How to Avoid a Bad Building--Part I
When Looking for an Apartment, What Exactly Should You Look For?
Every day, thousands of people in Gotham, armed with listings from newspapers like the Times and hundreds of Internet resources, hit the pavement to look for the elusive place to live. Everyone has his or her own personal shopping list: southern exposure, a terrace, high end appliances, health club facilities, proximity to public transportation. Those considerations are endless and personal. There are other factors that show go on the wish list, which are just as important as the river view and the closest Citarella. These less glamorous factors fall into two categories:
- The financial condition of the building; and
- The physical condition of the building.
What should you be looking for when it comes to these two critical areas of concern?
Judging a Building's Financial Status
Co-ops and condos operate in basically the same manner: each unit owner contributes a certain amount of money each month for the purpose of paying the common expenses of running a building. With a co-op, these monthly payments are known as "maintenance" and with a condo the monthly payments are known as "common charges". Depending upon the operating costs of the building and the necessity for repairs, the amount of monthly maintenance or common charges can vary significantly from building to building. Secondly, co-ops and condos also maintain cash reserves usually known as the "reserve fund" to handle unexpected repairs or anticipated capital improvements such as replacing a roof. As you might have guessed, it would serve your best interests to find a co-op or condo with the lowest possible monthly carrying charges and the highest possible cash reserves. Why? First of all, low monthly carrying costs make good financial sense because it helps you keep your monthly living expenses as low as possible. Secondly, high cash reserves allow a co-op or condo to pay for repairs or improvements out of the reserve fund rather than by increasing monthly carrying costs or by imposing special financial assessments on unit owners to pay for all or a portion of the repairs or capital improvements. Thirdly, buildings that have low monthly carrying charges and high cash reserves are more attractive to buyers, when you need to sell sometime in the future. Now for a little detective work.
What Should You Be Concerned About When a Building's Carrying Charges Appear High?
The primary reason why buildings suffer from high monthly carrying costs is because they have inadequate cash reserves to fund capital improvements and major repairs. Sooner or later, every building will be forced to replace the roof or boiler, redecorate the lobby and hallways, replace the central air conditioning system, re-point the facade of the building or make some other major capital improvement or repair. These types of repairs or improvements can be quite expensive, running into the hundreds of thousands of dollars and sometimes millions. There are a limited number of ways to pay for these expenses:
- Out of cash reserves;
- By increasing the monthly carrying charges;
- By imposing a one-time special financial assessment; or
- By refinancing the underlying mortgage on the co-op or by borrowing against a condo's future income (now possible) or against real estate owned by the condo (like the super's apartment).
When a building does not have adequate cash reserves, the vicious cycle of annual increases in maintenance or common charges begins and, in most cases, never stops. Unless you are looking at a building that is brand-spanking new, you must anticipate that major capital improvements will eventually have to be made. It simply cannot be avoided. But it gets a little tricky. Here's a "what if" check list for your consideration:
Large Cash Reserves, But Costly Capital Improvements-- What do we mean by large? Obviously the size of the building impacts on the significance of the amount of the building's cash reserves. Using a 200-unit building as an example, here are a few scenarios: Cash reserves in excess of $250,000 are adequate; cash reserves in excess of $500,000 are good; cash reserves in excess of $1,000,000 are very good. Even with high reserves, the issue is not resolved based solely on the amount of reserves the co-op or condo is presently holding. Once you've determined that your building has at least satisfactory cash reserves, you must determine the capital improvements and repairs that will be required over the next three to five year period. If you determine that your building needs to have its facade re-pointed, that cost alone could be in excess of $500,000. A new boiler could cost another $400,000. As you can see, even if a building has significant cash reserves, imminent capital improvements can use up a significant portion of the piggy bank.
Low Cash Reserves, But Few Needed Capital Improvements-- When you find a building with less than adequate cash reserves, it may not necessarily be a reason to walk away. Sometimes you will find a building that has just completed a major capital repair and replacement program, so that future repairs to mechanical systems or to the building's roof or facade are not anticipated. In that scenario, major capital improvements may not be required for a number of years. Although it is always best to find a building with at least adequate cash reserves, if you know that major capital improvements are unlikely for a number of years, the good physical condition of the building can balance out the negative impact of inadequate cash reserves.
High Cash Reserves and Few Needed Capital Improvements-- This is the optimum combination. There are buildings out there which have significant cash reserves and few capital improvements on the horizon. This combination bodes well for minimal annual carrying cost increases. Buildings in this category exist, they are just few and far between. Taking current economics into consideration, if you find an apartment in a building with this profile, consider yourself lucky.
Every building is a little different so the above rules have to be applied in a flexible manner.
Why Are High Monthly Carrying Charges Bad?
Here's a good general rule to keep in mind:
Once a building is forced to increase the carrying charges to pay for capital improvements or unexpected repairs, it is difficult or impossible to get the costs to go down. But how do you know if monthly carrying charges are high in the first place? Assuming you've looked at a number of apartments, you'll soon find out what the monthly carrying charges should be for each category of apartment (studio, one bedroom, two-bedroom and beyond). With co-ops, once the carrying charges significantly exceed the square footage of the apartment, inquiry is required to determine why the monthly costs are higher than normal. Of course, other factors have to be considered: if the apartment is on the ground floor as opposed to a floor with view of Central Park, the maintenance on the higher floor apartment will generally be higher. Nevertheless, keep this rule in mind when you're running the numbers. Because a condo, historically, has lower monthly costs (since there is no underlying mortgage which the unit owners have to carry), it is more difficult to rely on a square footage analysis. Looking to comparable apartments may make more sense. In any event, crunching the numbers is essential as someone else will be doing the same number crunching when it's time to sell your apartment.
High monthly carrying charges also can affect the amount of financing for which you may be able to qualify. The bank will analyze the amount of monthly expense you can handle based upon your monthly income. Depending upon your monthly income level, the higher carrying costs may diminish the amount of debt which the bank will let you carry.
Residential Reality: High Monthly Carrying Costs Are Never a Good Thing
Keep your emotional attachment to the apartment in check. Being trapped in a co-op or condo in bad financial condition can be worse than a subway car without air conditioning in the middle of August. It can take years to sell an apartment where the co-op or condo is in bad financial health. Your personal status can change and could require you to sell your apartment at an unexpected time. Your inability to freely trade your apartment can create serious financial problems and can impact on crucial life decisions. When analyzing the “feng shui” of your apartment, make sure you also determine whether building’s finances are headed in the right direction.