Or pay me later: property reserves
“Gimme some money, gimme some money!”
While debt service is the predominant element in occupancy cost, it’s far from the only one, and yet because debt service tends to be the controlling factor in how much house people can afford, the others are often overlooked, including the vital element of capital improvement or replacement reserves, as revealed in this New York Times story:
FROM the stacks of allergy medicine at Duane Reade to the students “doing homework” at the Sheep Meadow in Central Park, it’s clear that spring has overtaken
Though in individual ownership a woman’s home is her castle, in multi-apartment buildings — condominiums and co-ops — group governance applies, and what may be self-evident for one owner is opaque to others. Or even more fundamentally, the difference is not in perception but rather in economic position and personal economic value function:
The owners who paid the most for their apartments are usually the first ones to argue for upgrades so their buildings do not lag behind newer condos, and so they can live in a style commensurate with a seven- or eight-figure purchase price.
When I was young, I had brains … and no money
The oldsters, who have fewer resources and probably less motivation to upgrade the property, tend to spend less.
But unless these buyers are very generous, they cannot simply repaint all the hallways, convert the basement into a gym or hire a new landscaper for the common garden.
It’s not generosity, it’s simple equity. Common-area improvements benefit all residents by access and consumption, and individual residents on resale. Contributing all of the cost of a common benefit is simple charity, and while that may be laudable, it’s by no means necessary or expected.
The costs have to be shared by all of the residents, and there’s the problem. Not every war chest can satisfy every dream. Many can’t even finance must-do budget-busters like replacing deceased boilers, dilapidated roofs and temperamental elevators.
The longer you own your property, the lower your personal occupancy cost relative to the property’s value. This is the flip side of building up appreciation. In multi-unit dwellings, where some apartments are changing hands all the time, the newer folks coming in have by definition always paid a lot more than the older residents, so they are — in general — richer, and particularly richer in cash terms, so they have a greater propensity to spend money.
Thus capital improvements can kick off an inter-generational war.
We’re your co-op board of directors and we’re here to protect you
Property values aside, assessments are painful for apartment owners in the obvious way that parting with one’s money usually is. But they also tend to provoke a degree of hostility largely absent when, for example, a toilet — or entire bathroom — needs to be replaced.
How to prevent it, other than letting the building run down?
There are three choices:
- Pass the hat for emergencies
- Increase charges for an interval
- Level-fund a replacement reserve
It’s never as much as it needs to be
Buildings that have failed to accumulate big nest eggs have to make some tough decisions.
Their boards are often inclined to levy assessments on the individual shareholders, for one or two or six months in a row (or even years), rather than increase the maintenance (or in condominiums, common charges), an act that is often seen as a deterrent to sales.
It’s all about predictability. Yet it’s also about building physical condition.
Even a four-year-old child can understand it!
Quick, get me a four-year-old child!
People need predictability; capital costs are large and random. How to span the gap?
“There’s a balance here,” said Jonathan J. Miller, the president of Miller Samuel Inc., a Manhattan appraisal company.
Miller’s looking to find balance
Driven by escalating costs of fuel, insurance and property taxes, maintenance fees have risen an average of 24.1% over the last five years, compared with 10.2% in the preceding five years, according to Miller Samuel.
The current fee escalation is just under five percent a year, probably about what the buildings need. The five years preceding were a fool’s paradise of below-equilibrium costs — living on borrowed time.
Yes, we’ve been keeping up with the maintenance
“If the maintenance levels are kept at too low a level, then you’re basically firefighting anytime something breaks,” Mr. Miller said. “It impacts the appeal of an apartment. So having very low maintenance charges is not always a good thing.”
It’s one thing for an individual homeowner to defer replacements. The homeowner has infinite decision flexibility — the family’s board of directors meets over the kitchen table. It’s quite another to do so in a large development, where apartments are being bought and sold all the time.
Buyers come, buyers go; maintenance never changes
(In appraising an apartment, his company checks two years of assessment history; a troubled scorecard can neutralize the boost that would otherwise be provided by low maintenance.)
Bad capital management means bad financial management, and it always shows up in the end, in a deteriorating building. As Richard Feynman said, “nature cannot be fooled.”
“I don’t think there is the same sensitivity to the frequency and amount of special assessments and their impact on value as there is with maintenance,” Mr. Miller said. After the last increase in property taxes in New York City in 2003, he said he fielded questions from around two dozen co-op buildings about the competitive standing of their maintenance fees. “No one asked about assessments,” he said.
As properties get larger, with more owners, anyone’s personal share of the decision and accountability for it declines. This leads to a decline in ownership-type behavior:
“People have a renters’ mentality,” said Paul J. Herman, the executive vice president at Brown Harris Stevens Residential Management, which handles 150 co-ops and condos in
No surprise, therefore, that condominiums and co-operatives have their own specialist management companies, and that many companies shy away from doing them, because of the aggravation of dealing with the client(s).
Meet your condo owners!
Especially galling for owners who do not sit on their buildings’ boards is the lack of control over how their money — and how much of it — is spent. Within their own apartments, owners can choose whether to install a $300 toilet or a $2,700 model, or simply to keep a plunger handy and hope for the best. But they have no standing to choose a $100,000 lobby renovation over one costing $500,000, or even whether to renovate at all.
In most cases, an owner’s only practical recourse is to catch the attention of a sympathetic board or to toss the board out on its ear in the next election, by which time it may be too late.
In the meantime, just as influenza disproportionately affects those with the weakest immune systems, assessments inflict more misery on people with fixed incomes …
Time for your next assessment
‘Misery’ is a bit strong here — we’re talking about people who own their own apartments, and if their income is fixed, that’s only because they have not pursued a reverse mortgage. They may be cash poor, but they’re asset rich.
…and those just starting out.
As for those just starting out, nobody made them ignore their common sense:
Among the latter group are the thinly stretched first-time buyers who failed to anticipate the possibility of being assessed.
One of us will be on the co-op board; the other won’t
“With a house I think I would have been a lot more thorough,” said Jason Rogers, 30, referring to his lack of attention to the condition of the condo building where he and his wife, Sarah, 27, bought three years ago. “But in an apartment building, if one person has a problem, you all have a problem, and I didn’t even think about it.”
Economists call this the ‘toddler in swimming pool’ problem: if multiple parents are watching the children, some children may be overlooked, because everybody figures somebody else is keeping an eye on it. These problems are magnified when a building is resident-controlled.
To buy their $310,000 one-bedroom apartment in Clinton Hill, Brooklyn, the couple leveraged themselves as steeply as the pitched slate roofs of their neo-Gothic building, which once housed a Catholic prep school. Their no-holds financing included a three-year adjustable-rate mortgage and a home-equity line of credit to supplement their 10% down payment.
At a board meeting a month after closing, their homeowners’ honeymoon ended. They learned that the building was about to level [sic: levy] a $600,000 assessment to repair the gorgeous but apparently dysfunctional roof.
If their lawyer had unearthed this looming expense while they were negotiating, they might have been able to deduct it from the purchase price. Now they had no choice but to pay the assessment through a 10-year financing plan offered by their building.
Forgive my lack of sympathy: the building provided internal financing? Seems to me the generosity has flowed toward them rather than away.
At $161 a month, the $12,000 tab will wind up costing them $19,358, about two-thirds the size of their down payment on the apartment.
Meaningless figure, since one is current dollars, the other future dollars. However, if their figures are right, the loan interest rate was 10.5%, probably not unreasonable considering that it’s an unsecured loan.
And that doesn’t include the additional $2,040 assessment imposed six months ago to cover budget overruns on the roof project.
The key to all this is proper capital planning via a structured capital needs assessment. In multifamily properties, wise owners establish a replacement reserve, and fund it with monthly deposits that are part of the operating budget.
Just reviewing our capital needs assessment
That’s why I’m careful, in calculating Net Operating Income, to talk about operating expenditures, not operating expenses. Expenditures are cash out of pocket; expenses are only those that are deductible.
If you don’t pay the escrows now, in the monthly deposits, you’ll pay later, when it comes time to sell.
When it comes time to sell, somebody gets whacked
Two years ago, Mercedes Menocal Gregoire, a sales agent at Stribling & Associates, sold a friend’s $3.2 million TriBeCa loft to a wealthy out-of-state couple buying it as a pied-a-terre. The couple had signed the contract knowing that several years earlier, the 3,000-square-foot apartment had been assessed $100,000-plus as its share for repairing shoddy work done by the sponsor.
“Two days before closing, there was a notice under the door announcing a $200,000 assessment for more work to the building,” Ms. Gregoire said.
“I cannot tell you how stressful those two days were.” Eventually, after learning that the assessment hadn’t been deliberately hidden, the buyers agreed to pay.
Ms. Gregoire argues that the buyers actually profited from the building’s unfortunate situation. “I would have gotten so much more money for this apartment if it wasn’t in this building,” she said, “maybe $500,000 more.”
Ms. Gregoire can get you more money if you’re a better class of seller
Spoken like a broker.
Pay me now or pay me later!
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