When the bank took back a Harlem condominium, the rest of the building's residents were stuck with years of unpaid arrears by the former resident. “There was a tremendous amount of arrears from about three or four years already accruing and the building never got paid,” says Ellen Kornfeld, vice president of The Lovett Group in Manhattan. “We had to assess everyone at the building to pick up the shortfall. So you're asking others to absorb the debt of those who cannot afford the purchases they've made. That's a tremendous burden.”
This is just one of the many situations affecting co-ops and condos all across the city.
According to Crain's New York Business, foreclosures have declined since 2006 but through June of 2012, there were still more than 6,000 properties facing that fate this year.
Crains also notes that in metro areas across the country with a judicial foreclosure process, the average foreclosure rate stood at 7.2 percent. In the New York area, it was a slightly higher 7.9 percent at year-end 2011. Courts also have a serious backlog of delinquent properties that will take years to clear.
Throughout New York City, boards of directors must grapple with a variety of problems relating to foreclosed units, delinquent payments and absentee owners.
The procedure for dealing with a foreclosure depends on whether the unit is a condo or co-op. “In a co-op, a bank that forecloses gets the ownership of the stock and lease but does not have the right to put anyone into the unit,” says Jeffrey S. Reich, a partner at Wolf Haldenstein Adler Freeman & Herz LLP in Manhattan.
He continues to say that in that sense, “A condominium is like a house, and the bank can do whatever it wants with the unit. They could put someone in it, [but] generally they sell the unit, and there could be a question of whether or not the condo has the right of first refusal with respect to the auction sale. In most cases, it does not. The bank holds an auction, and whoever is the high bidder does not have to go through a right of first refusal and simply purchases the unit at the auction price.”
In a co-op that is not the case. “When a bank goes to foreclose on the co-op, depending on the proprietary lease, the board may still have the right to approve or reject any occupant,” Reich explains. “So someone may be able to buy the unit but they may not have the right to reside in the unit unless they get the board's approval.”
Leniency vs. Fiduciary Duty
Before dispossessing delinquent owners, most boards will encourage them to erase their deficit. How can boards strike a balance between working with residents and putting their foot down?
Having a collection policy is something that all the industry experts advised. “It is important to work as best as you can with residents,” explains Robert Ferrera, director of Anker Management in Hartsdale, “the reason being if a resident isn't able to make a payment for a month or two because of a financial issue, you don't want to send them to the attorney right away. If you are able to come to an agreement through a payment plan or a lump sum payment within a reasonable time frame, that's the best way.”
Ferrara continues, stressing that is is crucial to keep on top of who is paying late, or not paying at all. “We spend more time trying to review arrears and make sure we monitor them,” he says. “If someone falls in arrears, we immediately get in contact with them. If the money is not received and the board has reached out, the matter goes to the building attorney—because the board has a fiduciary responsibility, and must take a proactive approach to collect.”
Kornfeld has observed that speaking to residents in person or on the phone is more effective than letters and notices. “You get on the phone and you call people and you discuss with them the situation,” he says. “You give them some time. You try to encourage them to make small payments so you work with them. You can say, 'Okay you're in arrears, when do you think you can bring me current? Can you bring me current in three months? Can you pay a little extra now? Can you pay half down and then we go on a payment plan?' You give them something that they have to ponder and they see different solutions. I think something of something is better than something of nothing,” she says.
The benefits of a certain amount of flexibility aside however, she adds that it is important to make sure that your collection policy is legal. “Sometimes buildings will try to charge huge amounts in late fees to discourage delinquencies,” she says. “But the courts can fine you and not uphold the late fees.”
Kornfeld reports that having an aggressive collection policy has been successful in getting residents back on track with their payments. She cites an example of a 40-unit building she manages where eight residents were in arrears and after establishing an individualized policy with them, she was able to receive payments from all.
Coping with Absentee Owners
Owners who don’t actually live in the community pose other problems for its board. Some absentee owners leave because they lose a job and have to move away. If they haven’t abandoned their unit or home, they may rent it out. Others are investors who sought rental income and/or a profit upon an eventual sale. Either way, they may limit the financial opportunities of other residents as well as the co-op itself.
“Any time you have absentee owners in a co-op, it can affect everyone's ability to borrow money,” Reich says. “If a resident wanted to refinance their co-op, the bank will invariably ask what percentage of units are owner-occupied. And if it is not a high enough percentage, that resident will not be able to [get the loan]. It also can affect the co-op's ability to refinance their underlying mortgage. You have to meet certain thresholds for both the individual and building”
Similarly, “In a condominium, it will affect your ability to borrow individually on your unit, says Reich, “depending on how many investor and absentee owners there are.”
The Rental Dilemma
As the percentage of renters rises, the market value of individual units can be adversely affected, and prospective purchasers may have difficulty in securing a loan. The Federal Housing Authority, Fannie Mae, and Freddie Mac won’t approve financing in a building or community where residents own fewer than 51 percent of the units or homes.
However, renting out the units may bring in some income. Ferrera describes a situation in one of his properties where a unit owner was an absentee owner and the unit was vacant. He had this own belongings in the unit and the path was leading to either foreclosure or short sale. Ironically he came back to the building and he assigned the rights of the unit to the condominium building, which was able to rent the unit out. “That has now provided cash flow because the rental market is very strong. It is keeping the monthly common charges up to date, he is able to pay off his arrears and it has stopped the legal fees, because until the unit is sold or foreclosed the association is paying the attorney. So this was a win-win situation to the unit owner and the building,” he says.
Ultimately, how many units are rented out depends on how they will financially impact a building. “The Board has the fiduciary responsibility to do what is best for the property. Given the economic times, it is more advantageous to rent the units if the Board controls who they are renting to, if they are able to rent the unit and get a significant amount of money covering more than the common charges and taxes and given the slow sales at the time, it more be more advantageous to rent. Each board has to assess each property,” Ferrera says.
When a Community Fails
What happens when a condo or co-op has so many units defaulting on assessments that it lacks money to operate? Once again, the outcome depends on whether it is a condo or co-op.
“When a co-op can't pay its debts, the bank that holds the underlying mortgage has the ability to foreclose on the property—which would then become a rental property. Depending on when the property was built, it may even become subject to rent stabilization. So if you have a building that was built in the 50s, converted in the 80s, and is now foreclosed on, then because they were built prior to 1974 those apartments could become subject to rent stabilization,” Reich says.
Eric Goidel, attorney at Borah, Goldstein, Altschuler, Nahins & Goidel, P.C., adds, “this question is more theoretical than it is real. In the worst case scenario, a cooperative apartment corporation which was unable to pay its financial obligations would likely have its mortgage foreclosed upon. However, prior to that, a cooperative apartment corporation would likely file for bankruptcy protection, preventing some plan of reorganization. Typically however, individual units would have been purchased by bidders at foreclosure sales and those individuals would have not only paid the arrears due the apartment corporation, but started to pay current charges. In the short term, non-defaulting owners would have had to make up deficiencies in the cash flow. In a cooperative setting, the cooperative has a priority lien for its unpaid maintenance and comes ahead of all liens of record. So eventually, a cooperative is likely to be made whole.”
For condominiums, the procedure would be different. “In condominiums, the building itself does not get foreclosed on, but rather the unit. There is no one central lien on a building in a condominium. You would have different banks foreclosing on different units and most banks turn around and sell the unit. It is conceivable that the bank might turn around and turn the unit into a rental unit. I haven't seen it done and it is unlikely but that is a right that they may have,” Reich adds.
Goidel adds, “In a condominium, a condominium lien for unpaid common charges, once filed, jumps ahead of all liens except for the lien of a first mortgage of record and certain governmental liens. Accordingly, in the case of a foreclosure upon a condominium unit, it is conceivable that the purchase price at foreclosure might be insufficient to satisfy both the lien of the first mortgage of record, as well as all charges due and owing to the condominium. To the extent that there is this deficiency, the lien of the condominium may not be fully satisfied or satisfied at all. It would then be incumbent upon the remaining unit owners (including the successful bidder) to cover the shortfall in operations. However, as a condominium does not own the building as a cooperative apartment corporation does, there is no risk to the overall building. There is however some risk to individual unit owners who may not be able to cover an assessment for a shortfall.”
Condos and co-ops throughout New York and the country are faced with new and ongoing financial situations brought upon by the Recession. With open communication, prudent financial planning and flexibility, boards and residents will hopefully be able to ride out this post-recession wave with their value and equity intact.
Maggie Puniewska is an editorial assistant and writer for The Cooperator.