The A-Word: Taking the Sting Out of Building Assessments

Historically co-ops and condos have been able to borrow money for building improvements and compliance requirements in an affordable way. With interest rates still high, this is not an attractive option any more. In this episode, Andre Kaplan, CFO of Orsid New York, provides some practical solutions for keeping your building financially healthy while managing resident expectations. Habitat’s Emily Myers conducts the interview.

How To Run Your Building: For Co-ops and Condos

Transcript

Emily Myers: Welcome to Inside Track, a conversation with New York's leading property managers. I'm Emily Myers with Habitat Magazine and my guest today is Andre Kaplan, chief Financial Officer at Orsid New York. 

Increased compliance from the city is adding regulatory pressure on co-ops and condos, increasing the need for careful budgeting to ensure the building remains financially healthy and compliant.

No one likes higher carrying costs, so Andre, how are the buildings in your portfolio balancing the need for assessments with the very real resistance from shareholders and unit owners about raising monthly dues? 

Andre Kaplan: The landscape in terms of assessments to address this additional compliance has changed dramatically over the last 18 months.

And the reason for this is the rise in interest rates. So historically, for the past 20 years in the co-op and condo world, buildings have been able to borrow money to fund these compliance needs for co-ops via underlying mortgages. And there have been loan avenues to condominiums to achieve a lot of their capital needs, both in terms of compliance and this basic infrastructure and sort of amenity upgrades as it were, in terms of being competitive as a building in the marketplace. 

That landscape has changed and there's been additional compliance as you have mentioned, which has limited the opportunity for buildings in New York City to meet these compliance needs and make necessary infrastructure improvements and necessary maintenance.

So it has left the buildings where they've took out additional cash under mortgage refinancing where interest rates were low, that this is no longer possible. And the reason for that is one is the existing mortgages. Most buildings, fortunately are now locked in to low interest rate mortgages.

They generally are classified as commercial mortgages, so they generally tenure terms. Most buildings took OP took that opportunity and therefore they are not in a position to refinance those mortgages, because they're at such preferential rates. Second mortgages, which buildings have looked into take on an additional mortgage to fund the necessary compliance or capital needs are no longer generally possible.

And the reason for this is because banks, where they're locked in at 3% or under are trying to force these buildings to refinance so that they can refinance at higher rates because banks are not really generating much of a revenue at 3% in today's marketplace. And so therefore, it's left the building with no option but to assess, or how do they fund? So many buildings took the view where they took a long term capital plan, which is absolutely key in terms of, understanding your funding requirements. So you need to look at it at one year, five year, and 10 years out. You need to understand what cycle you are on in terms of your compliance needs. And some of those compliance needs would be your facade, which is now called FISP, historically Local Law 11, Local Law 1 52, which is your gas testing, which could lead you to exposure should you have a gas shutdown. And that's not a one and done. It's every four years. And then there's, the local law 97, which is energy emissions, which is a big contributing factor, which needs to be understood and you need to proceed with caution.

And then there's your basic infrastructure. Roof, sidewalks, elevators, and all those that you have to build into it. And then you have to keep the building maintained in terms of lobbies and hall. How are you gonna fund all this? If you didn't take out enough cash at your mortgage, you have to assess.

And how do you address the assessment? 

Emily Myers: Yes. So what are the best ways then, to approach an assessment, particularly for the infrastructure projects you're talking about, which can be sizable six and seven figure numbers? 

Andre Kaplan: So firstly, again, understand that long-term funding needs because you want to be transparent with your residents.

You want to explain to them why you're doing the assessment. And you as a board are in the same position as every resident. So you want to explain, this is what we need to address. You want to give them a big picture approach, number one. And then you're gonna say, we are going to need over the next five years, this amount of funding. We can't go and borrow it, so we are going to have to raise it from the residents. And so we wanna give you options. And so nobody likes the A word, which is assessment. And so you need to look at the assessment and can you spread the burden and work with your community to achieve that?

And that would mean, say for example, you need to raise a million dollars. The first question is, how quickly are we really going to need the million dollars? And let's say we are going to need $500,000 today, and not everybody's in a position to write a check for $500,000.

This is the many ways you can address it. So one is you can say, we are going to ask, we are going to levy an assessment of a million dollars. And you have two options to pay it. One, you can pay it upfront. Or a lot of the buildings have linked to their mortgages, lines of credit, but there are floating rates and they link to the prime rate.

So you're looking at possibly in excess of 9%. It's a big expense in terms of debt service and so that's why we wouldn't utilize that option of a credit line that is available. But there are some owners that might not have the cash flow and might not have that option. So we would say, you can pay upfront.

It's a million dollars your share, or we'll give you 12 months. To pay the assessment in equal installments. However, we will utilize our line of credit on your behalf. So almost, the building is offering individual owners or shareholders a home equity as it were. And it's whatever the pervading rate is, and we would set that at the beginning.

So you would pay an interest component over and above if you choose to pay it over 12 months. Or you can pay it upfront. What you will find is that some people will pay it upfront, which will give you the necessary cash for your immediate fund, and you need to understand what that would look like for your immediate funding needs.

And some buildings do it over a longer period and don't charge an interest component because we are only gonna need the money in 36 months. So we would do it over 36 months. There are other ways to address these funding needs via assessment. And one is the co-op tax abatement. I would say 95 to 99% of buildings assessed for the co-op tax abatement.

And that assessment historically has always flowed into the operating budget , because it's helped to keep maintenance low or reasonable, and that's what it was designed for. However, that has not flowed into reserves. So now where we have interest rates that are high and we have interest rate exposure in terms of when that mortgage will refinance, which as I said, are they commercial mortgages?

So generally they're for 10 years a lot of buildings are looking at how to utilize that assessment for the abatement. And so they might take. 10% or 20% or 25%, or they might just start with 10%, which used to flow into operations and put it towards their reserve fund or their capital fund to start building up savings of capital funding or reserves to fund these necessary items that we've spoken about.

So it forms part of the operating budget, but it's separate. And the one point that I want to make about assessments, especially when it goes towards all these projects that we've spoken about, is that they should be designated as a capital assessment, not an operating assessment. And the reason for that is you want to distinguish the two.

Because it's helpful for value, when shareholders are buying an apartment that they understand that this assessment might not be forever, their maintenance will be. So you never want to include it in maintenance necessary. You wanna show it separately that it is a capital cost, number one.

Number two is a long-term resident, we would have a capital gains impact, a capital assessment. You designated as a capital assessment is very important because they can add that to their cost basis. So for example, and in terms of how capital gains works with the capital assessment, there's sometimes a lot of confusion in the marketplace, whereas you think you make all these capital improvements, you can automatically add that to your cost basis in a co-op. That is not fact. There are only two basis where you can increase your cost basis. One is if you have an amortizing underlying mortgage that is classified as paid in capital, or you bill an assessment as a capital assessment and it's done for a specific purpose, including funding reserves, those are the two avenues you have to actually increase your cost basis on.

The question is where, and we've just had this, a similar scenario with buildings, where should we raise $750,000? 'Cause this is what we need today for an assessment, but we know that we are going to need another $250,000 in three years time. And looking at, should we ask for it all now or should we ask it in two?

Now, if you look at the differential, they'd rather ask for it all now and give the shareholders a longer time with no interest component to pay it over 36 months instead of 12 months or 18 months. It gives a lot more flexibility to owners and shareholders to fund those assessments. 

Emily Myers: So you've outlined a couple of strategies.

That give shareholders and unit owners a little bit more flexibility. They are a little complicated. How do you communicate these financial decisions and plans to shareholders so that they can make the best decision for their building? 

Andre Kaplan: So firstly, we take the board. We help the board in developing the long-term plan.

That's number one. We lay out all the options and we show them the impact on every individual apartment. If you raise the million dollars over 12 months, 24 months, 36 months, if we utilized the line of credit, if we had to refinance the whole mortgage, what it would cost you.

We lay out those options once the board and we as the management come to a conclusion as to we have no alternative in terms of the assessment. What I like to do is actually called a shareholders meeting, whether it's an informational meeting or it's addressed at a special meeting or an annual meeting, but generally I would like to do an informational shareholders meeting in a relaxed forum.

Let everybody know why. Lay out the challenges, number one. It's very important to communicate to your residents what the challenges are because they are owners just like everybody else. They are shareholders. This is what we're facing and this is what it's gonna look like five and 10 years down the line, and we have this mortgage, but it's gonna come to an end.

Or we are locked in and explained to them exactly as I've explained to you . I like to be very visual, so do a PowerPoint presentation. It's really very helpful. Explain to them the challenges on those projects, number one, and then show them this is your apartment and if we raise a million dollars, this is what you would have to pay for the million dollars. Or two, if we did it in monthly installments, this what it would look like on average. And do that simplistically. And then remind everybody that if you had to own your house, and this is very important, if you owned your own personal house and you needed to fix the roof, you have options. If you had savings, you would utilize those, which is the buildings reserve.

If you had an opportunity to refinance your mortgage, which people have done historically, you would pull out additional cash and pay for the replacement of your roof. If you didn't, you would have to either get a home equity. Or if a roofing company provide an option to pay it off over time, that's what you would do.

It's no different if you live in a co-op. It's your home. It's co-op living, and so we have to work together to try to find different avenues to find the necessary repairs or maintenance that are necessary to maintain the building. 

Emily Myers: Have you had a situation where there's been a commitment to a particular route and you've persuaded the board to pivot in some way?

Andre Kaplan: So the board's biggest concern is how are we going to deal with the community? And we had a building which was in dire need of funding for their roof replacement. And they did not have sufficient reserves, and they were extremely anxious about going to the shareholders because they needed to raise a lot of money and they needed some of it very quickly.

We did a complete PowerPoint presentation. And we assured the board that if we really explained this well, and then the real need that the building had that we would get the buy-in and that you'd be surprised how many shareholders would be able to pay a chunk of that upfront. And so we gave them payment options with an interest rate, as I explained, where they could utilize the line of credit and we had such great results that 75% of the building actually paid the assessment upfront. We did not need to utilize the line of credit, and we were able to fund this roof project and get it completed prior to the winter. 

Emily Myers: Wow. A good success story there. You've talked about a long-term plan and the importance of long-term strategic planning, but we all know that emergencies happen and they can happen when your reserves are depleted.

How can that long-term planning help in managing unexpected costs? 

Andre Kaplan: A lot of the long-term planning is cyclical and so it's not as hard as you think it is. So it's key to have the long-term plan. Some of them are fluid, and they're variable. So we always say this is coming up, but it could happen a year or two earlier, so we have to plan for it in advance. And so making sure you do have a line of credit available to you in the case of emergency. Even though it might be expensive, but building up those reserves to a reasonable level. So I'm not telling a building that you need to sell, sit on $5 million of cash just in case. Start a workable solution that you have reasonable reserves. 

Emily Myers: And how often should the long-term financial plan be revisited and updated? 

Andre Kaplan: Every single year. So when you prepare your operating budget annually, at that same time, you should be updating your long-term capital plan. 'Cause as I spoke about when we deal with the operating budget, we wanna deal with the capital budget and the necessary funding.

And I'll give you another example. Where we've had a building that has done a much better than budget in a given year. They've either generated a surplus. Or they don't need a maintenance increase in that given year. My suggestion is to allocate the surplus to reserves and designate a portion as a capital assessment. There's a mechanism of doing that, because that will give the shareholders the benefit of the cost basis, number one, and then to encourage boards where you don't need a maintenance increase , or you might only need a 1% increase to maybe go with a 2% or a 3% increase and take that portion and allocate it to future capital needs. The following year you might not be able to allocate it because you might need the three to 5% maintenance increase, and that's okay.

You'll put it towards operations, but the year that you didn't need it, you're going to take it and allocate it to capital and the year after you might utilize it for operations. So if you took the 3% in one year, you won't need a six paying increase next year.

So you want to always keep pace. Even if you don't need it, allocate it to your reserve account. 

Emily Myers: Okay. You've offered lots of great financial strategies for boards. Is there one principle takeaway that you can offer? 

Andre Kaplan: The principle takeaway is twofold. Long-term planning, number one. Interest exposure, when your mortgage is set to mature. You need to keep your eye on both. Because when you refinance that mortgage, when it comes up for refinancing, you have another 10 years ahead in that mortgage. If interest rates are still high and you're not in a position to pull out additional cash to fund those next round of capital needs, you have to be ahead and you have to plan, and there might be capital needs falling in that period.

So you wanna get ahead of it. You want to be able to be transparent with your shareholders. As a board, you don't want to give anybody any surprises or elude that you were not on top of things and you were not ahead. So we work with boards. We make them aware of it. We want to communicate it to the shareholders.

It's just like owning your own home. There's necessary maintenance. You want to keep at least three steps ahead. 

Emily Myers: Great. Andre Kaplan, thank you so much. Andre Kaplan, chief financial officer at ORSID New York.