been strategizing with co-ops that are grappling with the problem. But before we talk about that, can you describe the lingering impact of the pandemic on the economic landscape as it stands now?
Carl Cesarano: Absolutely, Paula. It's very hard to navigate the landscape these days. We have very high inflation. Currently, inflation's at 8.5%. The usual run rates for expenses are now all off the table. Everything has to be looked at individually and evaluated individually.
Carl Cesarano: So our first step is to reexamine our current budget and reevaluate our priorities. There are certain things in your budget that may be wishlist items, and there are certain things that are certainly priorities. And those have to be looked at carefully.
Carl Cesarano: The assumptions and assertions that were in the original budgets — of course, you do your budget in advance of your year — they've changed. So we have to move on and see what expenses we can cut.
Carl Cesarano: We have to see if there is any opportunity to raise charges other than maintenance and assessments. We want to, and especially where we lose or have lost commercial income, really try to get our residential unit owners to pay. After all, they are shareholders. They have a chip in the game.
Carl Cesarano: Optional capital projects may have to be postponed, or even canceled. We're only doing projects that are the most important and required under the local laws. We have to make sure we get competitive bids for projects that can't be delayed. Everything has to be really tight. We're working with a lot of buildings, almost kind of as an owner's rep to make sure that there's not a lot of cost overruns. We're looking at change orders.
Carl Cesarano: And to basically wrap it up, you can't leave any stone unturned. Anything we can reduce, we want to reduce. Any ancillary revenue we can raise, we want to raise it. That's currently where we are.
Paula Chin: Those are the strategies that you are recommending to your clients. Can you tell me any particular buildings that you're working with where they're facing these problems?
Carl Cesarano: Well, sure. Our firm audits in excess of 300 co-ops or condos or HOAs. But I'll talk about one in particular in Queens, where they have 24 commercial units. When you have lots of commercial units, your whole budget is based upon the revenue coming from these units.
Carl Cesarano: In this particular case, our revenue from the commercial units were in excess of a million dollars. As the pandemic closed a lot of the stores down — a lot of them were restaurants or non-essential businesses — our revenue was cut in half. Now we had to find a way to make up the shortfall in order to balance our budget.
Carl Cesarano: And we made up our shortfall in a number of ways. We looked at everything on our budget. Two things that were really integral to the process was refinancing our mortgage.
Carl Cesarano: In this particular case, we were able to reduce our rate and save about $40,000 as a result of that reduction. We went from 3.87% to 2.85%. So we were able to save money from the operating side, and also put some money in the reserve fund.
Carl Cesarano: The other thing was PPP. And we do want to thank the President's Council, the Federation, Habitat, all the different organizations that worked on getting the second round of PPP passed for co-ops, as that cash flow that we were able to get helped stabilize so much of the situation. Those were two of the things that we looked at that were the big revenue raiser and the big expense reduction item.
Carl Cesarano: The other thing we did was, as everybody is well aware of, utility costs are getting out of control, as they say. Like I had mentioned before, the inflation rate's 8.5%, the energy index is up over 30%. Gas is up. The delivery rate is over 28% increase.
Carl Cesarano: As you know, when you talk about getting utilities, you can buy from an alternative supplier or an ESCO, but there's three components to the bill. One is delivery, one is supply, and the other is taxes. On a rounded basis, we could say they're about a third apiece, just on a rounded basis.
Carl Cesarano: What we were able to do was we envisioned prices would go up. So we shopped different alternative suppliers. We were able to lock in our natural gas rate till 2023. We were able to lock in our electric rate through mid-2022.
Carl Cesarano: That stabilized the nightmare that you hear on the news and social media these days about escalating utility costs. We were able to stabilize at least the one-third sector that represents supply. That was some of the other things that were really, really lifesavers to help this budget.
Carl Cesarano: Of course, then, there was this whole issue with what do you do to save this very important stream of cash flow: the commercial tenants and their associated rents? That was the real tricky part, because each business has had different issues. Some were allowed to stay open, but by and large, most had to close. The restaurant industry got hit the hardest.
Carl Cesarano: We had to come up with different models and a philosophy: Would our philosophy be we're going to play hardball? Was our philosophy going to be, we want to work as business partners with our commercial tenants? Which means if they're having financial problems, we have to absorb some of that? And we're absorbing it through the PPP money and through the refinancing.
Carl Cesarano: And we've worked out a number of different deals, depending on the type of business. We've offered different models of leases. Certainly, one of the things was rent forgiveness. We did forgive rent in the cases where restaurants were shut down; they had no income at all.
Carl Cesarano: We also restructured how some of the leases are. We tried to get more flexible terms to help make it easier for small operations to stay in business.
We're trying to make it very flexible for our tenants, and we're looking at different types of options. Percentage rent structures: those types of models entitle the co-op to a percentage of the retailer's gross rent.
Carl Cesarano: Historically, this approach has been used to bridge the gap between what the landlord wanted to get, or the co-op wanted to get, and what the tenant wanted to pay in terms of base rent. It doesn't have to be done on long-term rent deals. Again, offering them a little bit of breathing room on the short term; again, flexible terms, forgiveness.
Carl Cesarano: Also with the, again, big spaces, we're talking about maybe indexed linked rent. There is something called a retail price index, as opposed to the consumer price index. A lot of these indexes are now becoming inverted, or maybe not favorable.
Carl Cesarano: So we're looking at different indexes to tie these rents to a lot of these index links. Rents are not simple. Landlords obviously want minimum increases, while tenants want a cap or a maximum.
Carl Cesarano: What we did in terms of this particular building was it was a combination of all of these things. It wasn't cookie cutter. We basically took it on a tenant-by-tenant basis.
Carl Cesarano: The good news is we have everybody back up and running. We have no empty retail stores at this point. We have our existing tenants back in action. And we're just about up to our million dollars again in terms of our cashflow for rent.
Carl Cesarano: Again, the PPP and the refinancing were just the thing we needed to help us out in the short term. But it was my opinion and the board's opinion, that if you played hardball, you might wind up with a lot of these tenants leaving, as there were certainly some other buildings offering very aggressive deals.
Paula Chin: How many commercial tenants are we talking about, Carl?
Carl Cesarano: In this particular case, we're talking about 24. Certainly for a co-op, that was a large number. A lot of them are smaller operations, and we had to be a lot more flexible. But certainly, the good news is we were able to work it out.
Carl Cesarano: We still have a lot of challenges ahead of us, as we all know. Once you stabilize your tenants and you get that cash flow back, we have still record inflation you haven't seen in 40 years. Most of our costs, a lot are weighted towards things like labor.
Carl Cesarano: As everybody knows, the 32BJ union contract is expiring; that's going to weigh in on our budget. Of course, if you have a December year end, as this building does, our budget is already set. These things may have to be augmented.
Carl Cesarano: Our budgets are going to have to be a living, breathing thing; have to be looked at in real time all the time. And we're going to have to keep tweaking and augmenting as appropriate.
Paula Chin: What about buildings that haven't yet refinanced their mortgage as rates are going up? This Queens building was lucky in that they did this in the nick of time. Any words of advice there?
Carl Cesarano: Well, yeah, as the Federal Reserve tries to reign in inflation, we're seeing rates rise. The 10 Year Treasury, which all these mortgages are tied to, it has certainly increased. We're just about 5% now. So that's far from the 285 we got back in October of 2021. The 10 Year Treasury low was 1.17 at 8-20-2020. So those folks who refinanced then hit it at the low.
Carl Cesarano: But right now, it certainly depends on what's going on. Every property is unique. If we have to do a lot of capital improvement remediation, Local Law 11. We have something, Local Law 97, Climate Mobilization Act: elevator upgrades, roofing, windows. You may not have that much of an option if you need a large amount of money. So it's better to start analyzing this sooner than later.
Carl Cesarano: So I am suggesting pulling out all the stops: mortgage brokers, whatever resources we have, let them shop it. They get a fee for doing this. Let's look at what's out there.
Carl Cesarano: The only other alternative will be to ride it out. And if things get worse; as everyone's well aware, most of these mortgages are balloon-type mortgages. They're going to mature, and they're probably going to mature probably at a time where the rates are even going to get worse.
Carl Cesarano: So this is not to say if you have a decent deal now, you want to change it. But certainly we have to always keep analyzing, looking where we are. What's the rate spread?
Carl Cesarano: Actually, I do have some buildings ... not this particular building, but other ones that it would still make sense for them. They had mortgage deals that they didn't refinance because it was cost prohibitive to refinance when rates were low. So it may certainly be something to look at now, but it's getting very tough out there.
Carl Cesarano: And that's why, when you think about what an accountant is supposed to do ... I mean, technically, we're auditing and we are supposed to be looking for things like fraud and producing financial statements. And we're not supposed to really be totally involved in the management.
Carl Cesarano: But my approach is to work as your business partner. I want to work along with these boards. I want to help them look at stuff in real time. And we want to look at every option that's available to us. And yes, refinancing is not as attractive, but it depends on the individual situation.
Paula Chin: That's great advice, Carl. Thank you so much for joining us today.
Carl Cesarano: Well, thank you for having me. I truly appreciate the opportunity, and I want to thank everybody very much.
Paula Chin: Great. Thanks again, Carl.
Carl Cesarano: Thank you.