Publication Date: Spring 1997
CNYC's annual Cooperative Housing
Conference, held each autumn on a Sunday, is New York's most
comprehensive source of cooperative and condominium information
and education. With product exhibits to visit from early in
the morning, a video theater showing Co-op
Roundtable throughout the day, and dozens of workshops
and seminars, the Conference brings together hundreds of CNYC
members for a day of learning and sharing.
The 17th Annual Cooperative Housing
Conference will be held on Sunday, November 16, 1997 (see
Coming Events). This Website,
as well as the summer issue of the CNYC Newsletter,
will include a brochure featuring the full line-up of workshop
Reviewed below are two presentations
from the 16th annual Cooperative Housing Conference: Improving
Your Building's Bankability and Creating
Rules that Work.
Many cooperatives and condominiums, while functioning very well, do not
precisely meet the standard borrowing profile set by lenders. This makes
it difficult for potential purchasers to obtain loans to buy apartments
in the building. But according to Neil Davidowitz, Esq., vice president
of Orsid Realty Company and Patrick Fay, of Bank of New York Mortgage
Company, there are ways to overcome the obstacles and to improve the chances
of bringing financing to your building. This includes a series of practical
guidelines for presenting your building in the best possible light.
To get started, Mr. Davidowitz advises the board to compile a comprehensive
and well-organized packet which includes all the information that a lender
may request about the building, supplemented with documentation that accentuates
all positive features. Lenders refer to this as a "due diligence"
packet. It should include:
1. Cover Letter. A
succinct and readable cover letter should provide a snapshot
of your building, describing its current financing including
underlying mortgage amount(s), the lender, the rate and the
maturity date and the current distribution of units among
homeowners, sponsor, investors and rental tenants. It should
also offer a quick summary of the building's history both
financial and physical, including what work has been done
and what projects are planned. Your goal is to show that this
is a well-run, well-financed building, worthy of the attention
of this lender as it considers share loans. If the building
is seeking underlying financing, the cover letter should describe
how the loan amount will be used.
This cover letter, as well as any accompanying charts and documents you
provide, are your opportunity to stress all that is positive. In many
cases you will use the package to counteract negative impressions that
the bank could derive from information available in public records, including
your own offering plan and its amendments. "It is critical, especially
if your building does not hit many of the so-called standards of the lending
market, to cast your building in its best possible light," says Mr.
Fay. "Banks look at the whole picture, not just a portion, so a lot
of good points can overshadow a few less-than-good points."
2. Offering Plan.
Lenders will ask for the Offering Plan for buildings where
the sponsor still holds units. Make sure that the plan is
up-to-date, with all amendments. Sponsors actively selling
shares by prospectus are required to amend their plans annually
and to include a financial disclosure amendment, which lists
the remaining number of sponsor-owned units and describes
any cash shortfall between the maintenance payments and the
rent that the sponsor collects.
The financial disclosure amendment also contains information on all buildings
where your sponsor still has an interest of 10% or more, which raises
another issue: "He may be okay on your building, but behind on his
other buildings," says Mr. Davidowitz, who suggests that your cover
letter stress the positive situation in your own building, or that you
bring to bear additional information that improves the way the lender
deals with potential problems. "Negative cash flow is not always
a problem," Davidowitz notes, "particularly if the sponsor holds
an income-producing wrap-around mortgage or is collecting income from
Mr. Fay stresses that sponsor units are now of less concern to lenders
because of a change in the General Business Law passed in 1992, which
allows cooperatives and condominiums to collect rent directly from the
tenants of a defaulting sponsor's units, ensuring continued cash-flow.
"All in all, the 51% owner-occupancy threshold has become less of
an issue," he says.
3. Financial Statements.
At a minimum, all buildings should include their past two
years' audited statements, notes Mr. Davidowitz. If your building
shows a low reserve fund (less than the equivalent of three
months of maintenance collections), compile a detailed list
of completed capital improvements, including the date and
cost and an engineer's report discussing the condition and
expected life of building systems. "You want to tell
the bank in very clear terms that you have been taking care
of the building, despite a low reserve," he says, adding
that you should "also mention any lines of credit or
other sources of funds that the building may have in lieu
of a reserve fund."
4. The Budget. If
your building does not have a current budget, make one, suggests
Mr. Davidowitz. But be realistic -- even if it means raising
maintenance. "I don't recommend showing operating deficits,
but don't rob the reserve fund when you should be raising
maintenance," he says. "That is not a situation
that banks look favorably upon."
5. Sublets. Disclose the number of sublets in the building. Mr. Davidowitz
feels that the number of sublets is less of a liability today than it
was a few years ago. "Banks still want to see the number, but it's
a less crucial part of the analysis," he says. "The reason,"
explains Mr. Fay, "is that a strong rental market has reduced the
number of negative cash-flow sublets. And, lenders almost always consider
sublets preferable to sponsor-owned or investor-owned blocks of units.
If an investor goes down, you have 10 or 20 apartments going down at the
same time. But sublets (at least from a creditor's perspective) go down
one at a time." Include information on market rental rates in your
area if it strengthens your profile.
6. Protective Building Policies.
If your cooperative or condominium has policies designed to
protect the financial health of the building, feature them.
For example, lenders like to know if your building restricts
the duration of sublets. "They want to see that their
exposure is limited," notes Mr. Davidowitz. "In
addition, lenders are also reassured to see limitations on
the level of financing that a cooperative will permit its
shareholders to have on their units." A good percentage
of cash requirement is 20% or 25%. "If people only have
to put 5% or 10% down, then the building doesn't look so good
to lenders," he says.
7. Sponsor Information.
Banks like to see confirmation of the sponsor's information,
including a certified copy of the sponsor's rent roll, even
if it does no more than repeat what is stated in the offering
plan. Break out the number of rent controlled and rent stabilized
units, and mention any other information that might prove
how responsible and financially sound the sponsor is -- for
example, the sponsor's personal reserves or his last two months'
bank statements. In addition to the concrete information that
this documentation provides, it also attests to a cooperative
relationship between the sponsor and the building.
8. Comparable Sales.
Banks like to see what prices apartments have been selling
for. This sales information is readily available from your
managing agent. A review of recent sales gives you the opportunity
to document any special situations. If negatives like foreclosures
have been dragging down your comparable sales figures, mention
this in your package.
"Put an asterisk next to individual sales and footnote them as bank
foreclosures," says Mr. Davidowitz. "Don't think you can hide
these. Explain that the problems are in the past, and show that the building
is healthy going forward."
9. Floor Plan. Banks
analyze your building on a room, apartment and square-foot
basis, so they are pleased to have a floor plan showing the
size of the apartments. "It could be beneficial if you
can show your building has one-bedrooms that are 1,200 square
feet where other buildings have two-bedrooms that are 800
square feet," says Mr. Davidowitz.
10. Building Highlights.
"If there's something unique and special about your building,
its worth addressing," he says. "If your property
is a landmark or in a landmarked district, mention this in
the packet." He tells of one landmarked West Side building
that included architect's sketches highlighting details and
elegant floor plans. "It was a hit with the lender,"
he says. However, if the unique aspect of your building is
less than positive, such as the lack of an elevator, Mr. Davidowitz
advises against highlighting it.
Even the best due diligence packages can't work miracles. "There
are a few progressive lenders who are willing to overlook certain problems,"
says Mr. Fay, "but ultimately they all tend to bend to what the secondary
market has to say." Yet the basic theory holds true for any building.
"To improve your building's bankability, pave the way for the lender
as much as you can," concludes Mr. Davidowitz. "When it's easier
for them, it's easier for you."
RULES THAT WORK
Not all cooperative and condominium rules are created equal. Some are
clear, even-handed and readily accepted by shareholders and unit owners.
Others stir up animosity, and can provoke expensive lawsuits brought by
unhappy residents. A board's goal, says attorney Bruce Cholst, a partner
in the Manhattan-based law firm of Rosen & Livingston, should be to
put together rules that keep the building running smoothly and also keep
"When it is within the board's power to make rules, the board needs
to use that power intelligently," says Mr. Cholst. "People get
ticked off when they think that the board is being arbitrary or capricious
in passing rules. It's up to the board to help avoid this."
There are two levels of rulemaking in a co-op or condo: amending the
governing documents and passing house rules. The former, which constitutes
making a change to the proprietary lease or bylaws of a cooperative or
the bylaws of a condominium, is more difficult since it typically requires
a two-thirds majority vote of the owners. An amendment can generally be
proposed by the board or by a group of owners holding at least 25% of
the common interest or allocated shares. Voting would take place at a
meeting of shareholders or unit owners. However, under many co-op proprietary
leases, you don't need a meeting to amend the document. If the amendment
provision allows, you can pass the proposal by collecting proxies representing
the requisite number of votes. Proxies are valid for 11 months after their
Amending governing documents can be more difficult in buildings with
a large sponsor presence, says Mr. Cholst. Many sponsors have provided
in their offering plans that the board "cannot amend the governing
documents in a way that diminishes any of the sponsor's interests without
the sponsor's written consent," he says. "That really is a restriction
on your ability to amend."
According to Mr. Cholst, the governing documents "tell you in general
terms what a board can do and how far it can go in making rules with respect
to any given facet of community life. They don't contain any specific
directives for shareholders or unit owners to follow." For example,
the governing documents might say that the board can attach conditions
to subtenant approval. A co-op board might then put through a house rule
specifically limiting sublets to two out of every five years of ownership.
PASSING HOUSE RULES
By comparison, house rules are almost completely within the
board's domain. According to Mr. Cholst, house rules are "edicts
that regulate the use of dwelling units and common areas of
the development. In a co-op, they also regulate the sales
and sublet policies. These are policies and guidelines that
can be passed by board resolution alone, without shareholder
or unit owner approval."
House rules cover such specific areas as how long sublets can last, how
much the co-op or condo will charge as a late payment fee, move-in/move-out
restrictions and deposits, and even specific restrictions on pets and
House rules apply to shareholders and unit owners, or to subtenants and
tenants of sponsor-owned apartments. In the case of sublets and rentals,
the legal recourse for violation would be against the owner or the sponsor.
"In 9 out of 10 cases, the misconduct will stop once you lean on
the sponsor to speak to his tenant," says Mr. Cholst.
Yet passing a house rule is more complicated than just voting upon a
resolution at a board meeting. After a board votes to adopt a house rule,
it must notify the shareholders or unit owners before putting the rule
into effect. "House rules are not binding on residents until you've
disseminated them," says Mr. Cholst. "No court will hold someone
liable for violating a house rule unless he's been notified in advance."
There are specific steps the board must generally take in notifying residents.
"Virtually every set of governing documents has requirements for
serving formal notice to residents," says Mr. Cholst. "This
is most often by certified mail. My strong suggestion is that when you
pass new house rules you do it in accordance with the notice provisions
contained in your building's governing documents. This gives you a way
of documenting that you've served notice of the house rule, and nobody
can say you didn't abide by the legal requirement of serving a formal
notice. There's a good chance that a judge would say a house rule isn't
binding unless it is served properly."
Why go through the trouble of amending a governing document with a super-majority
of shareholder/unit owner approval, when you can pass a house rule by
mere board resolution? The answer is that not every form of regulation
can be implemented by means of a house rule.
Boards often run into trouble when passing house rules because the new
rule oversteps the boundaries set by the governing documents. "The
house rules cannot go further in restricting residents' freedom than the
governing documents permit," says Mr. Cholst. "A rule of thumb
is that if the restriction exceeds the board's rulemaking power as defined
in the governing documents, then the regulation can't be done by house
rule. You need to amend governing documents.
For example, if the governing documents say that a co-op board can't
impose a sublet fee greater than the actual costs incurred by the co-op
in the transaction, the board has to keep its sublet fee beneath that
limit. If it wants to impose a greater fee, it would need a shareholder
vote to change the governing documents, says Mr. Cholst.
That was the outcome of the 1993 case, Bailey v. Grand Concourse Owners,
Inc., in which the Appellate Court found the co-op could not impose
a sublet fee of 30% of the annual maintenance charge because, says Mr.
Cholst, its "authority to regulate subletting was limited by the
requirement in its bylaws that any fee bear a 'reasonable' relationship
to 'actual' expenses in the transaction." Those expenses, said the
court, might include attorney's fees and a service fee.
Whenever the board attempts to redefine the shareholders' responsibility
to the co-op or condo - such as by requiring them to pay a flip tax (many
condos are enacting a form of "flip tax" called "capital
contribution fees") - it requires an amendment of the governing documents.
"You can't afford to be confused on this matter," says Mr. Cholst.
"Courts will strike down improper house rules and the building will
have to refund any money it has collected." In the case of a flip
tax, the amendment must include the amount of the fee; such fees cannot
be set with a house rule.
House rules can also be overruled if they conflict with any local, state
or federal laws. "A practical application is the Americans with Disabilities
Act (ADA), which says 'reasonable' accommodation has to be made available
to the disabled," says Mr. Cholst. "A strict no-pet policy that
prevents a tenant from keeping a seeing-eye dog would give way to this
Another danger area is when a house rule results in a breach of the board's
fiduciary duty to act fairly on behalf of all shareholders. This can be
through the rule itself, or in the way the rule is enforced, and in such
instances, courts will overturn the house rule. According to Mr. Cholst,
there are three ways boards can breach their fiduciary duty with a rule:
1. Self-dealing. When a board member benefits personally or financially
from a board activity, it is called "self-dealing". "If
you put yourselves on top of the waiting list for parking spaces in the
building's garage, you're breaching your fiduciary responsibilities,"
says Mr. Cholst.
2. Personal vendetta. If board members use a rule to harm someone they
don't like, it's a breach. Example: If someone is denied a repair that
would normally have been done for others.
3. Selective enforcement. "Any time you give favorable treatment
to one resident, you are breaching your fiduciary responsibility,"
says Mr. Cholst.
Business Judgment Rule Protects Good Rules
The Business Judgment Rule, applied by the courts since 1990 after the
decision in Levandusky v. 1 Fifth Avenue, states that the courts will
not interfere with the judgment of the board in carrying out the business
of operating the cooperative or condominium. Basically, this shields certain
board decisions against judicial intervention. In the case of house rules,
the board's judgment is protected if the rule is: (a) authorized by the
association's governing documents; (b) doesn't violate any local, state
or federal laws; (c) is conceived in good faith for a valid corporate
purpose; and (d) is applied in a manner that is consistent with the board's
fiduciary duties. According to Mr. Cholst, the Business Judgment Rule
is "not a rationale for regulation; rather it is a shield with which
to fend off unwanted judicial interference with regulation provided that
the applicable guidelines are met."
Indeed, the board's ultimate goal when making and enforcing house rules
is to run an orderly building where people get along well and therefore
stay out of court. According to Mr. Cholst, the best way to start is with
effective communication. "If people understand what you're doing
and why you're doing it, they will be less likely to challenge it,"
he says. "You can do this through letters and door-to-door campaigns,
newsletters and informal chats. If it is a controversial topic, explain
to residents how your solution addresses the problem. Explain it both
in quality of life terms and economic terms - which is how most residents
will view it."
Boards can also work to keep potentially contentious people out of the
building. "When you're doing pre-admissions screening, don't just
look at the financials, but see if the person has been a problem tenant
elsewhere," says Mr. Cholst. "If he has, he's likely to break
your rules, too." He notes that condominium boards can use their
right of first refusal to deny such buyers.
The board can also avoid problems and protect itself in the event of
legal challenges by carefully documenting all rule changes. Before passing
a new rule, detail in the meeting minutes what you want to accomplish
and how a new rule will bring it about. Then write a letter to shareholders
explaining why you're making the change. And finally, scrupulously enforce
the policy evenhandedly, documenting all cases in the minutes.
Perhaps the best way to steer clear of problems is to create rules that
don't unnecessarily step on residents' toes. According to Mr. Cholst,
the worst rules cover too much ground. For example, if there is a problem
with a resident practicing her piano 11 hours a day, a bad solution would
be to pass a rule ending all music-playing at a certain time. A better
answer would be a rule that limits instrument practice sessions to, say,
"The board should of course listen to all complaints, but it should
then contemplate the nature of the complaint and create a house rule that
addresses a particular issue in the narrowest way possible," says
Mr. Cholst. "Don't draft house rules that go broader than the problem
at hand, because you will get complaints that you are being too restrictive.
If you apply a degree of common sense to making your house rules, you're
most likely to stay away from trouble."