Breaking the Budget Code

Budget shortfalls are a nightmare. But manipulating the numbers to create artificially low assessments or maintenance increases can have even worse consequences in the long run. Kyle Gregory, managing member and operating partner of New Way Management, explains how boards can successfully manage their building finances without falling into common traps. Gaming operating costs might be tempting, but ultimately it can damage potential sales and create distrust among buyers. Gregory offers sophisticated approaches to addressing budget deficits, and addresses the long-term consequences of short-term financial maneuvers. Habitat's Emily Myers conducts the interview.

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

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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 Kyle Gregory, managing member and operating partner of New Way Management. 

Realistic co-op and condo budgeting can ensure the financial stability of your building, but it's also important to be transparent about how budget deficits are addressed.

 Kyle, in preparing for the annual shareholders meeting at a new construction condo in your portfolio, you've recently faced the challenge of getting some residents on the same page when dealing with budget overruns. Can you explain what happened? 

Kyle Gregory: , absolutely. Budgeting exercises in general are challenging, just inherent in the exercises, the acknowledgement and acceptance that your out of pocket expenses are gonna increase as the unit owner. But it's a decision that you have to make as a board member and a fiduciary to the entity. So it is one of the most stark or poignant examples of the inherent conflict that individuals face when they serve on an HOA board.

Emily Myers: Because you are oftentimes making decisions, at least nominally to your personal detriment in effort to benefit the collective whole. 

When you say your personal detriment, are you talking about assessments? 

Kyle Gregory: When I say your personal detriment, I mean many of the decisions that boards maketo define roles and responsibilities within their HOA result in additional work or out-of-pocket expenses for themselves. So what I mean by saying that one of the most kind of poignant moments of that conversation is anytime you're navigating a deficit, really what you're talking about is fundraising, and the principle mechanism for fundraising in a homeowner's association is either an increase in maintenance or an assessment.

So you are, by nature taking money out of your own pocket and the pocket of your constituents and neighbors in order to ensure that business is operating financially solvently and prudently. In candor, it's just an annoying thing, right? You're asking yourself to cut a check for something that maybe you can't really feel or touch in a way that you would, your new television or that air conditioner you wanted to buy, or the floors you wanted to refinish in your apartment.

It's more of the collective good of the building of the HOA. And that's true with an alteration agreement, right? You are asking everyone to follow these very specific rules, which is best for the collective, but then when it comes time to hang your shelf or paint your walls, then you have to follow those rules too.

So there's an inherent sort of dichotomy of being a board member which is oftentimes challenging for people to navigate. So budgeting and managing deficits is one of the most poignant one of those, but they happen across your service as a volunteer board member. So specific to this building, this new condominium, a couple of things happened that, I think probably happen across new construction condominiums and I think would be interesting to relay. And that is that a lot of times when you buy a new construction condominium, the offering plan and the expectation on the carrying costs of that condominium are outlined many years before you actually purchase your unit, sometimes as many as seven to 10 years. And there's a hope that as the developer is finishing construction, they're reevaluating the operating costs for the condominium and communicating those increased costs to potential buyers.

But inherently that's somewhat against the interest of the developer because they wanna maximize their revenue when they sell the units. And demonstrating higher operating costs is a difficult thing to relay without reducing asking prices. So by the time you get to the sell off of the units, it's possible that something as simple as the labor costs of the janitorial expense, or something as complicated as the insurance markets which have changed dramatically in the last three to five years, have increased the cost of operating the property. And it can be a surprise to people who purchase a unit based on perspective costs. And then in the first 24 to 36 months of actually operating the collective asset, they find that, hey, guess what? It costs more than we all anticipated. 

Emily Myers: And is this what had happened at this building? There was running a shortfall. What kind of figure are we talking about? 

Kyle Gregory: Correct. And this is a small building. It's a six unit new development building. In aggregate, I don't remember the exact numbers, but I think that the entirety of their annual budget was no more than 45, $50,000 a year collectively across the units. So in gross dollars, their shortfall was manageable, especially when you think about how much these apartments are worth in the Brooklyn market. Everyone cutting a thousand dollar check to fill this gap is not that severe. However, when you think about $6,000 in comparison to a $40,000 annual budget, that then is 15% of the annual budget.

So people get very startled by percentages, even if the magnitude of gross dollars is not that severe. And they become very reticent to produce those funds to match budgetary shortfalls. 

Emily Myers: And there was obviously a mismatch in opinions on how to deal with this. 

Kyle Gregory: Correct, that's right. And I just wanna be clear, everyone's opinion was justified and thought through. It wasn't a whole bunch of people just immediately saying, I don't wanna, I don't want to cut a check, or I don't want to contribute to the funds. It was a conversation that we had about what's the best and most prudent way to raise these funds for the next operating year as the projected cost to operate the building increased. And what was discussed principally was the difference between a significant year over year increase in the dues versus assessing a one-time fee for what, what would've been an operating shortfall?

Ostensibly to posture to perspective purchasers or the marketplace as a whole, that actually the dues didn't increase so dramatically. So to calcify that it's sort of the difference between saying, Hey. If everyone has to contribute an extra a hundred dollars a month because our expenses are projected to increase significantly.

Should we actually only ask everybody for $30 a month and then do a one time assessment of $840 to make up the difference, to minimize the year over year change in the dues because dues are so often how purchasers make their decision on if they can or cannot afford a prospective apartment, right?

So it's very reasonable to think, Hey, if I keep my dues low as a unit owner and I turn around and I wanna sell my apartment, the dues reflect a lower number and it attracts more potential purchasers, and then the value of my apartment inherently increases. So a very reasonable kind of thought process, but in my experience in imp prudent decision for a handful of reasons.

Emily Myers: So can I just ask, what were you advocating for this board? 

Kyle Gregory: So in the simplest terms, I advocate the same thing across all boards, which is to ensure that your monthly revenue as a business, which is your monthly HOA fees, be that dues in a condo or maintenance in a cooperative matches and exceeds your expected expenses.

Ostensibly zero gamification or posturing towards the outside market. And a lot of times internally within our industry property managers are often either operating tangential brokerage businesses. So think about that frequently in terms of asset value management, in addition to managing the business of the HOA. And from the individuals on the boards and the balance of the unit owners, think about that as their asset management. So I very specifically try to separate those thought processes. One process is I'm running a business. The business has to make enough money to pay its expenses. And then as a secondary exercise, is what I'm doing to appropriately run the business, damaging the asset value?

And are there avenues to mitigate that damage or negate that damage if, and when possible? 

Emily Myers: So what you are saying is misleading assessments can create question marks, which actually do not help buildings and trying to mask ongoing costs as temporary assessments, it's misleading to buyers, to banks, attorneys; ultimately harming the properties market value and creating perhaps instability in transactions.

Kyle Gregory: A fair desire for a unit owner and a board is to balance and manage costs for their principal residents. What they're saying is, Hey, if I posture that this carry cost is lower then implicitly, my asset value will be higher.

But what's interesting about that rationale is you are presuming an inability of the perspective purchaser to discern that gamification. And the reality is buyers are smart. Their lawyers are even smarter. Real estate agents are trained to sniff out these deficiencies or gamification in presentation of information.

It's really part of the value proposition of the brokerage community, having gone through however many more transactions than an individual buyer goes through, their attorney and their broker is really meant to say, Hey, I've seen this before. What happens is instead of being forthright with, Hey, this is actually what it costs to operate this business, the purchaser doesn't find that out until later in the process, and it can really become very punitive.

And if you'll forgive my verbosity, I'm just gonna take a step back and just talk about what a transaction looks like. So in a real estate transaction, you have a marketing exercise, right? So either you do it as an owner or you hire someone to put together very lovely photographs and descriptions, and you advertise your asset on a marketplace.

And you have shoppers come and look at the asset, right? And this happens for however long it happens. If you are the seller, you're hopeful that it's one blowout open house weekend, and then you have 35 offers in front of you. Maybe it's three weeks, maybe it's three months, but you have a marketing period, and then you have an offer and acceptance.

So the buyer has gotten themselves over the mental hurdle of spending all of the dollars that they're gonna have to spend to own real estate in New York, and they've come to terms with your request predicated on the information that they've been provided. And what you want as a seller, and any agent will tell you this is as few bumps in the road between that decision that that person has made and when the actual transaction happens.

So once you have an offer and acceptance, then you have a week or two weeks of contract due diligence and then a contract signature, and then you have a month of financing, due diligence where the bank asks lots of questions, and then you have a loan commitment and a closing. And the idea is you want as smooth a ride between when someone offers you an amount of money and you accept it, and when the check actually clears the bank.

Any time you add a question mark to that timeline, you create the opportunity for the very natural emotional cycle of buyer's remorse when people are cutting million and a half or $2 million checks and presenting an opportunity for that bump in the road. Gamifying or slightly obfuscating the actual cost to carry the apartment is actually long-term detrimental because yeah, you might get more buyers in the door on the front end and more offers in the door on the front end, but as that attorney looks through the due diligence, as the bank looks through the due diligence, someone is gonna raise their hand and notify the buyer.

And then the buyer is not only gonna have to do the math again to decide whether they're prepared to incur the new carry. They're also gonna have an inherent distrust for the process in its entirety, and that is far more dangerous to your asset value because as any real estate broker will tell you, if a deal falls through when you're trying to sell your apartment, you are almost guaranteed to sell your apartment for less the second time you try to market.

Emily Myers: So how was your message received by the board? Your message being that gamifying the operating budget is damaging and can damage deals in the building? 

Kyle Gregory: I think it was actually very well received. It just hadn't really been thought about that and why would it have, right? An individual board member is not apt to have watched as many transactions as a managing agent has watched . So they are thinking with their limited experience about, what would most benefit them? And they don't necessarily have the full breadth of hundreds of transactions crossing in front of their desk and the possible hiccup.

So once I explained it and interestingly enough, it was the first time I had ever been forced to really articulate it clearly. Once I had explained it, everyone was fairly receptive. They were like, oh yeah, that actually makes sense. It hurts a little to cut this extra couple of dollar check every month, but given that context and the inherent risk of the opposing strategy I think we are better off just really running the business as fiscally responsibly and prudently as we can.

Emily Myers: And is this an issue that comes up more frequently in new construction condos? Is this an attitude that is perhaps more prevalent in these types of buildings? 

Kyle Gregory: Yeah. In candor, versions of this conversation happened across my portfolio. Whether the co-op is one of the early 1960s era transitions to cooperative, or it's a 2023 certificate of occupancy, new construction condominium. So nobody likes raising their dues, and everybody thinks of ways around raising their dues, but it's certainly more prevalent in new construction because of what we discussed earlier, which is just that in the first two or three years of operating a new construction building, you are finding out what that building really needs, both from just a core facilities management standpoint and from balancing the desires of a new collection of people who have never been in business together, right?

If you are in a six or a 10 unit, new construction, condominium building, you guys have all signed up, whether you meant to or not to be business partners, and some of you may have standards and expectations that exceeded the financial provision of the sponsor, because the sponsor figured, hey cleaning the carpets in the hallway can be done once every five years, but then everyone moves in and everyone's got, three kids under seven and snow shoes and bicycles and tricycles and everyone decides actually we need to do this twice a year so that we all feel comfortable and our home is kept to a standard of cleanliness that we're comfortable with.

So it's more prevalent in new construction just because you don't really know what the building is gonna need, and you don't really know what you and your neighbors are gonna want above and beyond the core needs of the property. 

So what would be the principle takeaways here for buyers and boards in the city's co-ops and condos? 

The principle takeaway for boards is to, put your emotions and the implications of making board level decisions on you personally on the back burner when you're sitting in that boardroom. You really need to be principally the fiduciary to the collective entity when you're in that room.

Kyle Gregory: And far secondarily, a representative of your own interests or financial constraints or personal desires. Which is incredibly challenging, both for HOA boards and I think probably for politicians at large. And then , for purchasers, when you're walking into a new construction building or even a building that maybe this is the first or second resale, but it's within the first three to five years of operating the new construction building, which are usually condominiums. You should be earmarking, additional carry costs. Just for your own kind of mental benefit and preparation so that you are not surprised by these changes in carry. And to be honest with you, that's true for anybody who purchases apartments, not just apartments in new construction buildings. It is more prevalent in new construction buildings for all the reasons we discussed. But the truth is a lot of people conceptualize purchasing an apartment as fixing their housing expense moving forward.

And to a certain extent, that's true. If you have got 10, 15, 30 year fixed mortgage, you fixed that portion of your housing expense, but the reality is every year it costs more to be a real estate owner in New York. And that's true whether you are an individual townhome owner or a giant commercial landlord or an individual unit owner in a condominium or co-op building in New York City, and people should be prepared for the cost of their housing to increase every year commensurate with all of the other moving pieces of being a New Yorker, utility expenses, insurance expenses, property taxes, all of the things that move on an annual basis. You are still subject to those movements. 

Emily Myers: What you're saying is that a New York City apartment is an asset, but also a liability, and you can't fudge the numbers on that.

Kyle Gregory: Unequivocally, it is also a liability. And that is forever something that gets overlooked. And understandably so, because, as you enter the proverbial property ladder, you get very excited about your asset appreciation and hitting that next rung. But the reality is that just carrying the asset, operating the property really costs money, and that's in the best of circumstances, much less the failure of a major piece of mechanical equipment or a roof, or an unforeseen weather event like we've experienced in New York over the past several years. There's really a collective dearth in the willingness to acknowledge and prepare for the financial downside of being a real estate owner in New York.

Emily Myers: On that happy note, is there anything else you want to say? 

Kyle Gregory: I suppose in juxtaposition of that, I still, would do it again 10 times out of 10. I personally entered the New York City property ladder, the real estate ladder, with a small cooperative purchase more than a decade ago.

And in fact generationally my family purchased a small apartment many, many, many, many moons ago in New York City and, it is a wonderful way to both be firmly tied to this city and to benefit from the long-term development of the city. It's just that it shouldn't be done with hazy glasses.

It should be understood as as an undertaking in its entirety, both for the potential enormous gains and even without enormous gains, just the security in owning your own kind of plot of this very dynamic land that we inhabit. But it should also be done understanding the potential risks and accounting for potential downside scenarios as you undertake that journey.

Emily Myers: Kyle, thanks so much. Kyle Gregory, managing member and operating partner of New Way Management. 

Kyle Gregory: Thank you. Happy to be here.