Sunday, July 8, 2012

UNDERSTANDING CO-OPS: That Riveting Co-op Financial Statement

WHEN you own an apartment in a co-op and the annual board meeting rolls around, the building’s financial statement arrives in the mail.

It’s tempting to let it languish in a pile of bills, but remember: you are a shareholder in the company that owns the building. Given how much New Yorkers invest in their co-ops, it’s worth giving the finances more than a cursory glance. Even if you’re just thinking about buying a co-op, here are questions that can guide you in analyzing whether you’re making a sound investment.
Financial statements typically present results for the past two years, in columns so you can compare the numbers. “I look for changes from one year to the next,” said Paul Wolsk, a real estate lawyer with Hartman & Craven. “If all of a sudden there’s a much higher accounts payable to vendors, that might mean the co-op is in a cash crunch.” It’s not that a big increase is necessarily a bad sign — the co-op might have had a big expense like replacing the roof. You want to understand why there was a significant change.
Obviously, a profit is better than a loss — meaning the building’s income from monthly maintenance fees, commercial rent and other sources covers its expenses. But if a building relies on an unpredictable source of income to pay for operating expenses, like the flip tax some co-ops charge sellers when an apartment changes hands, that can be a red flag. “If they’re making up a deficit with a flip tax,” Mr. Wolsk said, “it’s likely that their maintenance is not high enough.” Most buildings aim for a balanced budget, so if yours shows a loss year after year, that should be a concern.
Co-ops typically need assessments to pay for capital improvements or unanticipated expenses, like replacing a boiler, doing major work on an elevator or fixing the facade to comply with local regulations. “Try to find out what the assessment is being used for, and how long it continues,” Mr. Wolsk said, noting that longer-term assessments, payable in monthly installments, have become more common than single lump-sum payments.
Unlike individual homeowners, co-ops don’t usually try to pay off a mortgage, because that would mean current shareholders were paying for something that would benefit future shareholders. So a large mortgage isn’t necessarily a concern. But you should pay attention to the interest rate and maturation date.
Arthur Weinstein, a real estate lawyer who serves as a vice president of the Council of New York Cooperatives and Condominiums, said a building’s mortgage should be evaluated in the context of economic conditions. “In a low-interest-rate economy like we’re in now,” he said, “you’d worry about a high-interest-rate mortgage that cannot be refinanced.”
If a mortgage is maturing soon, there will be expenses like legal fees associated with refinancing, but monthly payments may decrease if the new mortgage has a lower interest rate.
The one item that even number-averse shareholders tend to look at is the amount in the reserve
fund, which is generally used to pay for capital expenses. The question is, how much is enough?
“To analyze the adequacy of the reserve fund,” Mr. Weinstein said, “you have to do a little bit of due diligence with respect to the condition of the building.” If the building hasn’t upgraded its heating system to use a less polluting type of oil, as required by city law, that’s a major upcoming expense; so is doing facade work to comply with local regulations.
Some buildings rely on a line of credit instead of a large reserve fund to cover unanticipated expenses, Mr. Weinstein said. Another variable, for buildings that have recently refinanced, is whether some of the proceeds were used to beef up the reserve account.
“You cannot say that a building should have a reserve fund of $25,000 per unit,” he explained. “It’s a complex cross-analysis of each of these pieces of a large puzzle.”
Real estate lawyers say one of the most important sections of a financial statement is the footnotes, which detail, for instance, any litigation involving the building. “Are they paying a lot of money to lawyers, and if so why?” said Eva Talel, a partner in the real estate group of the law firm Stroock & Stroock & Lavan. “The footnotes would be helpful in giving some explanation about that.”
The footnotes might also reveal whether the building had a tax abatement on the verge of expiring, which would mean the monthly maintenance fee was likely to increase, or whether the co-op leases rather than owns the land on which the building sits. This is also where you’ll find details about the mortgage and any approved assessments, as well as comments about major repairs that have been undertaken or might become necessary.
Financial statements are typically prepared by independent accountants, who should note whether their audit meets “generally accepted accounting principles,” an industry standard known by the acronym GAAP. “If it’s not in accord with GAAP,” Ms. Talel said, “then it’s not an audited financial. It just means that different criteria have been applied by the auditors.”
She says that smaller co-ops in New York City often use unaudited financial statements because they cost less to prepare, but that doing so would be unusual for a larger building. One difference is that GAAP standards require cost estimates for anticipated major repairs. “That’s where audited financials give you more information, because they’re required by internal rules to do that,” Ms. Talel said.
The co-op’s treasurer or the accountants usually attend the annual meeting, giving shareholders a chance to ask questions about what they’ve found in the financial statements. “If you’re finding stuff that you think is egregious,” Ms. Talel said, “it’s also your opportunity to say to your fellow shareholders, ‘We’d better get some people on the board who can run a tighter ship.’ "

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