The Real Deal New York

Lenders tighten up standards for co-op loans

Audited financials, reserves just two benchmarks of increasing scrutiny of buildings
By David Jones | October 03, 2008 12:21PM

While co-op boards started rejecting Wall Street buyers because of their shaky job security at the start of the downturn, it now appears that buyers are getting rejected for another reason. Increasingly, lenders are denying buyers who are looking to get into a co-op when the co-op can’t prove that its financial house is in order.

With increasing frequency, co-op boards are being forced to deliver audited financial statements to a lender before any transaction takes place. They must also show a high percentage of owner-occupants and provide evidence of reserve funds adequate to protect the building in the case of major repair or improvement.

“I think it’s pretty common across the marketplace to find that most banks have tightened their guidelines,” said Chris Goettke, a regional president at National Consumer Cooperative Bank (NCB), the nation’s leading lender to the New York cooperative market.

NCB has been one of the most conservative and profitable mortgage lenders in the U.S., but like many others, it has been burned in recent years by underwriting loans in buildings that were poorly managed or controlled by speculative investors. Citing its inability to sell many of its loans on the secondary market, the firm reported a $500,000 loss in 2007, its first-ever annual loss, compared with a net income of $19.4 million in 2006.

Officials say the goal of the increased level of scrutiny is to uncover any embedded financial risks within a particular building, because a poorly managed co-op will heighten the risk for all the individual owners.

Broken deals

Sindi Schorr, a broker at DJK Residential, said a couple of her clients have seen their co-op deals delayed, and in other cases denied, by snake-bitten lenders.

At least one of her clients ran into problems at 101 West 23rd Street, a co-op apartment building where the co-op corporation does not own the underlying land, but operates the building under a long-term lease from another investor. Such land-lease buildings are generally considered riskier than standard co-ops because, according to brokers and co-op experts, the land owner could choose to sell the land or not renew the lease.  Schorr said the lease at the 23rd Street building still has 31 years left before it expires; however, the payoff date on a 30-year mortgage is considered “too close for comfort” at many banks.

“[My client] would not have been able to get a loan, because the [date] was so close,” said Schorr. “They decided to put a moratorium on everyone else in the building. The board is trying to figure out what to do with the lease.”

The land lease, plus a former bankruptcy at the building, has created significant financial hardships there. Maintenance payments on some of the larger units approach $2,000 per month. Records from StreetEasy, a real estate data provider, show that at least three apartments were sold since December 2007, with the latest transaction being the March sale of a 500-square-foot studio for $290,000, which was 6.5 percent below its original asking price.

Officials at Siren Management Corp., which manages the building, declined to comment and referred questions to the co-op board. Several apartments from the building are currently listed for sale by various brokers.

The last dip

Despite all that, New York co-ops are considered much sounder investments than other kinds of real estate inventory. Co-op boards are known to closely — in some cases, zealously — screen out potential problem tenants. However, that was not always the case.

During the last major housing bubble in the 1980s, about 830,000 apartments were either built new or converted into co-ops and condos, according to the New York State attorney general’s office. In Queens, 25 percent of those units subsequently
defaulted or suffered some level of financial difficulty that caused New York’s housing market to nearly collapse.

The fallout was so bad that the secondary market for buying co-op loans nearly dried up, and several major banks pulled out of co-op lending altogether. It took years of public hearings, heightened oversight by the New York state attorney general and major changes to underwriting standards before the market began to recover.

“Right now, it’s clearly not as bad as it was in the early 1990s,” recalled Myles Horn, principal at developer MJH Birchwood. “Banks are not looking with that kind of circumspection — yet. I have not seen the kind of tightening I would expect; I would expect it to get worse.”

Debra Shultz, director and senior certified mortgage advisor at Manhattan Mortgage Co., said that co-op boards are placing closer scrutiny on potential buyers, and many boards have banned the use of interest-only loans.  

Lender guidelines

On the other hand, she noted that the majority of co-op guidelines have not changed at most lenders. They want at least 50 to 70 percent of a building’s units occupied by primary owners, no more than 20 percent investor-owned units, as well as strong financials, no outstanding litigation and a minimum of 10 or more units per building, which lessens the risk that one individual in default could drag an entire building into foreclosure.  

The fear is that with a high percentage of sponsor-owned or investor-owned units, a financial default by one shareholder could place an enormous burden on the rest of the shareholders, thus placing the underlying mortgage payments in jeopardy.

At successful co-op buildings, a sponsor will usually gain pre-qualification from a lender, which will then place the building on a list of approved co-ops, which in turn speeds the process of approving loans for individual apartments.

Developer Horn noted that at his company’s newest development, the Towers at Water’s Edge in Bayside, Queens, the complex has already been approved by M&T Bank. Horn acquired about 230 units from the original sponsor and is selling those units for about $500 a square foot.

Attorney Lawrence DiGiovanna, whose firm represents more than 30 co-op apartments in Brooklyn, said he has not seen any widespread crackdown on co-op boards. However, he noted that one of his clients, a 300-unit co-op in Sheepshead Bay, was asked by Washington Mutual (which was bought last month by JPMorgan Chase) to put 25 percent of its annual maintenance into Fidelity bond insurance, which protects the building against employee dishonesty.  

“The first time it occurs, the co-op board is being asked on behalf of one little lender for a revision to the entire building’s insurance policy,” he recalled. “The initial reaction on a lot of boards [would be], ‘Don’t be ridiculous.'”

He said that banks are also demanding that co-ops set aside increased reserve funds to handle future capital repairs. “This co-op had $1 million cash in the bank, [but it] wasn’t clear if it was for capital improvements or a reserve fund.”  

Co-op boards that fail to shore up their financial practice can suffer further repercussions. Attorney David Schachter said that banks are refusing to lend to buyers if a co-op board cannot produce audited financial statements.

“If they see a financial statement that’s not audited, they say, ‘We don’t want to do the loan,'” he said. “Before, you didn’t hear any of this.”

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