New condos have a few drawbacks, however: often higher selling prices and closing costs as well as difficulties in obtaining loans.  New buildings must have offering plans approved by the state attorney general’s office, detailing important points about the building.  This complex document can be intimidating to the lay person. 

Bringing in a good attorney familiar with new construction to review the offering plan early in the process can save a client thousands of dollars by identifying taxes and fees that can be negotiated.

Tax abatement is another point that bears close scrutiny.    While it is a great selling point because it keeps monthly costs lower for a while, an attorney can help determine the time span of the abatement and what the tax bill could be when the abatement expires.

Closing costs are much higher on new construction.  Expect to pay the transfer tax and the seller’s attorney fees in addition to the customary closing costs for established apartments.

Be sure the building has a temporary certificate of occupancy, required before you can close on an apartment in a new building.  Check the Building Department Website

Financing a new condo can be difficult.  Buyers may be approved for a loan, but it is entirely possible the building will not qualify.   Certain FHA and Fannie Mae requirements may preclude the building, such as flood zone or percentage of sold apartments.  Individual banks may have their own additional requirements.  Many new buildings have preferred lenders and mortgage brokers to overcome this hurdle.

Appraisals must match the purchase price.  It is not unusual to have difficulties finding nearby comparables to the new apartment you wish to buy, causing appraisals to come in lower than expected. 

Inspections are recommended for new construction.  Cost cutting measures like lower-quality windows and problem with floors or exterior stucco may affect the quality of your life.  Significant problems can be addressed in the contract.  Smaller issues like paint drips or broken screens should be addressed on a ‘punch list’.

Doing your homework now can save you a lot of aggravation down the road.

 Inspired by New York Times Article by Jim Rendon, published October 30, 2011

“Sales activity jumped above last year’s levels, as listing inventory slipped.  Negotiability between buyers and sellers held steady.”

• Median sales price declined 3.2% to $365,000 from $377,250 in the prior year quarter. Average sales price followed a similar pattern, declining 3.9% to $457,496 from $475,946. The decline is largely attributable to last year’s federal homebuyers tax credit that had pushed sales prices higher.
• There were 5,141 sales in the third quarter, 18.4% above the 4,343 total in the prior year quarter and 22.3% above the prior quarter total of 4,205. The current total is the fourth highest quarter in three years, led by three quarters significantly impacted by the federal homebuyers tax credit from the second half of 2009 through early 2010.
• There were 21,462 listings on the market at the end of the third quarter, 1% less than 21,670 listings in the prior year quarter and 5.8% less than 22,772 listings in the prior quarter.
• The average number of days to sell a property from its original list date to contract date was 116, nominally longer than 112 days in the prior year quarter.
• The listing discount, or negotiability between buyer and seller, measures the percentage discount from the original list price and the sales price, was essentially unchanged at 6.5% in the third quarter compared to 6.6% in the same period last year.

Tips for home-buying freelancers:

• Pay off other debts, including credit cards, and build a cash reserve.
• Identify the source of the down payment, whether a gift or loan from your 401(k), and be prepared to show statements.
• Prepare for a closer examination.  Review at least 3 years tax returns.  If your income increased substantially from one year to the next, be prepared to explain why and whether you expect it to continue.  If your income declined last year, be prepared to explain that.
• Check with local banks and credit unions which may be more inclined to spend the time necessary to qualify you for a mortgage.

It is always wise to address any credit problems before beginning the house hunt.  With a little preparation and answers to some tough questions, you may be able to get into the home of your dreams.

Inspired by New York Times article by Vickie Elmer, August 26, 2011.

I remember seeing a cartoon in the New Yorker Magazine Cartoon Bank showing two mice talking about the size of their in-wall apartment. One said to the other “Counting the space behind the pantry shelves, it’s eleven square feet.”

Nowhere is caveat emptor more applicable than when referring to the stated square footage of a Manhattan apartment.  Many real estate sites have disclaimers like this: “Exact Dimensions can be obtained by retaining the services of a professional architect or engineer.” At best all stated square footage and dimensions are approximate. At worst they are deceptive and misleading.

It is part of the overall marketing plan with most brokers: clean up, de-clutter, professional photos, and professional floor plans.  Brokers want to show the property in the most flattering light.  A floor plan in black and white (lately I’ve seen 3D color floor plans), provides a visual that shows walls, doors, fixtures and open space. 

In addition to the stated square footage, does the floor plan show the whole truth?  Are columns shown in the proper location and proportion to the space?  Are radiators and moldings shown?  How about the thickness of the walls?  Sometimes they are, sometimes not.  While technically correct, some graphic designers will measure from wall to wall, without taking into account such things as moldings and radiators.  But, these things eat into usable floor space.  Many times columns and window and door placements, even wall thickness are just estimates based on educated guesses and knowledge of building practices for a particular building.

For more information on how floor plans are created, see the New York Times article here.

Be prepared is the name of the game. 

• As part of your real estate team, in addition to an attorney, financial advisor/accountant and real estate broker, seek out a mortgage professional you can trust.  They will be privy to all aspects of your financial life.
• Check your credit score and review credit reports
• Gather your Documents
  • Two years of complete Federal Tax Returns including W-2s
  • Two recent and consecutive period’s paystubs
  • two complete and consecutive months bank statements
  • two complete and consecutive months brokerage account statements
  • one recent quarterly retirement account statements for each retirement account
  • photo ID
  • Mortgage professional will review and point out any potential red flags
  • Complete mortgage application and submit to lender.
  • Get a pre-approval letter.

With the approval letter in hand, your real estate broker will have a better understanding of the price range you qualify and can show you properties that fit your needs and budget.  Your broker will be able to negotiate from a stronger position.  Before you know it, you’ll be moving into your new apartment.

 Adapted from an article written by Richard Martin/SVP/DE Capital Mortgage an affiliate of Prudential Douglas Elliman.

Assessing a Coop’s Financial Condition

It has been my experience that very few buildings are in such a state of financial disrepair as to warrant a decision on the part of the buyer not to purchase in a particular building.

This was not always the case especially in the 1980’s and early 1990’s, a time that saw a tremendous amount of new conversions and with that, the problems that arise in such situations. Currently, the overwhelming majority of coops have been established for over fifteen years (a very conservative estimate) and has in many ways gotten the kinks out of their financials. They tend to enjoy low or no sponsor ownership, attractive financing and low instances of shareholder default.

In spite of the likelihood that the majority of buildings are solvent, buyers are concerned about the potential for increased maintenance and assessments, these concerns are the main motivation behind their question; “Is this a good building?”

Before forming an opinion, it is essential to understand the following points:

• Buildings, regardless of their location, age and prominence, need on-going repair and the replacement of parts, systems, and structure.
• Operational costs are subject to inflationary pressure and therefore are likely to rise.
• Salaries are subject to union mandates.
• Taxes are subject to the municipality.
• The only manner in which a building can raise money is by employing one or more of the following sources:
  • Refinance their underlying mortgage.
  • Exercise their ability to draw upon a line of credit.
  • Raise maintenance. 
  • Institute an assessment.
  • Institute a flip tax on resales.

Based on the aforementioned, it is logical to conclude that ownership costs are going to rise in 99% of the cases.

The job at hand is to assess that a building is being run conscientiously (an imperative) and predict to what extent future costs are likely to rise.

Finally, I recommend a NY Times article which describes some Red Flags in a co op’s statement.

In Part 1, we discussed the General Principles of a Coop Corproation and the Telltale signs of a GOOD Building.  This post will discuss what to look for in Coop Financials.

Basic Items to Focus on in a Cooperative Financial Statement

• Liquid Assets.
• Underlying Mortgage(s).
• Total Income
  • Maintenance Income
  • Miscellaneous (Other) Income
• Total Expenses.
• Income from Operation before Depreciation.
• Income from Operation after Depreciation.
• Notes to the Financial Statement.

Liquid Assets

• Cash and cash equivalents. These constitute money that can be spent irrespective of prepaid items and mandated escrow funds. Cash typically exists in a in an operating account, savings account or is designated as a reserve fund.
•  A building’s cash accounts should equal at least 2-3 months’ maintenance charges.

Underlying Mortgage(s) 

• The overwhelming majority of coop corporations have an underlying mortgage as well as a subordinate mortgage. The latter generally appears in the form of a credit line that can be drawn upon as need presents itself.
• Underlying mortgages are generally 7-15 years in length with the final payment in the form of a balloon payment. These mortgages are considered commercial mortgages and are subject to higher interest rates than found in a conventional mortgage and are subject to pre-payment penalties. Additionally, mortgages of this type are commonly interest-only mortgages and seldom self-amortizing mortgages.
• When the purchaser of a coop applies for a mortgage, the lender needs to ascertain to what extent the purchase price of the unit relates to its pro rata share of the underlying mortgage. Most often the pro-rata share of the underlying mortgage is usually less than 20% of the purchase price, and in such case, there is no resistance from a lender to lend.

To determine the pro rata share of the underlying mortgage: divide the amount of the underlying mortgage by the total number of shares issued which equals the amount of mortgage per share and multiply that number by the number of shares allocated to the unit in question.

For example:

$8,000,000 (underlying mortgage) / 22,000 (total shares) = $363.63 per share x

147 (unit’s shares) = $53,454 (pro rata share of the underlying mortgage)

$53,454 / $650,000 (purchase price) = 8.22%

Total Income

• Maintenance income is sometimes referred to as rental income. It represents the sum of money paid to the corporation by the shareholders. Maintenance can be stable, it can increase from year to year, and in some instances, it can go down.
• A maintenance increase of up to 5% over the previous year would be considered normal whereas an increase in the vicinity of 10% would be considered high; however, every maintenance increase must be looked at within the context of the overall financial condition of the building.
• Miscellaneous income is income received from non-maintenance sources such as assessments, tax refunds, interest, dividends, flip taxes, proceeds of un-sold shares, commercial income, and laundry income. In most instances, income from non-maintenance sources should not exceed 20% of a building’s total income otherwise it will be a breach of the 80/20 rule and create a tax consequence for the building. In some instances where a building is receiving too much miscellaneous income, it has become necessary for the building to increase their maintenance to comply with this rule.
  • In the past year or two, the 80/20 rule has been made more flexible to allow exceptions to the rule if certain conditions exist. One such condition would be when no more than 20% of the building is allocated to non-residential occupancy, the building may receive more than 20% of its income from miscellaneous sources.

Total Expenses

• This is the sum of money the coop spent for such items as debt service, utilities, repairs, insurance, service contracts, real estate taxes, management fees, legal fees, and salaries etc.

Income from Operations before Depreciation

• This is the difference between total income and total expenditures. Ideally,the total income should be equal to or slightly more than the expenditures. Realistically, the income flow might be slightly more or less than the expenditures.
• The significance of a negative cash flow before depreciation must be assessed in relationship to the existing maintenance level, the level of cash assets and the anticipated need for additional income. A negative cash flow of 5% or more would cause concern if it were the result of normal expenditures and not an extraordinary event. At times a coop may purposely budget a negative cash flow in order to absorb substantial cash reserves, and in doing so, would eliminate the need for a maintenance increase which might have a negative impact on values.

Income from Operations after Depreciation

• Income after depreciation is a “phantom number” and has no significance as long as it remains a negative. Should it be a positive number, the coop will be liable for federal income taxes.

Notes to the Financial Statement

• Pay notice to any items that might impact the coop’s need for additional cash flow or asset accumulation such as:
  • Terms of the underlying mortgage(s).
  • Land lease escalations.
  • Rental income variances.
  • Tax liabilities.
  • Late shareholder payments.
  • Assessments.
  • Capital improvements.
  • Impending lawsuits.

Miscellaneous Items

 Sponsor Ownership

• Ideally, a low percentage of sponsor ownership is preferable to a high percentage of sponsor ownership. The latter places the possibility of a material default in the hands of a single shareholder and restricts or even inhibits a bank’s willingness to lend in the building.
• In cases where a sponsor or investor entity owns 10% or more of the shares, New York City mandates that such entity provide an annual affidavit that illustrates the differential between the rental income received (if any) and the maintenance due on the units in question.
• Other issues aside, the essential concern of shareholders is “Does the sponsor pay his maintenance in a timely manner?” The answer to this question is yes in 99% of the situations.

Future Repairs

• Coops seldom conduct a study to determine the remaining useful lives of the building’s systems and major components. Additionally, coops are seldom required (if ever) by their governing documents to accumulate funds in advance of the need of such repairs.

Ground Rent

• Ideally, it is better for a coop to own its land rather than to have to lease it. Leasing land is never a positive situation but not necessarily the reason to forgo purchasing in such a building. When evaluating a land lease building; notice the remaining term of the land lease, rent escalations, and renewal options. Pay particular note to when the property is going to be re-appraised for purposes of determining future ground rent.
• Land lease buildings do not necessarily have high maintenance charges, although they usually do.
• Land rent does not contribute to the tax deductibility of the maintenance.
• A “too short” land lease term (15 years or less) with no renewal option would severely impact the values of units in the building. In such an instance, a unit’s value could be defined as the difference between the fair market rental value, less the maintenance charge, multiplied by the number of years remaining on the land lease.
• It is always advisable for a purchaser to have an attorney review the land lease prior to signing the contract of sale.

Obtaining Updated Information from the Managing Agent

• Most financial statements reflect the state of affairs on December 31st of the preceding year. Such statements are usually issued between March and May of the following year.
• It is advisable to obtain updated information with regards to maintenance increases, assessments, and capital improvements when the purchase is to be made between June and December, otherwise, the buyer would be relying on information that is 6-12 months old.

High Maintenance / Low Maintenance

• Too often, buyers and brokers are apt to state an industry standard for the cost of maintenance in terms of $X.00 per square foot. This way of thinking is erroneous because there are many variable items that comprise maintenance and the amount of people that share in these expenses varies from building to building. For example: a building with 250 shareholders has the same expense for a 24-hour doorman as a building with 25 shareholders.
• Other variables include:
  •  Terms of the underlying mortgage: amount, interest rate, interest only payments vs. amortized payments, amortization term.
  • Improved building systems versus the status quo.
  • High service versus low service: concierge, elevator operator, lobby attendants, handymen, porters, resident manager.
  • On-site amenities versus no amenities.

Reserve Fund

The lack of a reserve fund, or cash cushion, is not necessarily a negative condition. Having money in reserve is relative to the need of having money in reserve. If there is high need, then a reserve fund is important. If there is low need, then a reserve fund is not as important.

Additionally, money can only be accrued if the coop takes measures to create such a fund from the following sources:

• Positive cash flow (income over expenses prior to depreciation).
• Assessments
• Cash-out refinance of their underlying mortgage,
• Secondary financing or credit line.
• Flip taxes.
• Sale of un-sold shares (if any).

Assessments

• Assessments are a viable means to create needed cash to pay for improvements or supplement cash flow in lieu of increasing maintenance or borrowing money. Assessments tend to be considered single events (sometimes ongoing) in which case they are less likely to inhibit values as does “too high” maintenance frequently does.
• Unlike a maintenance increase, an assessment accrues towards the building’s cost basis and in doing so adds favorably to the building’s ability to depreciate against income.
• Many coops choose not to accrue such funds until the actual need for such funds arises. Coop documents typically do not impose mandates on the accrual of such funds.

In Part 3 we’ll discuss Assessing a Coop’s Financial Condition.

Like investing in shares of any corporation you should consider the financial viability of that corporation.  As always, I suggest that before buying any real estate you create your team of trusted advisors which should include a broker, attorney/financial advisor and mortgage banker or broker.

General Principles of a Coop Corporation

• A coop is a “not for profit” corporation.
• The coop’s board of directors has a fiduciary responsibility to operate the building in a responsible manner.
• The coop board of directors generally appoints a managing agent to attend to the day to day operation of the building.
• Coop corporations, regardless of size, are mandated to publish an annual financial statement that details the nature of their financial affairs. Included in these statements are the following: assets, liabilities, income, expenses

Telltale Signs of a GOOD Building

• A building that is in obvious good repair and in immaculate condition.
• A condition where maintenance is commensurate with services and sustains a cash reserve commensurate with the impending need of such a fund.
• Tax deductibility of maintenance that is under 58%.
• Cash flow variance within 5% above or below expenses.
• Assessments dedicated to ongoing capital improvements.
• A reserve fund equal to two to three months’ maintenance charges.
• Low or no instance of shareholder or sponsor default.
• A building that owns their land.
• A defined land lease escalation as opposed to one based upon an appraisal.
• An actual income / expense statement that reflects the budget projection.
• Stable or reduced fixed costs.
• Exhibits a net loss after calculating depreciation.

Next time we’ll discuss what to look at in a Coop’s Financial Statements.

Here’s some samples:

Points:  1% of the loan amount to lower the interest rate, or cover some fees involved with the transaction

 Float-Down:  After locking in your rate, the lender may give you the opportunity to lower your rate if the market rate falls.

Margin:  On Adjustable rate loans, the margin is how much above the index you are going to pay.

Cap: On Adjustable rate loans, the cap is the most the rate can increase in one year.

 Walls in Insurance:  additional insurance that banks may require insuring what’s inside the apartment.

 See the full article and video on ny1.com.

Plan on putting up at least 20% for a down payment for a conventional loan (more if you’re looking at coops).  You might be able to qualify for a government-backed loan or private mortgage insurance if you’re strapped for a down payment, but it will cost you more in the long run.

It’s entirely possible the applicant could qualify, but the building won’t.

Scrutiny is the name of the game when it comes to a mortgage these days; consistent, stable income, high credit score and enough assets to cover not only the down payment, but also closing costs and reserves.  Even the coop or condo building financials will be examined very closely.  It’s entirely possible the applicant could qualify, but the building won’t.

See the full story and the video interview on ny1.com