Before 1989, during the height of the real estate market, shareholders were buying and selling apartments at an accelerated rate. But when the recession hit the market, between 1989 and 1993, co-op sponsors (holders of unsold shares) couldn’t sell their units and began renting them instead. As a result, shareholders felt trapped; they were tied to co-ops that because of the low percentage of owner-occupants, could no longer meet the standards necessary to obtain mortgage financing. Dara Gardens is one such property that was caught in this predicament.

A Case Study

Dara Gardens is a 534-unit co-op in Kew Garden Hills, Queens, that was in turmoil until earlier this year. The sponsor and successor investor groups owned 78 percent of the apartments, and were running the community as a rental property. One management company wore two hats: managing the co-op, and managing the sponsor or investor groups’ rental portfolio. Renters’ lack of concern for the property they were merely renting, coupled with a large turn-over rate, increased wear and tear on the common area and grounds. The manager was directed to use the building staff and co-op supplies to renovate these unsold apartments, thereby neglecting the common areas and leaving the buildings looking tired and worn. Adding to this disaster, a huge underlying mortgage ($16 million) was expiring, and with the co-op operating at a deficit, the options for refinancing the mortgage seemed dim. As a result, the shareholders’ investments were diminishing, causing them to be hostile toward the sponsor and subsequent investor groups.

The shareholders’ biggest grievance was that the sponsors had not created a sales program. By not selling, genuine potential buyers for the shareholders’ units were regularly turned down by every lender when they applied for a purchase mortgage (an end loan). The banks told prospective buyers who were credit-worthy that "the project [Dara Gardens] doesn’t meet our lending criteria." Residents of the community found it difficult to obtain end loans.

There has been much speculation and hope that some legislative act or lawsuit could force sponsors to continue selling their units. But, despite the lobbying, articles and appeals for such actions since 1997, a new solution still seems slim. The only option for Dara Gardens was to discover the most efficient way to meet the required standards for financing.

However, despite the relaxed guidelines and Fannie Mae’s increasing reliance on the lenders’ underwriting decision to make the home loan (most lenders in New York are approved to sell and service Fannie Mae end loans), Dara Gardens still could not meet the necessary qualifications. Then, in early 1997, the situation changed dramatically.

Dara Triumphs

A new investment group bought the unsold units, and agreed with the board that the co-op and the investor’s units would be better served under separate management firms. After extensive bidding, the board awarded the co-op management contract to Diversified Property Management (DPM), a full-service real estate company based in Bay Ridge, Brooklyn. DPM began managing on April 1, 1999 and I became their property manager, overseeing a two-person site office. At that time the co-op had approximately $500,000 in reserve funds, but their operating account was overdrawn. The current underlying mortgage lender was offering a five-year extension on the loan, based on an interest rate increase from 8.5 percent to 10 percent (an additional $240,000 in annual interest payments). The prior manager handed me a folder with more than $150,000 in unpaid bills and wished me good luck.

To stop the financial slide without increasing maintenance charges required drastic measures: DPM immediately stopped all staff from performing renovation work in private apartments. All overtime pay was also eliminated. Repair request calls were rerouted to the site office and work orders were issued by the site managers instead of the superintendent. This freed the superintendent from all paperwork allowing him to concentrate on other matters. Every service contract was reviewed and either renegotiated or changed to utilize less expensive vendors. Decontrolled gas was purchased from an independent provider. Only essential supplies were bought through DPM's bulk purchasing order department, using a purchase order system requiring my approval. Maintenance arrears in excess of $24,000 were collected without legal costs, by demand letters to shareholders and their end loan lenders. The late fee policy was enforced. A modest sublet surcharge was adopted and billed. Other administrative fees for preparing non payment cases for an attorney for with renting an apartment without board consent were enacted. Within three months, every unpaid bill was paid and the co-op began operating on a financially sound basis.

The maintenance staff was told to concentrate on beautification projects, which eliminated the annual cost of painting contractors. In addition to the two year paint project, a landscape contractor was hired for a two year project of his own. By the end of the summer this gatehouse community began to look like a botanical garden. It was now time to concentrate on obtaining a new underlying mortgage.

Obtaining The Mortgage

The investor group obtained a proposal from one lender, then obtained a proposal with better terms from another. DPM was also able to engage a mortgage broker with a strong relationship to (NCB) National Cooperative Bank who had previously declined a loan. NBC was convinced to take another look at the property and the turn around in the financial picture. NCB made a very competitive offer, and a unique idea was adopted by the board. They risked paying two application fees, which totaled over $30,000, to process both loan offers simultaneously. The reasoning behind this decision was that just six months earlier, the property didn't qualify for underlying mortgage refinancing, using standard lending criteria. It was unclear whether these two competing banks would ultimately issue a loan commitment that was acceptable to the board. The work was doubled in preparing information for the two banks’ appraisers. The inspections by two banks’ engineers and environmental consultants, and by the loan officers were conducted. Ultimately, both banks issued loan commitments, and the board chose NCB. Sheldon Gartenstein, vice president and loan officer of NCB, called Dara Gardens the ‘best kept secret in Queens.’ The refinancing added $500,000 to the reserve fund, and reduced the annual loan payments by $96,000 due to obtaining a fixed rate loan at a 7.69 percent. In addition, NCB closed on a note for secondary financing (a line of credit) of $750,000, to be available only when performing major capital improvements. Finally, Dara paid one point at closing to purchase stock in NCB. One year later Dara received NCB first dividend check in the amount of $135,000.

Obtaining A Waiver

At the end of 1997, Dara Gardens financial statement showed a net surplus of $250,000 before depreciation and amortization. Due to the dividend check, the net surplus on the 1998 financial statement exceeded $410,000. The goal was now to obtain end loan financing for buyers, despite the fact that the investor group still owned 78 percent of the shares, was not selling their units, and the average pro rata share continued to exceed 50 percent. The key to the plan was to sell a lender on the turn around and new trend at Dara, both financially and in terms of the property's appearance. Once a lender was convinced, I would ask them to approach Fannie Mae and apply for pre-approval for a project-based waiver from the standard lending criteria. I approached First Empire Funding, the largest mortgage broker in the area, whose evaluation would be highly valued by Fannie Mae.

Naomi Bayer, Fannie Mae’s director in New York City, says that the lender must be convinced, "there are compensating factors that outweigh the detailed contract language which lists the normal guidelines and criteria between Fannie Mae and lenders." Fannie Mae has become more flexible, and will rely heavily on the lenders’ understanding and presentation of the financial soundness of an individual property, and any unique factors that prompts the waiver request. The experience and track record of that lender with Fannie Mae is also considered. Using a mortgage broker to find the right lender for a particular cooperative in need of such waivers is almost essential.

Samuel Jubert, head of the mortgage brokerage division at First Empire, saw the potential for sales at Dara. He carefully analyzed the financial trends from 1996 through 1998 and the 1999 budget, which continued to project sound fiscal management and a significant net surplus. He visited the property and immediately appreciated the curb appeal of this gatehouse community, with stunning new landscaping and sound management. Selling Jubert was the key to having First Empire's principals use their resources and connections to find the right lenders, who, if similarly sold, would apply for the Fannie Mae project waivers. Within three months First Empire delivered two lenders who had successfully applied for and obtained the waivers. In March of 1999, the lenders’ best offer was a low $20,000 loan, with a 10 percent down payment at prevailing interest rates. Even studio owners could now sell their units to qualified buyers. The shareholders’ nightmare of feeling trapped in their co-op and being blacklisted by banks was over at Dara Gardens. In addition, the holder of unsold shares changed their amendment to include a sales program, knowing that end loans were now available.

Sound Management Strategy

The management strategy, for a building such as Dara Gardens, is always the same: restore the property to financial health and sound physical condition, build up the reserve fund through a carefully timed refinancing of the underlying mortgage, and concentrate on curb appeal beautification.

There are still thousands of shareholders in hundreds of co-ops throughout the New York area who are trapped because the sponsors have stopped selling, and their cooperatives are blacklisted because they do not meet the banking industry standards for obtaining home loans. By instituting a successful plan to beautify the property and bring it into sound financial and physical condition, a well-managed co-op should be able to obtain Fannie Mae waivers and begin sales again. This would create the turning point that the entire embattled co-op community needs.

Mr. Grant is director of Diversified Property Management.