The Financial Consequences of a Condo's Near Collapse

When a loft condominium faced a potential collapse, residents were forced to vacate, revealing the financial and logistical challenges of such emergencies. Carl Cesarano, the accountant for the condo and principal at Cesarano and Khan, discusses the complex process of securing emergency funding, the importance of reserve funds, and the critical role of engineering assessments. Habitat’s Carol Ott conducts the interview.

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Transcript

Carol Ott: Welcome to Problem Solved, a conversation about challenges facing New York's co-op and condo board directors. I'm Carol Ott of Habitat Magazine, and with me today is Carl Cesarano, principal at the accountancy firm of Cesarano and Khan. Calamitous events happen, and while most don't like to think about this possibility, it behooves co-op and condo boards to be prepared.

What prepared means, though, is tricky. Carl, you worked with a condo that suffered a truly calamitous event. Can you tell us what happened and the financial ramifications of this event? 

Carl Cesarano: Absolutely, carol. Thank you very much for having me. 

This particular condominium, actually was leaning. Several of the walls on the west end, on the north end, they were literally going to collapse and the Department of Buildings issued a vacate order. And this is a building that is historic. It was converted to loft type units.

As a result a lot of the due diligence with respect to how sound an old structure was, although it's very historic and loads of amenities and certainly the right place to be living, it had its challenges and think of everyone in the building asked to vacate. You have to look for another place to live.

It's a tragic event, similar to what you see where sometimes even the Red Cross comes in and tries to house these people. 

Carol Ott: Let me just step in here for a moment. So this was an old loft building as I'm understanding it, that was converted to a condominium. The loft buildings are like, a lot of residential buildings built, 50, 60, 70 years ago, probably one assumes solid and an event happened that sort of indicated there was a big problem, which I guess nobody was aware of.

When you say people had to vacate suddenly. Now if I'm a resident in this building and I come home from work, or I'm at work, what? What does that mean? I'm getting a phone call, you gotta leave? 

Carl Cesarano: The Department of Buildings actually mandated emergency remediation and said that nobody was allowed in the building.

Yes the building had I guess you could say a cease and desist from entering. And yeah, it was very abrupt but of course what are the options? If the building collapses, obviously that could be a fatal event. There wasn't many choices. 

Carol Ott: I understand from a, operational point of view, a logistical point of view, a construction point of view. Lots of things are now in gears, but I actually think most of us do not think of what is happening from a financial point of view. I. 

Carl Cesarano: Thank you for bringing that up. And that's where I guess my expertise comes in.

So with respect to the engineering and the architectural issues and actually the remediation from a contractor point of view, I act as part of the team. As we all know, co-ops and condos, especially in New York City their accounting slash finance operation are outsourced. Unlike other industries where they have in-house CFO, controller, all sorts of accounting structure, co-ops and condos don't have that luxury. My approach is to take more of a business person's approach, which means I understand the challenges, I want to be part of the team. Now it's all well and good to get the engineering and architectural assumptions straight, and of course work with New York City Department of Buildings.

But now what about the finance side? How do we raise the capital to remediate a project which has a range from two to $3 million at a minimum? 

Carol Ott: I'm assuming this condominium didn't have a reserve fund that would meet the needs of whatever this repair project was.

Carl Cesarano: Absolutely not. The amount of remediation was such that it could not fund it. Now we have an emergency situation with respect to A, okay, we have to secure funding. How are we gonna do that? In a cooperative model they could leverage the building as collateral, refinance, get lines of credit because they have an asset to leverage.

In condominiums, the legal structure is everybody owns their unit. Everybody has a deed. So now it's a little trickier. You have to get what is referred to as a CIRA Loan, CIRA, or a common interest real estate loan. And they're not as available as regular mortgages. 

Carol Ott: You have to get a loan if you can't turn to your unit owners and say, we need $3 million divided by the number of unit owners. So each of you is gonna have to give us whatever that is. 

Carl Cesarano: What happens is we wind up doing a combination of both. Given that these structural remediations, improvements, have a useful life of many years. One of the things we try to do is match the useful life of the remediation with some sort of structured financing model. In addition, we have to figure out what the unit owners could come up with collectively. And it's really a combination of both. And one of the interesting things about this particular project was it was hitting a moving target.

 As folks probably realize, when the engineers contractors come in, they give you an initial base bid. They say, based on what we see so far your price for remediation is X. But as we go along, we, we may see further issues and additional remediation that needs to be done. So as a result of that there's usually a margin, in most cases, somewhere around eight to 10%. But in this case the remediation was so extensive they were giving a range of a million dollars. So what we then had to do was, in addition to helping them structure the financing, they wanted somebody to watch the contractors and almost act as an owner's rep in a sense, where you're looking in real time at the finances and how the scope of the work and cost changes through the project. Because not only are we doing it to make sure everybody's aware of how the scope changes and how the costs change, but it would also augment how we need to structure assessments and ultimately what we would get in terms of a loan. 

Carol Ott: Talk to me about the loan. How complicated was it to get a loan and how much was left to the unit owners to fund? 

Carl Cesarano: Excellent question. So with respect to getting the CIRA loan, there are a handful of CIRA lenders for condominiums; co-ops, again, would be a different story. And as we went to the different lenders when they heard that this was a potential building collapse, just about all of them said it didn't meet their underwriting criteria. So we had to keep looking and looking until finally we came across a lender that said, look we are willing, based on this property, and with all the shortcomings, we're willing to give you a loan. However the owners must also have it a chip in the game. So I suspect in addition to their underwriting criteria, which talks about there can't be any significant remediation, there can't be lawsuits, everything has to be wonderful, this was a totally different case. So what the lender said was, put up at least 1.6 million dollars of assessment money. Then they would feel reasonably secure that they had a significant chip in the game. People weren't gonna walk away and the loan would perform, and their assertion was correct. Then we had to structure a special assessment, we had to raise the level of funding and fund the project to that point.

As soon as that happened, they said, okay, now you're allowed to draw on this revolving line of credit. 

Carol Ott: Can you gimme an idea of how much per unit owner I understand it's proportional, but just in general. 

Carl Cesarano: In this case, upwards of about 65,000 per unit owner, in this particular case with respect just to the assessment to get the job started. So again you have an assessment where they said, look, you gotta throw 1.6 million into the game. That was about 65,000 a unit. And then of course, once we were able to get the loan, they also wanted to make sure that funding is specifically secured to fund their loan. So now for instance, we have a $2 million line of credit. Now they said, okay, we want a specific line item in your budget, call at a capital assessment, to fund our loan. So in addition to that, you had what amounted to be more than double of that $65,000 number. However, one assessment was an immediate assessment.

The other assessment is over the life of the loan, so we were able to stretch out the second leg to cover the financing portion. 

Carol Ott: And what was the life of the loan? 

Carl Cesarano: Okay, so the life of the loan is, it's a six year loan and it's for $2 million. And of course now the owners are faced with, I either lose my equity or we have to remediate this. Condo owners are no different than one family homeowners. My house, for example, I'm a one family homeowner, needs structural remediation. I have to do it, or my equity is, greatly depleted if not down to zero. 

Carol Ott: So let's say I'm a unit owner.

I had to come up with on average, $65,000, next week, and I still have a common charge I presume to pay each month. And on top of that, I have whatever, that $2 million divided by how many unit owners assessment. 

Carl Cesarano: That's correct. 

Carol Ott: And on top of that, I'll just add my current living expenses where I'm currently living.

Carl Cesarano: That was the unbelievable challenge of this. So we did work with some of the owners who could not fund the assessment immediately. You really have no choice. At the end of the day, this is also people's homes. They're your neighbors. It's very hard in common interest real estate to balance.

We all want to work with each other, be good neighbors versus running a business, which is basically what this is as well. So we worked along with owners. Some of them could not come up with the money right away. Again, keep in mind, the number I quoted was like an average assessment. Some paid less, some paid more.

And of course, as you pointed out, their own living expense for emergency housing. So a lot of them rented apartments if they didn't have any relative or any other place to go. So they had, as you pointed out, their common charges, these assessments and their living expenses. Fortunately the residents or owners were folks that can afford to pay for it. And that was really fortunate for the condominium association as a whole. Because if they were all in distress we may have to look at other options, but the emergency assessment was put through once the funding, of $1.6 million was started.

And of course the AIA contracts with the contractor was sent to the bank. They said, now you have the financing. Now finish your project. And of course, during that period, I'm also monitoring the project. These are the cost overruns. They originally started at 2 million, we're up to 2.2, 2.4, 2.6, because they did give us another million dollar range.

And because the loan was a revolving line of credit, we didn't have to draw on the whole 2 million. So this is where teamwork becomes really essential. And it's so hard in common interest real estate. And also it's hard for, we refer to ourselves in the industry as accountants, but we're really the independent auditors.

And as such, we're really supposed to be doing an audit of what's going on. Because of the unique structure of condominiums and co-ops and common interest real estate with an outsourced model for running their financial operations, except for the board, of course who's non compensated, right? And they all have lives and jobs, and now no housing.

We felt it appropriate to step in and help them out as much as we can. 

Carol Ott: Where is this building today? Are people still out? Are they back? 

Carl Cesarano: Things have been remediated. Folks are starting to trickle back in. There are still some challenges with respect to certain units.

For example, the penthouse unit had a little more structural problems and issues. The building will not be collapsing, thank goodness. But one of the interesting things, and of course we all love the old landmark structures and they have a certain character, and architecturally you're not going to find these type of things anymore, especially in new construction.

But again, if they're over a hundred years old, for example in this case, you could have challenges and it's my understanding some of these challenges were not discovered during the offering plan due diligence and crept up afterwards. And of course, everybody's pointing fingers.

Carol Ott: And I'm sure going to court. 

Carl Cesarano: Right. Who's responsible? Why? Who claims if you really read your offering plan, you would've saw that. I'm taking no responsibility for this. It was just a mess. But until the legal challenges are resolved, you still have to remediate the building, get people back into their apartments and finance it.

Carol Ott: Most buildings don't suffer this kind of large scale calamity. In general the advice is to be prepared. What would be your takeaway for other boards? 

Carl Cesarano: It's an excellent question. And we all know that New York City local laws are as best as possible trying to keep up with a lot of the challenges; for example, Local Law 11 which is facade inspections. But more importantly for not only just these older buildings, making sure that reserve funds are appropriate and we have significant reserve funds. And all that stuff is based on engineering.

There's a lot of folks in the co-op condo community, in the accounting community that say the rule of thumb is six months maintenance, or X dollars or a certain percentage of cost. Or if there's investor presence enough to fund whether they default. But the real answer is engineering, and you have to look at what do we need from an engineering point of view.

Have a funding plan. Make sure you have enough reserves because this type of situation. It was just fortunate that the folks who own units there, by and large, were able to come up with this money. We could look at the south Florida building collapse as an example. That's the extreme case.

Certainly we don't want that. My understanding was there was at least $15 million worth of remediation. Folks were trying to figure out what to do. Is it overkill? How do you fund? In the meantime it became a tragic situation. In the Morris Heights section of the Bronx, lately we saw a partial building collapse where part of the facade collapsed.

And of course there was a vacate order there. I think the last one was in Little Italy where an entire wall came down. These are all older structures. Some of them it is alleged that there were Department of Buildings, whether there were violations or you have to move forward with work type of orders.

But still, we can see how these situations can be trashed. From my perspective, again, not being an engineer or an architect, my takeaway is please do not think that reserve funds and studies are not important. They certainly are. If anybody looks at an auditor's report, the opinion page of the financial statements, you'll see it noted there that the real smoking gun, if you will, or the real uncertainty, you could see everything on the balance sheet. You'd see everything on the income statement in terms of the money and the finances. But what we're not disclosing or what we don't have or what we weren't given access to is what are the engineering structural challenges and systems challenges, because that could be a game changer.

So I could see that from an aesthetic point of view, they have a million dollars in reserves. And I could say, wow, for a building of this size that aesthetically looks wonderful, but what happens if I need 3 million? Then it's underfunded. And for the most part, you don't see that in financial statements.

What is a notation, basically saying that we're not providing that information. That's a double-edged sword also. A lot of boards feel engineers come in and overkill it, and it may give the reader a very negative opinion of a building when certainly that may not be the case.

Now if we look at this case it was certainly appropriate. 

Carol Ott: Bottom line, I'm gonna say the takeaway is embrace your engineer and have your accountant by your side. 

Carl Cesarano: Well, especially your accountant. 

Carol Ott: Thank you, Carl, very much. 

Carl Cesarano: No, thank you.