Every co-op board in New York City has a duty to maintain and preserve the value of their cooperative. Part of the co-op boards process is the operating budget that determines monthly maintenance charges required from each shareholder, typically used for building maintenance in the upcoming year. Additionally, the co-op board will determine and set aside a reserve fund. The reserve fund is the co-op’s “rainy day” money, funds used for expected and unexpected repairs when needed.
For anyone looking to buy an NYC co-op apartment, understanding the importance of a building’s reserve fund will be critical. Without it, the co-op risks falling into disrepair and losing value with an adverse impact on all shareholders.
Developing a Reserve FundDeveloping a Reserve Fund
Also known as a capital budget, a reserve fund aims to project major repairs and replacements costs. The best funds should try to look as far ahead as they can, say, five years. This is not as hard as it might appear. Regular maintenance for structural elements like roofs, balconies, elevators, and the exterior façade is required every few years. Assuming a major issue doesn’t go unnoticed for years, the costs of these repairs can be predictable and manageable.
That said, every building will be different. Relying on a reserve fund to cover the next 3-6 months can be a recipe for disaster. Instead, they should have a detailed analysis of the building to determine all potential problems, now and in the future. This can be carried out through the building’s maintenance staff but is best done by a professional architect or engineer. In conjunction with this, a detailed costs analysis needs to be carried out.
Financial AnalysisFinancial Analysis
Once a better picture of the building’s current state begins to appear, the board can perform financial analysis to estimate the costs of repairs. As with the operating budget, the board should perform a financial analysis annually to consider the last capital budget and any changes made since then. The best-run co-ops will have a more than adequate reserve to cover any major repairs and improvements. When there are inadequate reserves, the building’s value will begin to suffer, making it more difficult for shareholders to sell their units.
The board will also have a responsibility to increase the value of the building. The co-op can do this through an investment strategy that makes use of the reserve fund. However, this is not the time to speculate or aim for overly ambitious projects. As the custodians of the reserve fund, the board has a duty to ensure all investments are safe, liquid, and come with maximum returns. Most boards achieve this by investing the reserve funds in money market accounts, certificates of deposit (CDs), and treasury bonds. The co-op board’s investment strategy can and should be amended over time to align with market conditions and the interest rate environment.
Dealing with a Major Capital repairDealing with a Major Capital repair
Now and then, a major repair or replacement issue might raise its ugly head. To deal with this, co-op boards typically have three options to raise emergency funds. They can refinance the underlying permanent mortgage, secure a line of credit against the building or charge an assessment to the shareholders. Which option a board goes for depends on the economic situation they find themselves in. If an assessment on the shareholders proves too costly or unpopular, financing would be the prudent approach. However, this will come with costs of its own in higher monthly maintenance charges for the residents. It will be up to each board to decide the best approach.
Doing Your Due Diligence When Purchasing a Co-opDoing Your Due Diligence When Purchasing a Co-op
Anyone buying in New York City knows the importance of doing their due diligence. Here, it’s “buyer-beware” territory, and if there’s an issue with a unit or the building itself, it is on you to find it. Fortunately, this is one of the areas that makes having a good real estate attorney pay for itself. Their job will uncover any problems, looking into the building’s finances, reserve fund, and board minutes. Much of this information can gleam from the building’s financial statements, providing intel about the building’s underlying mortgage.
Keep in mind, co-op financial statements only come out once a year, and if buying an apartment early in the year, you may not have access to their most recent statement until May or June. To get around this and find more information that will supplement the financial reports, you should consult the board minutes. This is the best method for determining the current state and what the board has on the agenda.
Even that may not be enough if important details have been struck from the minutes or if the board does not meet every month. As the last recourse, your attorney can send a detailed questionnaire to the building’s managing agent. Building management can confirm important details like the monthly maintenance, the number of shares for the unit, percentage of tax deductibility, current reserve fund, maintenance history, and plans.
All of this ensures that the co-op building you are buying into is well managed with an adequate reserve fund, with no surprise assessments waiting in store.
Final ThoughtsFinal Thoughts
Reserve funds are a critical part of every co-op’s financials. You really cannot be too careful with something like this. It is in every buyer’s best interest to know the state of a building before buying. Even once you have closed on your co-op apartment, keep abreast of the building’s finances by examining each year’s financial statement, operating budget, and capital budget.