Flip Tax

The Necessary Flip

Built in 1958, Newport East boasts a mixed bag of tenants. According to long-time resident and board member Sandy Weiswasser: “You have all ages here. You have people who have young children and who are going to move. You have singles. You have young marrieds, middle-aged marrieds, elderly marrieds, as well as singles. It really has all ages, all groups, all types.”

By 2004, the cooperative was in need of cash. The co-op could no longer fund capital improvements out of operating surpluses because costs – such as insurance premiums and fuel prices – had gone up precipitously in the aftermath of the September 11, 2001, terrorist attacks. At the same time, because of the toughening of Local Law 11/98 regulations and the aging nature of the physical plant, the property would be needing many more capital improvements than it had in the past, and they couldn’t be delayed. The board also wanted to prepare for the unexpected. “You want to stay financially secure,” explains Weiswasser. “We don’t know what tomorrow brings. An example of that is that [recent] plane crash [on the East Side]. It went into a building. No one knows what next winter brings.”

The board examined its options. “We thought about assessments and maintenance increases and, alternatively, borrowing, which would have resulted in maintenance increases above and beyond the normal operating increases, and that would have destroyed resale values,” recalls Bruce Cholst, a partner with the law firm of Rosen & Livingston and also a member of the board. “So the flip tax was the only viable alternative.”

The directors examined the obstacles ahead and carefully planned their route around them. As an attorney specializing in co-ops and condos (but not representing his own building), Cholst had seen many flip-tax proposals go down in flames. He was determined not to let that happen here.

On Message

The first step was to develop a message that offered a rationale for the flip tax. “What you have to do – and what was intrinsic to our success – was to devise an effective message and then broadcast it early and often,” explains Cholst. The message: we need money for immediate and long-term building needs, and the flip tax is the most painless way to get it. That was repeated with several different variations of language, says Cholst, “so, that ultimately, it sank in by osmosis.”

The board launched a trial balloon at the May 2005 annual meeting. Cholst gave a speech about imposing a flip tax, which was presented as an alternative to a maintenance increase; the co-op had already had two such raises (of seven and eight percent) in the last two years after having gone 13 years without one. Cholst explained the capital problems and the limited options available. “I talked about flip taxes as a possible future way to deal with the situation, and we took a show of hands to see what kind of interest there was. This was a full year before it was actually implemented. We were encouraged because, out of about 100 people there, we got at least half who said they would be interested in hearing the particulars.”

In early January 2006, the board sent out a newsletter that again laid out the rationale for the flip tax – which had not been officially presented yet – and announced an informational meeting for the end of January. At that gathering of about 150 people, two board members spoke. Ken Zakin, the vice president, dealt with the financial rationale, employing a PowerPoint presentation and a chart that showed what could have been raised in revenues over the previous five years had the proposed two-percent-of-profit flip tax been in place. The other speaker was Cholst, who described the nature of the proposal and the legal process. And then the board fielded questions.

Be Flexible

The board got a lot of feedback – mostly, Cholst recalls, in the nature of “controlled skepticism.” There were a number of questions, some of which surprised the board. “We had an exemption for inter-spousal transfers,” says Cholst. “A number of people said, ‘What happens if we don’t have families? What happens if we don’t have spouses? That’s discriminatory. And what about transfers by wills and estates? What about trust transfers?’ So we listened very carefully, and at that point nothing was carved in stone. It was a mere proposal we floated, and we took that feedback and we modified the proposal. (We weren’t giving up very much, by the way. There have been very few inter-family transfers and very few trust transfers in our building.)”

By listening and responding to shareholder concerns, the board blunted the opposition, addressed the skepticism, and also demonstrated its responsiveness, which came in handy later when opponents accused the directors of being unresponsive. The board also promised to delay implementation of the tax for a number of months so that those who had apartments they were about to sell would not be affected. “That’s how we ultimately got those votes,” says Cholst.

Being flexible also meant using different forums to deliver the message. After that first building-wide informational meeting, the board sent out another newsletter reporting the changes and then announced that it was going to have informal lobby meetings. “We followed [the meeting] up very quickly, within a week, with the newsletter, summarizing our message, and again driving home the point and reinforcing it,” Cholst explains.

The board also invited people to submit questions, promising to share the questions and answers with everyone in future newsletters. “So, that really gave us an opportunity to have dialogue and to publicize it,’’ says the attorney. “Each time we got a question, we wrote a little newsletter about it. And then we had a series of informal meetings in our lobby that were each attended by maybe 30 people every time. We began to hear the nature of the opposition, and we began to craft rebuttal points.”

The biggest issue seemed to be the sponsor’s exemption. Many shareholders asked, “If he doesn’t pay a flip, why should we?” The board’s response was (a) some revenue is better than no revenue, and that (b) the sponsor is protected by the terms of the offering plan, so the co-op couldn’t do a thing about it. “We explained that it would be a disappearing problem because our sponsor is actively marketing apartments,” Cholst notes, adding: “We pointed out that the sponsor doesn’t completely get a free ride when the real estate tax abatements and corresponding assessments are administered. Everyone else just gets a credit against the abatement. The sponsor doesn’t; he has to pay his assessment of real estate taxes out of pocket. And, this year, the sponsor’s share was $70,000. So, that soothed a lot of people.”

The board also addressed an argument that flip-tax income is sporadic and undependable, arguing, “You can’t look at it one year at a time, you have to look at it over the course of five years. History shows that over the course of five years, even with fluctuations in the market, there are ever-increasing sales so, over a five-year period, the flip income would be there and would be a dependable source.”

Some brought up the old argument that it is not fair to hit people on the way out. A number of owners, particularly the ones who were planning to leave and move out to the suburbs soon, argued that they would rather pay as they went, via maintenance increases and assessments. The board responded by explaining why such increases and assessments would destroy resale values.

“It’s one thing to say and it’s another thing to explain it. We thought it was very important to actually explain it,” says Cholst. “So, what we said was, number one, if we’re having regular operating cost increases, adding to that additional maintenance increases or assessments would put us at a competitive disadvantage with other buildings who have the benefit of flip-tax revenue. We repeatedly cited Habitat’s article [on the subject] and even distributed a copy of the article. So, we said we’re at a competitive disadvantage with those buildings that won’t have that extra maintenance increase, and it’s a well-established fact that buyers compare carrying charges when all other things are equal. And the second thing is, if a prospective buyer doing due diligence sees that the building has to have capital projects but has no available source of funding, then they’re going to draw the conclusion that maintenance increases and assessments are coming down the pike. Therefore, the perception was going to be that this was not a desirable building, and they would use that to negotiate a lower purchase price.”

The subliminal point was: “We’re ahead of the curve. We’re looking down the road.” Notes Cholst: “This is all part of the idea of repeating our message early and often, and, in effect, badgering people to the point of being borderline obnoxious. We were forcing the issue into the consciousness, which I think is a very, very crucial part.”

More Steps

The board followed a number of other steps before getting to the final vote. The advice gleaned from the directors’ experience includes:

Anticipate arguments. Anticipating arguments that a flip tax would hurt resales, Cholst persuaded a broker in the building, who had sold a number of apartments, to sign a letter that validated the board’s position. “That really did help, because it came from an objective person who could have been expected to have an interest against the flip proposal,” says Cholst.

Campaign. Starting about six weeks before the annual meeting, the board began its personal, door-to-door and phone-to-phone lobbying campaign by three board members (Cholst, Weiswasser, and Andrew Weiss) and eight non-board volunteers. By this time, the board had about 50 percent of the proxies. “To inform, that was our point,” Cholst says. “We’d ask, ‘Is there anything we can tell you about the flip tax? Any questions we can answer? Can we have your proxy?’ Often, we had to call the same people four or five times.” There were also about 25 absentee shareholders who were contacted.

In addition, the people who were doing the door-to-door campaigning met three times weekly or talked over the telephone at least three times a week to compare notes, offer feedback, and discuss arguments that they were getting, with an eye to refining their methods. They also had a spreadsheet, charting the percentage of votes in favor.

Know your residents. What also helped was having long-time resident Sandy Weiswasser on the board. She had been there for 32 years, and had conducted nearly every admissions interview for many years, so she knew everyone. “She knew whose apartment was on the market and therefore who not to bother to hit,” Cholst explains. “She knew who was angry with the board for whatever reason, and who not to waste time on, and that really did help. With so many people to go after and limited time, we were able to marshal our resources.”

Adds Weiswasser: “When you come across somebody who says, ‘I’m moving; I’m putting my apartment on the market in September,’ then why go there? Nothing’s going to happen. Don’t waste your time on it. Move on and deal with people you can convince or make them understand how it benefits them.”

Avoid “horse-trading.” One of the things the board encountered was a few shareholders who tried to engage in “horse-trading,” which was rejected because it was illegal. For example, the biggest single shareholder, who has three apartments and 1,000 shares, wanted permission to put an enclosure on the terrace, which was against building policy. The board refused. “Other people wanted alterations or wanted repairs for which the co-op was not responsible [in exchange for their votes], and we just said no to them,” says Cholst.

Respond quickly to criticism. The board got an anonymous letter, distributed building-wide, a few days before the vote, and responded within 24 hours, rebutting every point.

Be fair. It is important to give the opposition equal time at the annual meeting. The board invited representatives from the opposition to come to the voting session and have exactly equal time as the proponents. “You have to come across as calm and fair and honest,” Weiswasser notes. “There’s no point in misleading people. It’s not for everybody.”

Payoff

In the end, the board’s approach worked. The flip tax ended up with 79.5 percent of the shares voting in favor of the measure. Cholst feels it was a success because the campaign reinforced what a co-op is supposed to be about: teamwork: “When you’re working as a team, you have to be consistent in your message. People can’t start saying different things to different people. You have to work out the pitch and have everybody comfortable with the message you’re trying to convey. The other thing we did, at least in the beginning, was we had our cadre of [campaign] people, and we tried to match them each with people they knew within the building, which was important. If there’s a personal bond, the ‘sale’ will be a lot easier to make.” He adds that starting to campaign early is key. “It was absolutely crucial to start early, months before the meeting, because this is an important message to get out. We had a lot of obstacles.”

“If you listen to people, you pretty much know where to go,” concludes Weiswasser. “It’s a constant work in progress. You cannot sit back.”