Following the Money: What New Condo Boards Need to Know About Sponsor Exit

During the period when a new condominium comes on the market and the sponsor finally turns over control to the condo board, who is paying for the condo’s operating expenses? The building is not fully sold so there aren’t enough paying owners to fund the budget, yet the building is operating as if it was fully occupied. Christopher Saray, manager at the accountancy firm of WilkinGuttenplan, explains the how this works, what new condo boards need to understand about the budget when they take over and what condo buyers should be aware of. 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 condo board directors. I'm Carol Ott of Habitat Magazine, and with me today is Christopher Saray, manager at the accountancy firm of WilkinGuttenplan. 

When a new condominium is formed, the sponsor files what is called a Schedule B, which is part of the condominium's declaration.

This schedule includes a number of items including a budget. When purchasers buy their apartments, they are relying on the accuracy of this information. Chris, many sponsors have what is called a waiver period. Can you explain what this is and what often happens when it ends? 

Chris Saray: Sure. Thanks Carol. So the waiver period is essentially a time period after the commencement of operations of these buildings, where unit owners or shareholders don't pay any common charges. The offering plans and governing docs of these buildings often include some language that says the sponsor reserves the right to delay the commencement of common charges. And that delay period is what we refer to as the waiver period.

Carol Ott: So a sponsor is actually trying to sell apartments. I presume this is a marketing effort. If I'm gonna buy an apartment and I see the sponsor said, you don't have to pay common charges for the next period of time, six months, a year, three years, whatever-- you can perhaps tell us what is normal. That's gonna make it more attractive to me to buy in. That is what the waiver period is about. 

Chris Saray: Sure. So the waiver period though is often not known from the get go. So as I mentioned, the sponsor reserves that right to institute the waiver period.

And there's often purchasers that are buying into the building prior to knowing that this waiver period will be in effect. It's required to be disclosed in an amendment to the offering plan. So any purchasers that are buying in after the fact that this waiver period has been implemented would be aware.

And of course, that is a sales tool that the sponsor can use to attract buyers. 

Carol Ott: Now, I'm gonna assume that once a condominium has entered into a waiver period, that the sponsor is in fact paying all the bills. Is that a good assumption? 

Chris Saray: That's a good assumption, Carol.

And there's often required specific language that says that. That terminology that I used about the sponsor's right to delay the commencement of common charges is followed by, in as much as, or so long as the sponsor is paying for all the operating costs .

Makes sense. How else would the building be paying for its bills as they come due without a little bit of cash infusion from the sponsor. That's normally the case. 

Carol Ott: I hate to interject distrust, but there is a underlying river of distrust between the person who has sold the condominium, the sponsor and the buyer.

Often in new construction, particularly, defects in construction begin to emerge, perhaps relatively quickly, perhaps a bit of time into its existence, and the sponsor may be on the line to provide more funds to fix whatever needs to be fixed. The sponsor may have other obligations, so I don't know that unit owners, and certainly when the board takes over that they're totally comfortable that all the bills have been paid, some bills have not been paid. Perhaps some maintenance contracts have not been entered into. There's a whole variety of things that can be avoided or ignored. My question is, when the waiver period is over, I presume there is some kind of a reckoning. Can you talk to me about what that reckoning is, and if a board has now taken control what they should be doing. 

Chris Saray: Sure. So when the waiver period ends, the responsibility for the operating costs, all expenses of the building fall on the unit owners, the shareholders, right? Prior to that date, whether the expenses that are being paid by the building , call 'em normal maintenance and operating costs, things like your maintenance contracts and things like that, or cost for repairs, for construction defects or anything like that, they're both the responsibility of the sponsor, right? Because conceptually, every cent is the responsibility of the sponsor before those charges to unit owners commence.

After that date, as mentioned, the responsibility falls on the unit owners to pay for the expenses via the charges whether they're common charges or in lieu charges, which I do wanna touch back on if we have a moment. But after that point, I think new boards should really work with management to review each and every invoice that they feel has any uncertainty behind it. I think the effect of the condominium needing to basically front cash for repairs, for remediation, construction deficiencies, that becomes an issue and the more that they pile up, the more ntentious it could get. I think best practice is to nip that in the bud.

And if there's an invoice that comes through for a repair that the condominium is up for it feels that it's, essentially the sponsor's responsibility. I think the discussion should be had before the bill is paid. Although the invoice may be addressed to the condominium or the board, if it's thought to be the responsibility of the sponsor, have that discussion before you pay.

Carol Ott: Often while the condominium is within the sponsor's control, the sponsor either is managing the condominium or has hired their own management company, or perhaps has an in-house management company. Once the board gets in control, they may decide to switch to their own management company.

I know you're an accountant, but I would assume that a board would want to bring in an accountant to actually look at books. This is not really something that you're paying a management agent to do, let's put it that way. 

Chris Saray: Of course. First of all, these buildings should have third party accountants perform an audit from the start. Regardless of who controls the board, of who's managing the books, an audit should be done from the start. They should be able to review the financial statements. 

Are we capturing the correct cutoff? So if there was a waiver period, when did common charges start? Let's make sure that we properly accrued the expenses. Even if they were paid three months after common charges started, if it was for a service that was incurred prior to that date that they did start, that falls under the responsibility of the sponsor.

So those cutoff procedures are important. We're not in the business of necessarily being able to determine if a repair should be a sponsor, funded cost. But we examine invoices and if there's ever anything that seems like, Hey, this is a brand new building, why are they having, significant repairs done to their floors or whatever it is, their facade. Those are things that light bulb in our head to say let's have conversation with the current board if there's validity to the fact that hey, this expense might be something that we can request be funded by sponsor. 

Carol Ott: I'm wondering in your experience in how many condominiums where the sponsor is controlling the board, do the actual residents say, wait a minute, we're gonna pay for a third party? That doesn't really happen, does it? 

Chris Saray: No, that doesn't happen in my experience. I think once the residents get at least a seat on the board that's when they can interject their thoughts and opinions and get involved.

Carol Ott: What would be your advice actually to boards then in new condominiums where the sponsor is exiting? Whether it's exiting after a waiver period or exiting just because they've sold enough units. 

Chris Saray: Sure. I think my advice would be to be as involved as they can be. Work with your accountants, because like I said, this is a huge point of issue for us when we're doing our audits for the newer buildings.

So work with your accountants to really learn about the issues. Over the course of time, if there's any kind of compilation of information or financial records or even just invoices that have been paid or even just, slightly a question, I think, maintain your representative support as detailed as you can, and that'll just help for the future when, the residential board is looking into this matter.

Carol Ott: I'm sure you've been called in to do this a number of times. Do you often find a discrepancy? Or is it normally, in your experience, I don't know if you can put a percentage on it. Is it normally sort of okay?

Chris Saray: It's never really a discrepancy, right?

The fact of the matter is there's activity for costs that are running through the condominium. It's not a discrepancy in that someone is saying this is a condominium expense versus a sponsor expense.

It's Hey, there's all of this activity. Let's be sure that we are on top of who's responsible for these costs, right? In working with some of the bigger management companies, it's often something that is considered by management, right? Again, speaking like an accountant, there's sometimes they have a separate general ledger account where they kinda store all of these costs that may be considered sponsor expenses.

And then management will request via, we call it a funding request. They'll say, Hey here's a list of 10 things totaling $50,000. Here's your funding request. And, most of the time, I work with a lot of the new construction buildings. Most of the time sponsors are agreeable and willing.

They just want the support, the understanding. When we issue a audit, and there is an amount on the condominiums or the building's balance sheet that says due from sponsor a hundred thousand dollars. I don't think anyone is just gonna accept that and say, okay here's your a hundred thousand dollars.

If we can provide the support, the reasoning, the understanding of that amount, generally it's worked out fairly easy. And something that we do is we request that the sponsor confirm and approve that number, right? Because we don't want to issue a financial statement with that a hundred thousand dollars receivable, for example, when that a hundred thousand dollars receivable may never get received.

So we, before finalizing any audit, we require that the sponsor look through the detail that we can provide and say, okay, we agree, we'll sign off, and then the resolution of the matter, whether it's a check cut or something like that, that happens down the line. 

Carol Ott: All right. I suspect that most buyers and new condominium boards find all of this to be pretty overwhelming, confusing, and something that really they hadn't maybe considered needs to be done. I guess finally, what would be your recommendation?

Chris Saray: Do you mind if I step back a bit? I wanna mention something I didn't mention. So at the end of the waiver period what we're seeing happen more often these days, over the past five years or so, is sponsors are implementing what we call in lieu charges. So these in lieu charges are charges to unit owners in an amount lesser than that budget per the condominiums governing documents call for.

So the budget is based on a full occupancy building for a full year. That includes, all of your maintenance contracts, your administrative costs, professional fees, utilities, so on and so forth. In early years of operation, we know that not all of those expenses may be real in early years. For example, HVAC systems may still be under warranty, so the budget may have a $50,000 item on it for HVAC maintenance contract, but in, in the first year or two, that might be still under warranty. So it's not actual cost. So sponsors are leaning towards implementing this in lieu charges, which is just an amount lesser, so it could just be a revised budget.

They might take that Schedule B budget and remove certain line items that they know aren't gonna be paid. Then that recalculates the amount that's charged to each unit owner. Something else we see is they base it on actual expenses from the prior month. So the expenses incurred in January of one year are calculated and billed to unit owners in February to cover the January expenses.

So we see it done in a lot of ways, but this is also, an additional sales tool. It's beneficial to both parties, right? It's beneficial to the sponsor because it ends the waiver period and the sponsor is no longer responsible for all the expenses. But at the same time, it's beneficial to purchasers and owners because they're paying an amount less than the full common charge budget calls for.

Carol Ott: Let me just understand. If there was a full budget, I as a condo owner am paying my proportionate share. Now there's not a full budget, 'cause let's say the building's half occupied and there's some warranties going on. How is my proportionate share figured out and how can I be sure that it's accurate?

Chris Saray: Sure. So in, in the example of the in lieu charges, let's use a million dollar budget for the example. The Schedule B budget calls for a million dollars in. common charges. 

In lieu charges are implemented and is reduced to 800,000. So now there's $800,000 of common charges to be billed. You as a unit owner still only pay your proportionate share of the revised 800,000 dollars. For any unsold units, the sponsor is responsible for the proportionate share related to that unit, so the building still receives a hundred percent of the reduced amount of eight hundred thousand. And every unit owner is still paying their proportionate share of just that revised amount. 

Carol Ott: I see. And I can feel confident that those numbers are correct? 

Chris Saray: It's something that's actually very re recalculate able, right? Your percentage share information is available to you. And your management or board should be able to provide a budget. It's as simple as some simple math. 

Carol Ott: So the in lieu payments I'm presuming would decrease over time as maybe more unit owners buy in and expenses go up. 

Chris Saray: So I think the opposite, right?

In the instance where in lieu charges are based on actual expenses, the presumption is that the actual expenses are going to increase. So it's a moving target. In January, all unit owners in total might be billed a hundred thousand dollars. But then in February as costs increase, utilities go up 'cause there's more occupancy and things like that, then unit owners are billed their percentage interest now 120,000. So in lieu charges increase. An important note is while that in lieu period is in effect, they can never go above the full common charge budget for the Schedule B. 

Carol Ott: I see. Okay. And at the end of the day, when the board who now has control and the sponsor has presumably left, brings in their own accountant to look at what's gone on, the accountant is not only looking to what happened during the waiver period, but also during the in lieu period.

Chris Saray: Absolutely. 

Carol Ott: I have to say as a non accountant, that sounds like a nightmare to me. 

Chris Saray: It's fun. It's fun to me. 

Carol Ott: There you go. And there's the difference. Alright, thank you very much. This has been really helpful. Thanks. 

Chris Saray: No problem. Thank you for having me, Carol.