Saturday, February 28, 2009

Co-ops create new conundrums

By Candace Taylor
February, 28, 2009

After a few years in the shadow of the glitzy condos that have been transforming the Manhattan skyline, co-ops may be emerging as a more financially stable and attractive option, but they are still facing a unique set of challenges.

Manhattan co-op boards — already known for their demanding requirements — have in many cases reacted to the economic crisis by becoming stricter than ever before. As a result, some real estate observers say board members are lowering the value of their own homes.

Brokers and market analysts say in an effort to preserve their property values, many co-op boards are rejecting buyers because the prices that they're offering on their target apartments are too low. However, these rejections, combined with a smaller pool of qualified buyers, are ironically putting additional downward pressure on co-op prices. In response, experts are encouraging boards to loosen up some of their restrictions, for their own sake.

"I'm finding co-op boards to be even further behind the market than sellers," said Jonathan Miller, president of appraisal firm Miller Samuel. "That's going to be a continuing problem during this period."

The most recent crackdown by co-op boards comes at a time when co-ops could actually be luring buyers who, while wary of the market in general, might be more comfortable with the secure financial footing that co-ops offer. Co-ops are not only cheaper than condos; experts say they're also holding their value better as the economic downturn grips Manhattan.

In the fourth quarter of 2008, the median price of a Manhattan co-op was $675,000, down 2 percent from the previous quarter, according to Prudential Douglas Elliman's quarterly market report, prepared by Miller. By contrast, the median sale price of a condo in the fourth quarter was $1.12 million, down 8.2 percent from the previous quarter.

"For the past 10 years, people thought 'why would anyone want a co-op?" said Kathy Braddock, co-founder of Charles Rutenberg Realty. Now, "co-ops are being looked at in a healthy way again."

Saving grace

Co-ops, which first began popping up in New York City in the 1920s, account for some 75 percent of the housing stock in Manhattan, according to Miller.

Their more restrictive policies mean they generally sell for 20 to 30 percent less than condos, said Aaron Shmulewitz, a partner at the real estate law firm Belkin Burden Wenig & Goldman. That's one of the primary reasons why nearly all new residential developments are condos, he said.

Yet the high percentage of co-ops in Manhattan is being viewed as a saving grace, and one of the key reasons the borough has largely avoided the same kind of fallout from the subprime mortgage crisis that many other places have seen.

For one thing, co-op owners are often required to put more money down and are thus less vulnerable to default. Moreover, when the owner of a co-op goes into foreclosure, the bank must step in and pay the maintenance charges, Shmulewitz said.

Finally, many banks now require 50 to 70 percent of units in a building to be sold in order for buyers in the building to obtain mortgages, making new condo developments — which once sold like hotcakes — a hard sell.

As a result, while co-ops risk devaluing their buildings, they will see fewer foreclosures and hold their value better than condos as the city heads into a downturn, Miller said.

"You're going to see less volatility with co-ops," he said. "They did a much better job of vetting the qualifications of buyers."

Amelia Gewirtz, an executive vice president at Halstead Property, agreed. "It's easier to get a deal going in resale than new development. That's totally flip-flopped," she said.

Threatening value

While co-ops may be holding up better than condos, the danger they face is real, experts say.

The practice of rejecting buyers because of their proposed low purchase prices occurred frequently in the recession of the early 1990s and continued sporadically as home prices in New York skyrocketed. Now, it's becoming more common as prices begin to dip again, Miller said. "Boards are turning down deals that are selling too low," he said.

The idea behind the practice is simple. "Co-op boards want to protect the value of each shareholder's investment in the building by keeping prices as high as possible," said Shmulewitz.

In better times, that practice often worked in shareholders' favor, with boards acting as a safety net to ensure properties were selling for fair market value.

Richard Hamilton, a senior vice president at Halstead Property, said he recently saw a board reject the sale of an apartment, part of an estate sale, because it was "ridiculously underpriced." The board felt it hadn't been marketed correctly, since it was sold to a colleague of the listing broker who planned to flip it.

"They knew the person who was buying the apartment was already showing it to other buyers before it was sold," Hamilton recalled, adding that the board did the seller "a favor."

However, now that the real estate prices are declining, the tactic ultimately hurts resale values by making it harder for shareholders to sell their homes.

"For them to kill a transaction because it's priced too low is counterproductive for them," Miller said. "It has the effect of damaging the collateral they're trying to protect. By constraining the market, they hurt the values in their building."

Agents avoid buildings with overly strict boards, Hamilton said. "There are buildings that agents don't want to show because they reject buyers for ridiculous reasons," he said.

While most co-ops are reasonable, "the ones that aren't are the ones that are going to be sorry" if they continue strict practices in the current down market.

Luckily, some boards already seem to be getting the message, said Gewirtz.

In a recent sale at Lincoln Towers on West End Avenue, she warned the buyer that the co-op board might think the sale price was too low.

"We said to her, 'If you take this price we can't promise you will pass the board," Gewirtz recalled. "They may reject you because it's just a drop in value from the last sale."

Surprisingly, the buyer was approved. "I was pleasantly surprised," she said, concluding: "Co-op boards are aware of what's going on in the world."

Rejections rising

Price isn't the only reason boards are rejecting buyers. As The Real Deal and other publications have reported, many are now stricter when it comes to financial requirements, and look askance at buyers who work on Wall Street.

Shmulewitz said he's seeing more rejections now than he did before the slowdown. He also said the number of conditional acceptances — where buyers are accepted only if they set aside a year or two years of maintenance fees in escrow — has now grown from 5 percent to 10 to 15 percent.

Since there are fewer buyers in the first place and financing is difficult to come by, co-ops should think twice before rejecting potential purchasers, brokers say.

"Boards need to get real," Halstead's Hamilton said. "They need to realize that this market is different and they need to be flexible."

Some co-ops "are being overly conservative," said Louise Phillips Forbes, an executive vice president at Halstead Property, who sometimes advises boards to resist the temptation to reject qualified buyers because they feel prices are too low.

"I caution boards that their role is to quantify if an individual is able to afford the maintenance," she said. "It isn't about trying to manipulate the market."

And of course, many boards have additional rules about pets, subleasing or certain renovations. Now that the market is declining and buyers are scarce, these rules, too, can depress the value of apartments.

Deanna Kory, a senior vice president at the Corcoran Group, said she recently sold an apartment to a buyer who planned to combine it with another apartment in the building. The board, which has strict rules about such changes, turned the buyer down. "We got a great price and the board turned the people down," she said. "Now it's on the market at a much lower price."

Sensing the change in the air, some boards are beginning to relax their rules, particularly when it comes to renting. "Managing agents are advising boards that their rental policies are going to have to loosen up," Forbes said.

Sunday, February 22, 2009

Soaring charges hit condo, co-op owners

Article can be found at
Soaring charges hit condo, co-op owners
By Amanda Fung
Published: February 22, 2009 - 5:59 am

Residents of a 54-unit Upper East Side co-op got the bad news last month—despite the board's intense efforts to trim expenses, maintenance fees are rising 15%, nearly double last year's hike. “People are furious,” says Steven Sladkus, president of the co-op board and a partner at law firm Wolf Haldenstein Adler Freeman & Herz. “Some of them have lost their jobs.”

It's an increasingly common problem. Even as the city's economy sinks, maintenance fees and common charges for co-ops and condos, respectively, are rising at the highest rates in years. Co-op managers blame soaring expenses, primarily property taxes.

And things could get much worse. Income derived from renting retail space and levying charges on unit sales is plummeting, and the number of owners defaulting is starting to rise.

Monthly fees at co-ops are going up at more than double the rate of recent years. Though steeply falling fuel costs have given buildings some relief, most boards cite drastic hikes in real estate taxes. Condo common charges are rising less dramatically, because such taxes are not included.

Fees have spiked 7% to 12% at the 300 Manhattan co-ops and condos managed by Cooper Square Realty, according to Chief Executive David Kuperberg. That compares with traditional average increases of 3% to 5%. Similarly, Halstead Property Management says the co-ops it operates are getting hikes of 8% to 14%, double historical rates.

At Lincoln Towers, an eight-building complex on the Upper West Side, owners are writing maintenance checks that are 4% to 13% higher than in 2008.

“This is by far the largest general increase we've had since 1987, when we became a co-op,” says Andrew Cooper, president of Residence Resource, which manages Lincoln Towers. “This is happening citywide.”

The squeeze has just begun at co-ops and condos where rental income from retail and office space is important. Ground-floor retail leases are major sources of revenue for many residential properties. For instance, such space in a building on Madison Avenue in the East 80s can fetch at least $300 a square foot. Retail rents can bring in millions of dollars, according to Faith Hope Consolo, chairman of Prudential Douglas Elliman's retail leasing and sales division.

The retail vacancy rate in Manhattan residential buildings is running at nearly 18%—triple that of 2008, Ms. Consolo says. “There is a lot of competitive space out there,” she adds. “Retailers have been victims of the recession.”

With declines in sales prices and transactions, co-ops that still look for income from flip taxes are feeling the pinch. Deal volume was down 23% in the fourth quarter from a year earlier, according to appraisal firm Miller Samuel. The building typically makes 3% to 5% of the unit sales price.

At the market's mercy

“Co-ops are at the mercy of the market,” says Eric Goidel, senior partner at law firm Borah Goldstein Altschuler Nahins & Goidel.

Condo buildings, which have less stringent financial requirements for initial purchase than co-ops do, face another threat. As owners lose their jobs or their bonuses, they quit paying common charges. And in the deteriorating real estate market, developers are increasingly left paying common charges for unsold units—a burden that could push some of them into bankruptcy.

“If developers default, everyone else will eventually have to pick up the balance,” says Jeff Reich, a partner at Wolf Haldenstein.

Meanwhile, operating costs—including water, sewage and labor—continue escalating. Many co-op managers point to real estate taxes for the hefty maintenance fee spikes. To help fill the city's $4 billion budget gap, Mayor Michael Bloomberg and the City Council recently boosted property taxes 7%.

“The city hit owners at a very bad time,” Mr. Kuperberg says. “Values of homes are decreasing, and people are struggling to pay their mortgage.”

Some condo owners claim that developers misrepresent operating expenses to attract buyers. Other estimates may be made in good faith but are outdated in a short time. One new Madison Avenue condo was forced to raise common charges 25% this year, according to Mr. Reich.

“It's a perfect storm,” he says. “Expenses are increasing, and people who [relied on financing] for an obscene amount of the price of their condos are seeing values decline.”

Sunday, February 8, 2009

The Downside for Condos in a Downturn

February 8, 2009
The Downside for Condos in a Downturn

DURING the recent boom, buyers who coveted condos for their sex appeal could also make the case that condos were a smarter choice than co-ops.

In theory, you didn’t have to prostrate yourself, financially and otherwise, before a board for approval, and you could sell or rent pretty much to whomever you chose, should the need, or whim, arise. You could also put down a lot less money than the 20, 25, or even 50 percent of the purchase price customarily demanded by co-ops.

But as the city’s fortunes buckle and heave, these very differences have potentially rendered some of the city’s condo buildings dangerously exposed to the downturn. Then there is a distinction many condo buyers probably dismissed as a boring legality: If a condo unit is the subject of a foreclosure, the bank gets first dibs on the equity. With real estate prices way off their peak, that means some condo buildings will collect nothing but dust from residents who have also failed to pay their common charges, leaving the remaining owners to shoulder the burden of higher costs or reduced services.

Defaults on common charges began to spike last fall, according to lawyers hired by increasingly jittery boards to file liens (the first step toward foreclosure) against owners in arrears.

“We had maybe four or five before October,” said Adam Leitman Bailey, a Manhattan real estate lawyer, referring to the number of liens his firm filed last year against condo owners in Manhattan and Brooklyn. “It really got going this fall. We had 28 filings here and 17 in Brooklyn. These aren’t in the wealthiest or the poorest buildings. It’s the buildings with the younger 30- or 35-year-old professionals buying a $1 million to $2.5 million apartment, who haven’t been working for 20 or 30 years and are relying on their job to pay for it.” Other lien-filing lawyers said the pace had picked up by at least 10 to 25 percent.

“We’re seeing more, especially in the higher-end buildings where you never heard of foreclosures,” said Adam D. Finkelstein, a real estate lawyer with Kagan Lubic Lepper Lewis Gold & Colbert in Manhattan. Starting last quarter, his firm began filing two or three liens a month, up from two or three per year.

According to figures provided by the online research company, condo lien filings more than doubled in Brooklyn during the second half of 2008, and the number of filings in Manhattan zigzagged, with 156 in the first quarter, 186 in the second, 154 in the third and 203 in the fourth.

While the aggregate number of liens is still small (47 in Brooklyn and 67 in Manhattan in December, for example), they may be the first sign of trouble: Liens typically lag months behind defaults in common charge payments, and the bottom didn’t truly fall out of the city’s economy until last fall.

Moreover, barring a swift economic renaissance, lawyers, managing agents and condo boards are bracing for things to worsen significantly this year as job losses mount, severances and savings evaporate, and the new reality sets in.

“The world as we’ve been living in it for the last several years has changed seemingly overnight,” Mr. Finkelstein said. “We’re at the very beginning of this.”

While lawyers are reporting a similar rash of defaults among co-op owners, the risk to the building (and by extension to the defaulter’s neighbors) is slight by comparison. That’s because a co-op building is entitled to its share before the bank can claim anything in the event of foreclosure (the ultimate consequence of nonpayment of maintenance charges).

But in condo foreclosures, the debt priorities are reversed. After a foreclosure process that these days can take two years — during which unpaid common charges proliferate — the building gets its due only after the bank is paid in full. And many condo owners have little equity in their apartments.

“I think it’s safe to say that the value of any apartment purchased in the last two years is less than its purchase price,” said David Kuperberg, the president of Cooper Square Realty, a Manhattan property management company. “The simple calculation is that if you bought an apartment a year ago and financed 90 percent of the purchase price, as many did, and now it’s worth 20 percent less, you’re upside-down as an owner.”

Even worse from the perspective of the condo building, if an apartment owner defaults on common charges but keeps up with mortgage payments, it falls to the building rather than the bank to pursue the foreclosure action.

In that situation, the building must pay the bank the entire balance owed under the mortgage. This prospect is so onerous in a down market that a vast majority of liens for unpaid common charges never advance to the foreclosure stage, said Aaron Shmulewitz, a real estate lawyer at Belkin Burden Wenig & Goldman in Manhattan.

Instead, buildings often sue the owners personally — looking for other assets and garnishing wages, if there are any. But they are effectively powerless to force the expulsion of a deadbeat owner who has no equity. So far, there hasn’t been an uptick in condo foreclosure filings in Manhattan and Brooklyn, according to Instead, owners in financial distress seem more willing to play chicken with the condo board than with the bank, and they appear to have some wiggle room when pressed.

Mr. Bailey said that to date, a majority of defaulting owners had paid up once his firm had filed a lien.

“The owners are hoping we won’t file, and then they find a way to pay, whether they’re borrowing it from relatives or using their last dime,” said Mr. Bailey, who observed that the days of refinancing one’s way out of debt were long gone. “Usually they will pay for their home first, before credit cards and health insurance, because keeping a roof over their heads is their family’s biggest priority.”

But the biggest priority for condo buildings is preserving cash flow. With smaller reserves dictating a more hand-to-mouth lifestyle than that of most co-ops, many have little choice but to assess owners if defaults grow large enough. Never welcome, increased assessments can push additional owners over the brink and into arrears. That is one reason many managing agents and lawyers have begun encouraging condo boards to forsake neighborly empathy and play hardball.

“It used to be three months and then you’d file a lien, and now at the most it’s two months and in many case it’s just one month,” Mr. Shmulewitz said.

Just how long to wait depends on a building’s exposure. “If two people are defaulting in a 200-unit building,” Mr. Finkelstein said, “you can probably exercise some leniency. But it’s more problematic in a 40-unit building, even though it probably won’t kill you. You’ve got to evaluate your risk. If you know someone has a very low mortgage and there’s a lot of equity, you can cut them a little slack, because you can collect if there’s a foreclosure.”

While all condo buildings share vulnerabilities putting them at greater risk than co-ops to defaulting owners, condos of recent vintage appear to be in the greatest peril. For starters, these buildings often have less-experienced boards to navigate a crisis.

“The fear is much more acute in newer buildings than in established condominiums,” said Mr. Kuperberg, the managing agent, whose company has helped about 40 buildings open in the past three years. “There’s a greater likelihood that many apartments were sold for more than they’re worth today. And newer buildings have many people who bought with no-income-verification loans and very relaxed criteria. They also have younger owners who may be less established.”

What’s more, many of these overleveraged, less well established owners are among the several hundred thousand who bought under the 421-a tax abatement program. As the 10-year abatements phase out in steps every two years, the recipients experience increasingly drastic tax increases — which many had been counting on income gains to offset.

Consider the following hypothetical situation, provided by Paul J. Korngold, a real estate lawyer in Manhattan, which he said was consistent with many Manhattan units selling in the $1 million to $2 million range under the 421-a program. What starts out as a $1,214 annual tax bill climbs to $4,613 in the third year, $8,012 in the fifth year, $11,411 in the seventh year and $18,209 when the abatement expires.

But those numbers assume that the city doesn’t raise assessed values or tax rates. Factoring in what Mr. Korngold called a historically conservative 3 percent combined average increase, the unit owner who begins with a $1,214 annual tax bill owes $10,046 in the fifth year and a staggering $32,887 when the abatement expires.

Nearly 300,000 condo units were constructed under the program in the five boroughs from 2002 through 2007, according to the Department of Finance. That figure includes 132,431 units in Manhattan, where about 22,000 owners are in their fourth year of the program, 31,000 are in their fifth or sixth, and 12,000 are in their seventh. Because 421-a purchases were concentrated in a limited number of buildings, they are potentially destabilizing to these buildings in a down economy.

Mr. Kuperberg sketched out a second chain of events, this one pertaining to new buildings with many unsold units. It unfolds like this: Unable to sell half the units in a building, a struggling developer stops paying common charges and defaults on obligations to the lender. Foreclosure by the lender may take years, while individual unit owners effectively wind up paying double their normal common charges. This pushes some owners, themselves struggling, into default. Meanwhile, they are trapped — unable to sell, even at a steep loss, because most mortgage lenders won’t lend to potential buyers in a building where half the units are in default.

“That is a death spiral that could push a building into bankruptcy,” Mr. Kuperberg said. “You basically have a building unable to meet its operating expenses.”

Once the lender succeeds in foreclosing on the developer, there may not be enough money to cover the lender costs and unpaid common charges, forcing the unit owners to permanently swallow the loss. And while the lender must pay carrying costs going forward, it may decide not to throw good money after bad and instead dump the units at auction. The investors who buy them may act against the building’s best interests — renting them out cheaply (introducing a transient population that, among other things, inflicts more wear and tear) and electing boards who defer maintenance and refuse to make improvements.

“We work with a building that’s about 50 percent sold and the developer is gone — they lost all their money and they weren’t able to sell,” said one managing agent who asked to remain anonymous out of concern for the impact on property values in the building. “The lender took over and pays the common charges but doesn’t talk to us and won’t return our calls. If you’re running a building and 50 percent of the ownership doesn’t give you direction, that’s a problem. But I’m really nervous about what happens if the lender sells into the vulture market.”

Even condo boards in fully sold buildings have begun to contemplate the once unthinkable: slashing the very amenities that defined the recent boom.

“The boards are starting to talk about cutting things that might be considered a little excessive,” said Leslie Bogen Winkler, the vice president and director of management at Penmark Realty, a property management firm that has opened 50 condo buildings in the last three and a half years. “They may reduce health-club hours and maybe scale back breakfast. The biggest amenities that are costly are the health club with a swimming pool. It can run up to $200,000 to $400,000, depending on the size, hours open and operator.”

Staff cuts may also be in the offing at some buildings, though union contracts present significant hurdles. Moreover, said J. Brian Peters, the senior managing director of property management for Rose Associates, which owns or manages about 20,000 apartments in New York, “you can cut positions, but at a certain level that’s devaluing the product. And it’s the best product that’s going to survive the easiest in this downturn. We’re really more focused on increasing revenue.”

To that end, condo boards are considering adopting flip taxes, increasing alteration fees and bumping up sublet fees. They are also easing restrictions on the length of sublets so that strapped owners unable to sell their units can more easily rent them out.

Then again, other condos have the luxury of spare cash and might actually come out ahead in the downturn, Mr. Kuperberg said. “The recession can be a good opportunity to buy capital improvements and do upgrades,” he explained, “because contractors don’t have a lot of work and material costs are way down. It’s an opportunity to invest not only in cosmetic things like the lobby but in infrastructure that could reduce operating costs.”