HDFC CO-OPS AND FORECLOSURES: RESOLUTION AND RESORATION?

EXPERTS WAY IN ON WHAT COULD BE DONE

At the heart of the crisis currently affecting affordable housing in New York City are the dozens of HDFC co-op buildings that are threatened with foreclosure by New York City for real estate tax delinquency or failure to pay water and sewer charges. While the obstacles facing the shareholders in these buildings may seem insurmountable at times, often the best way forward is to take a breath and size up the situation and what can be done to correct it.

Why Do These Foreclosures Occur?

One of the bedrock obligations for any property owner, co-op, landlord or commercial operator is the payment of real estate taxes. For many, those payments are simply a matter of proper financial management. But HDFC co-ops frequently suffer from both poor management and the inability to pay.

According to Glory Ann Hussey Kerstein, the organizer of advocacy group HDFC Coalition Anti-Foreclosure Committee: “The biggest factor in HDFC foreclosures is the City’s flawed model of disposing of landlord-abandoned buildings in the 1980s and 1990s to the tenants then in place. The City’s treasury was hemorrhaging, and in the rush to unload these buildings to rid itself of the cost of building ownership, little to no repairs and sub-par training for tenants were the City’s order of the day. Tenants got buildings ‘as-is’ and received no training in housing court procedures, probate court requirements, negotiating commercial leases, lead paint abatement or vacancy management, or how to conduct sales. No surprise that 90 percent of the HDFCs now facing foreclosure were incorporated as co-ops in the ‘80s and ‘90s when this flawed model prevailed.”

The bottom line is that the population who became owners under this program — primarily lower-income rental tenants — were ill-equipped to manage the buildings themselves. In most cases, they couldn’t afford to hire professional management, as would be the common case in wealthier, ‘market’ co-ops. That lack of effective knowledge, experience, and financial wherewithal has led to a perfect storm of circumstances resulting in these foreclosure actions.

Interestingly in most cases, unlike market-rate co-op buildings, HDFC co-ops rarely have a formal underlying permanent mortgage held by a financial institution. Under virtually all standard mortgages, the mortgagee—i.e., the bank—collects a portion of the real estate taxes owed each month with the monthly mortgage payment. This is known as a real estate tax escrow. The bank forwards these monies twice a year to the City in payment of real estate taxes to keep the taxes current and to protect the lenders’ collateral position secure. In the case of many HDFC co-ops—especially because there is no permanent lender—no one is collecting the tax money. And often the proper notice from the City about taxes owed and due, or the nonpayment of said taxes, is never received by the shareholders.

A Case in Point

Barry Korn, a mortgage banker and Managing Director of Barrett Capital Corporation, explains the notification process as follows: “The City must make two reasonable attempts to serve notice. If unsuccessful, they can mail the notice, by both regular and certified mail. As HFDCs must register with New York City each year, providing the city with a contact, the city should have a recent contact.” As previously reported in The Cooperator, New York City Department of Finance often has incorrect and/or outdated contact information for these properties, their ownership, and/or management. Korn outlines what is supposed to happen in a normal situation. “A process server must produce an affidavit of service, which is filed with the court,” he says. “A judge reviews the affidavits, and, if in order, can issue a judgment of foreclosure. In the case of many HDFCs there’s no evidence of process of service. The attorney representing a HDFC co-op for which I am arranging financing personally searched and could not find any affidavits of service. Furthermore, the appropriate building representatives also claim they never received notice.” This may be an all-too-common occurrence.

Financing Out of a Mess

Korn is currently assisting a 56-unit HDFC property located in the Bedford Park section of the Bronx to resolve its foreclosure issues. The building has been in the HDFC program in excess of 25 years. He explains his strategy as follows:

“We will arrange private bridge financing for the building from a traditional, private, short-term lender to pay off the arrearages in real estate taxes and also, to facilitate the renovation of some units owned by the co-op, as well as three commercial units. The renovated residential and commercial units will be rented out, and the proceeds from these rentals, as well as from increased maintenance receipts of occupied units under a new budget plan for the building will be used to pay down, and hopefully pay off, the bridge loan. In the event they can’t pay off the entire loan, we will seek conventional underlying co-op permanent financing when the bridge loan comes due and the building’s financial picture has improved.”

The general terms of the bridge financing are from 12-18 months floating over prime, carrying an interest rate today of approximately 10 percent. The loan also requires the payment of origination fees of between 1 percent and 2 percent and requires an appraisal. Korn says these loans usually include a six-month extension option. No personal liability is required from the shareholders.

As to the availability of permanent financing when the bridge loan comes due, Harley Seligman, Senior Vice President at National Cooperative Bank, which is a major lender to co-op apartment properties nationally, indicates that permanent financing to these co-ops is available. However, as is the case with all applicants, the loan decision is made on a case-by-case basis.

In the end, while the problems your HDFC co-op may be facing in terms of financial viability, stability and health may seem daunting, there are options open to you. Remain calm and consult qualified professionals to get on the right path.

Filename: HDFC-Co-ops-and-Foreclosures-Cooperator.pdf

AJ Sidransky is a staff writer at The Cooperator, and a published novelist.

You work hard and try to put money away to be used for a rainy day —hoping of course that ‘rainy day’ is a long-awaited trip to somewhere fabulous and tropical. Then, boom—the brakes on your car suddenly go, or one of the kids needs braces, and now you’re tapping into your reserves to pay for these surprise expenses. Sometimes though, you may not have enough dough to cover the costs, so you have to borrow from friends or family or even take out a loan with your local bank.

Even for a financially solvent community, a major repair or replacement project – such as a new roof, a total window replacement, or a similar big job — can trigger the same kinds of stress we feel regarding our own finances. There is the same concern about whether or not the board has put enough money aside to actually cover an emergency repair or capital improvement project. And if they haven’t, what then? How do you raise the money to get the roof get replaced or the clubhouse made whole after an uninsured mishap?

A Capital Idea

“Capital improvement projects fall under some pretty wide descriptions of anything that could go on at a property, from alterations and improvements to the common areas and replacement of mechanical systems, to concrete restoration, clubhouse upgrades, and even a new structure or amenity,” says Andrew Lester, president of FirstService Financial, a lender active in markets across the country.

A capital project is something that happens about every 10 or 15 years, so the board should definitely be planning to fund those repairs over time – indeed, it’s part of their fiduciary duty to the building and its residents. “Many buildings have what’s called a reserve study so that they can determine when things are going to need to be replaced and how much they need to put away over time to be able to handle those repairs when they come up,” says Lauren Peddinghaus, owner of Haus Financial Services LLC in Chicago. “However, we find that a lot of buildings have failed to plan for reserves, and no money has been saved.”

Peddinghaus says that an empty or inadequate reserve comes down to a lack of planning, and a hesitance to make that investment into the future of the building. “The owners who live there now don’t want to think about what’s going to happen 15 years down the road when they may not be an owner,” said Peddinghaus. “But it’s their responsibility while they’re using those elements to be contributing to the eventual replacement of those elements and not for that to fall on the new people who come in. Then there’s a 10-year-old roof and there has been no money saved and now the current residents get hit with having to contribute to get that replaced.”

Even if a building has done its due diligence and planned for future repairs and replacements, how much they saved may not always be enough. “You can only plan to hit the mark, but [sometimes] things happen, whether it’s a capital improvement costing more than you thought it would, or it’s a bigger project than you staked out,” says Lester.

Three Options

To pay for such projects as a new roof, repairing leaky windows or broken steps, a co-op, condominium or homeowners’ association has three sources of funding to turn to, Lester continues. “The first is using reserve funds that are set forth on an annual basis through the budget,” he advises.

While consumers are often advised to keep a minimum of six months of expenses in a savings account, how much a board should keep on hand depends on who you listen to. It should be commensurate with the general price or value of the assets. For example, according to Kurt Westfield, director of WC Equity Group based in Tampa, Florida, “An investment group that purchases a 64-unit apartment building for just over $6 million should have well more than $40,000 in cash on hand, unless a private round of fund raising is underway.”

The community’s membership then pays into that reserve fund on an ongoing basis. “The general rule of thumb is to maintain an operating reserve fund of two to three months of common charges for condos and maintenance for co-ops,” says Barry P. Korn, CFA, managing director of Barrett Capital Corporation in New York City.

The amount of the reserve fund is also determined by the size and the budget of the HOA. “The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, has suggested that HOAs allocate 10 percent of their annual budget to a reserve fund,” says Korn. “This is a good estimate, which can vary based on what the building anticipates, particularly if they have done a reserve study of the useful lives of the building’s major system components. As a building builds up its capital reserve funds, it can tap into this to pay for some capital items.”

However, Korn says that it is not recommended for a board wipe out their entire reserve fund for any one project. If this looks like that may happen, Korn says that the board should look into other financial resources, such as a loan or a special assessment, to cover the balance.

Loans and Assessments

To borrow money for any capital repair or improvement project, a board will go to a financial institution and negotiate rates and terms for the funds that they need and then pay it back over time. “Generally, the payment of that loan comes from either reserves or a special assessment,” says Lester.

But loans can be risky in and of themselves, cautions Westfield. “I would still object that this level of liquidity is dangerous to the ownership and the management of the asset. An alternative option is a refinance with a commercial/ conventional/private lender to pull liquidity out to cover the cost of improvements.”

If a board of directors and the membership decide that they want to move forward with a project, but they do not have enough funds in their reserves or from investments, and a bank loan isn’t palatable, they can pass a special assessment. “They collect that money [from residents] over a period of time or in a one-shot payment,” says Lester.

Reserves, loans and assessments, oh my! How does a board make a final decision on how to fund a major project? “First, a board should get competitive bids so as to determine a realistic cost for the project,” says Korn. “A board should make sure that its ‘soft’ costs, such as designer, architect and engineer fees are included, and a board should build a cushion of, say, 10 to 20 percent into the total project cost.”

Then, it’s up to the board of directors to decide what money will be used to pay for this project. “It depends on the association, the community and where they are, and their documents, and the size of the project,” says Lester. “The membership might have a vote or a say in the matter, but in general terms, the board of directors makes the final decision and then goes to membership for approval.”

To make an informed decision on a capital project, a board should have a team of experts to turn to. “The board, with the help of architects and engineers, should determine the approximate cost of the project to be funded, then the board or treasurer should reach out to financial advisors/mortgage brokers specializing in HOA loans to have the broker review the financials of the HOA, including existing debt and accounts in arrears,” says Korn. “After the broker determines the existing debt service and increase from the new loan, the board should review the impact of an increase in maintenance/ common charges on the owners.”

An attorney can also help the board to understand the financial documents. “Then obviously they help with the closing of the loan with buyers,” says Lester.

Tricky Situation

Unfortunately, a building with no reserves for capital improvement projects or emergency repairs is becoming all too familiar. “Clearly, the board is at fault,” says Peddinghaus, “but it is feasible to obtain a loan with no reserves, with the understanding that part of the proceeds are dedicated to go into and build the reserve funds to a level at which the bank is comfortable.”

Peddinghaus also reminds the residents that the board has a fiduciary duty to the entire association to do what’s in their best interest. “Everything comes down to who those people are,” she says. “I’ve seen associations where the owners aren’t going to have any problems coming up with money when it’s needed, and [the association] doesn’t put anything in the bank. They just do a special assessment whenever they need more money.”

If the residents aren’t happy with how the finances are being handled, there is a solution. “If owners aren’t happy with the way their board is financially managing the building, then they need to put a new board in place,” said Peddinghaus. “That’s the remedy. If you’re unhappy, then replace them.”

Filename: Funding-Capital-Projects-Cooperator-July-2017.pdf

Lisa Iannucci is a freelance writer, editor, and author, and a frequent contributor to the Cooperator.

Whether your community is a co-op, condo, or HOA, proper record-keeping is the difference between a healthy property and one headed toward peril. And while meeting minutes and election results require well-organized documentation, records such as bills, invoices, bank statements, receipts and taxes informs a community’s long-term 2 financial health—and how these financial records are stored and accessed is critically important.

What You Must Know

“Each board member should be familiar with their property manager’s monthly management report, which will provide cash balances, receipts and payments for the month and accounts receivable, a listing of residents who owe maintenance or common charges currently, and for over 30 days,” says Barry Korn, CFA and managing director for the New York City-based Barrett Capital Corporation. “Also, the monthly report will show income and expenses in comparison against the budget.”

Board members, Korn adds, must understand that the management report is most often prepared on a cash basis opposed to an accrual basis, which is an annual audited financial statement. “The difference is that the building may have incurred expenses in a particular month, but if they haven’t yet been paid, [those expenses] will not show up in the monthly management report,” says Korn. “While the monthly report shows cash balances, it does not show liabilities. Thus, understanding the timing differences and liabilities are an important financial consideration.”

At a minimum, explains Richard Montanye, CPA with the Uniondale, New York-based tax and business consulting firm, Marin & Montanye, LLP, board members should have a working knowledge of budget status, reserve fund balances, unit owners in arrears and major upcoming expenses. But beyond these basic financial touch points, board members can get careless or be otherwise uninformed.

“The most common mistake with record keeping is dependence on others to maintain historical information,” says Montanye. “Frequently, boards have a need to look back at financial documents that cannot be located. I actually had a board once lose the records for a certificate of deposit in the reserve fund. After the board members changed, it 3 ceased to be reported as part of their reserves. When we brought it to their attention, they thought they were rich again!”

Record Safekeeping

As is the case with most boards, each member brings a different professional skillset to the table. Some may even be accountants or professional financial advisors—but even if they aren’t, says Korn, they should be able to understand the building’s annual financial report in general terms. “It’s advisable for the building’s accounting firm and financial advisor to be able to clearly explain the ramifications of their building’s financial position,” he notes. “Every board member should have a general idea of the expected capital maintenance expenditures anticipated over the next three to five years. Reserve studies (sometimes called capital needs assessments in New York)…should be made annually so that board members’ can properly plan for ongoing maintenance expenses/common charges and the need, if any for financing and/or assessments.”

There are two basic requirements to ensure that a property’s financial documents are in fact being handled and stored properly: identifying who can view the records, and ensuring that the records are kept in a secure location. The latter issue may seem simple, but according to the pros, one might be surprised. For example, according to Robert Mayer, CPA and managing partner for the Long Island-based Prager Metis CPAs, LLC, important documents and records should definitely not be kept in a box in a board president’s closet.

Korn agrees, and says that documents, including all financial records, are generally kept by the managing agent at its office. “When the building’s auditor performs its annual review, it will request necessary information,” he says.

If the property doesn’t have an off-site management company, “Then the records should be kept locked in the [property’s] administration office – especially any bank account or 4 credit card numbers. Records should be kept locked, and access limited and papers should never be kept in open sight,” adds Mayer. “If they do not have an office, then the records should be kept in a safe deposit box at a bank.”

There’s a third solution that’s far better than a banker’s box, and perhaps more convenient than keeping documents in a distant office, says Korn. “For a self-managed building, I suggest some form of cloud-based storage, so that the information is available to successive board members.”

The storage and record-keeping methods used by boards usually don’t vary all that much between different types of ownership, but Korn says there are some differences. “Generally, co-ops tend to be much more secretive about disclosing financial information to owners than do condos.” Montanye adds that co-ops typically have more records than condos—things like proprietary leases, resale packages, mortgages and financing agreements, all of which need to be kept orderly, secure, and yet accessible to those who may need to reference them.

Electronic record-keeping doesn’t stop with simple cloud-based storage. When it comes to finances, many well-meaning board members labor under the often-false assumption that other board members or the managing agent are maintaining records. This can lead to redundant administrative tasks on one hand, and serious gaps in the community’s financial and administrative record on the other.

“It is extremely important for a board to institute written procedures for the maintenance and destruction of documents. Historically buildings had board rooms or offices where filing cabinets of paper documents were filed,” says Montanye. “Fortunately, with today’s computerized sophistication, documents can be maintained electronically, which will insure security, availability and orderly destruction. In addition, it is easy to transfer custody from one board to the next.”

Other Considerations…

There are consequences for boards that do not properly manage and secure their community’s documents. Industry experts implore boards to learn from the mistakes of others— and unfortunately, there are plenty of examples of mishaps and wrongdoing. When asked about theft of financial records, Mayer said there were too many examples to put on paper; however, he did share two instances from his own experience:

“We have had situations where a treasurer had the building’s bank statements sent to their home, [mixed up the information] and…used the property’s funds to pay their personal needs,” says Mayer. “We’ve also had experienced bookkeepers who have had wire privileges and used common funds for non-property expenses.”

While technology has streamlined certain documentation services, it is a double-edged sword, especially for co-ops. The frequency of identity theft has significantly increased, and it’s often very difficult to determine the origin of a hack or information leak. Nevertheless, it’s part of a board’s fiduciary duty to make sure residents’ sensitive information is properly secured.

“All boards have access to sensitive information about their employees, and co-op boards have custody of purchaser’s financial information, bank account numbers – even medical records might be available to boards,” says Montanye. “Often, social security numbers must be maintained for tax compliance reasons. Most boards would rather not have custody of sensitive information, but unfortunately it is part of the business operation, so security must be maintained.”

Streamlining Operations

While technology advances can help boards keep better financial records and secure access to them, there are time-proven approaches (like professional audits) that can better prepare boards for the managing of these all-important documents.

“An annual audit of the property’s books and records, if performed by a competent CPA, should reflect any defalcations—funds misappropriated by a person trusted with their charge,” says Mayer. “In addition, the management, as well as the board, should make sure that monthly reports are sent to the CPA to review. Unfortunately, the fees that some CPAs charge do not allow them to perform the proper and necessary work to prevent instances like fraud.”

To make the CPA’s job—and in turn the board’s—easier, Montanye advises maintaining the least number of bank accounts as possible. Additionally, he says board officers should be signatories on all bank accounts, and reserve funds should be centralized.

“Many boards are concerned with maintaining Federal Deposit Insurance Corporation (FDIC) coverage,” says Montanye. “The result of that can often be multiple accounts and banks being used, complicating record-keeping and reporting,” says Montanye. “There are investment vehicles available that provide centralized reporting and FDIC coverage of the funds without the need to use multiple banks.”

To further simplify operations, Montanye suggests that boards develop a collective calendar of deadlines to include date stamps for tax reporting, board meetings and insurance renewals, among other line items.

“The best answer is to have an active board and committees to keep tabs on all transactions and monthly activities. No one individual should be able to execute financial transactions unilaterally,” says Montanye. “Sometimes convenience is dangerous as well, such as having credit or debit cards for board members or employees. The temptations are too great, proper records are never kept and when mistakes are made or when theft occurs it never gets resolved quickly and rarely satisfactorily.”

Board Resources

While there are numerous education tools and industry portals for boards to access, the ability to tap these resources is dependent upon various factors, including how much a building or association is willing to spend on financial services and advice.

“This should be a team effort,” says Korn. “The property manager keeps the records, the accountant reviews the records and the building’s financial advisor/mortgage broker should be involved to provide an independent credit assessment for the building for proper planning purposes.”

For boards that do not have a managing agent or self-govern, board members can reach out to industry organizations in their municipality or state for guidance and resource materials. “I think the first resource would be the corporate accountant,” says Montanye. “Management companies also provide advice on how and where to maintain records. Since not every building has storage space, each building becomes unique with their needs and capacities. There are multiple membership organizations that provide classes on board operations that would be helpful.”

For new board members, there is always a learning curve, which is understandable for a wide variety of board responsibilities, such as elections and fielding general questions from unit owners and shareholders. When it comes to finances, however, there is no room for error. To this end, industry experts say boards with accountants must tap that resource whenever the smallest of questions arise. And whether a board is self8 managed or has a financial advisor, all documentation should be thoroughly vetted and backed up.

“All board should make it a priority that all financial records and software and [data] back up are maintained on site,” says Mayer. Korn adds, “It is the responsibility of the board members to review the monthly report and question any item that seems out of line.”

Filename: Financial-Record-Keeping-Cooperator-7.16.pdf

W. Brad King is a freelance writer and a frequent contributor to The Cooperator.