Behind the Foreclosure Curtain

As the economy sours, some people are defaulting, and boards need to deal – or make a deal.

In golf, people warn of possible physical danger by yelling, “Fore!” In co-ops and condos, nobody warns of possible financial danger by yelling, “Foreclosure!” Maybe someone should.

When it comes to apartment-owners who can’t pay their monthly carrying charges, a foreclosure auction is, to paraphrase H. Rider Haggard, That Which Must Not Be Named. Irrationally, boards fear looking inept at managing their buildings’ finances. More understandably, they’re afraid that potential apartment-buyers may consider the building a shaky investment that, to use terms of both golf and money, may fall far short of the green.

Yet the possibility of an apartment foreclosure is one that all boards need to face and know how to deal with, even though the likelihood is fairly small among New York City co-cops and condos. Data from Crain’s New York Business and the foreclosure specialty-press Profiles Publications say the number of city foreclosures rose just 18 percent from the latter half of 2005 to the latter half of 2006, compared with 45 percent nationwide. In more recent and more economically troubled times, an August 2007 New York Post report cites figures from RealtyTrac that says five-borough foreclosures jumped 55 percent from a year before – in raw numbers, from 1,648 to 2,561 homes. But that mostly involved houses. For co-ops and condos in New York City, a clearer picture comes from the mere 12 percent rise that the paper reported for Manhattan, where apartments far outnumber townhouses.

Despite that relative rosiness, however, virtually no co-op.condo board member in a building with an apartment facing auction would speak about the subject when contacted. Nearly a dozen called simply did not call back at all, after two attempts each. Among those who did, two even denied an apartment was facing foreclosure, despite auction listings in legal notices publicly available on the web.

Why the zip-lipped panic? Jessica Davis, head of Profiles Publications and a lecturer at the New York University School of Continuing and Professional Studies, gives a safely out-of-town example of board member reticence. “There’s an expensive South [Miami] Beach condominium where half the people are not paying their common charges,” she says. “This building is fairly new, built in maybe 2004, with large, expensive apartments, a number of them belonging to team-members of the [NBA’s] Miami Heat. And the board is not going after anybody since it looks very bad if someone [on the outside] finds out that half the apartments in the building aren’t paying. Because once the board goes after them, it becomes public record.” If that happens, she says, “that may prevent people from buying a unit. A buyer doesn’t want to buy in if it’s a troubled building.”

It happens in rich and middle-class neighborhoods alike. “There are people whom you never in a million years would think are having financial problems,” Davis says. “Anybody can overextend themselves.” In mid-January, for instance, public records showed auctions scheduled for apartments in all sorts of neighborhoods at all sorts of price ranges, in such building lots as:

• 220 Riverside Boulevard, in Battery Park City, a 631-unit condominium where a fourth-floor apartment bought for $1.49 million in November 2005 had a lien of $823,179
• 381 Argyle Road, in Brooklyn, where a sixth-floor apartment bought for $89,610 in July 2005 had a lien of $78,586
• 338 West 19th Street, in Greenwich Village, where an 18-unit walk-up co-op had a lien of $106,844
• 40-48 Boerum Place/90-96 Schermerhorn Street, a 13-story prewar building in Brooklyn, where an eighth-floor co-op apartment, bought for $420,000 in July 2005, had a lien of $327,669

So if none of us is immune, no matter how monied, what can a savvy board do to minimize the impact on the building as a whole when one apartment faces foreclosure? Real estate professionals, foreclosure experts, and a few brave board-members offer some steps you can take – including a few that show some foresight in recognizing possible danger.

Three Months and Foreclosure

What exactly is foreclosure, and do you need a silent movie villain’s curled mustache to go about it?

Glibness aside, there are two main components – the foreclosure itself and the auction – and the process is different with co-ops and condos.

A condominium is valued as real property rather than as shares in a cooperative corporation, and so property law applies. In a typical condo scenario, says Ryan Slack, CEO of the real estate information site PropertyShark.com, “someone’s in over their head and stops paying the mortgage. After three months of delinquency, they go into default, and the bank sues them. In New York State, you have to go through the courts to foreclose, so a case gets filed at the supreme court and there’s a series of notices and affidavits that usually take six to eighteen months.”

The process starts with a “notice of pendency,” a document stating that litigation is, logically enough, pending. During this phase, called lis pendens, the person facing foreclosure can appeal. At some point, there’s a judgment. If the judge finds in favor of the plaintiff, he assigns a referee to conduct a foreclosure auction. “It’s published that there’s going to be an auction,” Slack says, “and four to five weeks later there is, and highest bidder gets the property. They have to put 10 percent down and close within 30 days.”

That time frame is a best case scenario, says attorney James Samson, a partner at Samson Fink & Dubow. “With a condo, even an uncontested foreclosure can take four or five years,” he says, “during which time they’re paying common charges or real estate taxes. Although,” he notes, “you can petition for the actual cost of maintaining the property – paying for the heat, keeping it insured, things like that.”

Another problem is that with condos, unlike co-ops, the bank that holds the mortgage has priority over the condominium getting its common charges. This means that whatever a property goes for at auction, the bank gets first crack at the proceeds. Only if there’s anything left can the condo association recoup its common charge arrears.

“Ever since court of appeals decided [the case of] Banker’s Trust vs. Pal, the bank holding the mortgage has the lien priority,” explains veteran real estate attorney Stuart Saft, a partner at Dewey & LeBoeuf, who also chairs the Council of New York Cooperatives & Condominiums. “If the amount of the sale is not enough to cover the mortgage amount, the condo would get none of its back common charges.”

The solution, he says, is for the condo to “file a lien against the unit for unpaid common charges, commence a lien foreclosure, and ask the court to appoint a receiver and have the receiver rent out the apartment and use that rent to pay the common charges while waiting for the bank foreclosure to be over.”

Tugging at the Lease

With co-ops, what is colloquially called a mortgage is actually a home loan under the Universal Commercial Code (UCC). A shareholder lives in the co-op unit as, technically, a tenant under the building’s overall proprietary lease. Since a co-op doesn’t fall under real property law, this means you can do a “non-judicial foreclosure,” which, says Samson, takes only about six months.

That’s if you’re aggressive, of course. Josh Salon, vice president of Manhattan’s Salon Realty, describes the recent case of an Upper East Side co-op his firm manages. “The shareholder wasn’t paying maintenance charges, and so, every three or four months, we’d have to initiate an eviction proceeding under the proprietary lease.” At that point, he says, the bank that held the shareholder’s loan “would step in and pay for her, which is great for the building [in terms of cash flow], but it’s a lot of paperwork and it’s a headache. After doing this four or five times, we finally told the bank, ‘Look, we’re sick of doing this,’ and asked the bank to push for foreclosure” on the $90,000 loan. “The bank did foreclose,” Salon says, “and the shareholder – whom nobody could get hold of – miraculously showed up and paid her maintenance charges. Once the bank filed the paperwork, it actually got as close to a day before the auction was to take place.”

Co-op foreclosure auctions, which generally don’t need to be arranged by a court, use a traditional auctioneer. New York’s grand old man in the field is 20-year veteran Bill Mannion, president of JP&R Advertising – whose company, despite its name, specializes in foreclosures and a hodgepodge of such other things as helping to expedite liquor licenses and nonprofit-foundation filings.

“Lately,” he says, “I’ve been seeing more and more co-op corporations going after shareholders for not paying maintenance. A lot of people are stretched out, a lot of people bought over their heads or through catastrophe or a family situation and can no longer afford to pay their mortgage or maintenance.” And maintenance is usually the first thing to go. Explains Mannion: “If they have a non-payment issue with the lender, that would more adversely affect their credit rating than not paying their maintenance.”

What should a co-op board do when a shareholder gets two or three months behind on maintenance? “My first reaction would be to turn it over to our legal counsel if they miss two months,” says Samuel D. Williams, board president at The Phoenix, the 32-story, 184-unit co-op at the building lot of 1090-1108 Third Avenue/187-193 E. 64th Street/158-160 East 65th Street. Managed by Suz Landi of David Frankel Realty, the building – there’s just one on the lot, according to the Department of Buildings – had a January 10 auction scheduled for a 30th-floor apartment with a lien of $264,936.

Jim Goldstick, vice president at Mark Greenberg Real Estate, agrees with Williams’s approach. A co-op board, he says, should begin foreclosure proceedings “once a shareholder falls behind in arrears three months at the max. Notify the lender that the shareholder is in arrears, and in the vast, vast majority of cases, the bank will then pay the maintenance to protect its lien, because the bank’s lien is subordinate to the co-op’s maintenance” – just the opposite from condos’ common charges.

It isn’t a pleasant task, and it’s worse when you have a small building where everyone knows each other. “Unfortunately, sometimes they’re your friends and neighbors” who may be facing foreclosure, says Goldstick. “But when you are elected to serve on the board of directors, you have a fiduciary responsibility to do what’s in the best interest of the co-op. And the co-op needs to collect its full revenue to pay its bills. That’s why you have a lawyer and a managing agent – we’ll do the dirty work,” he says. “If it means a foreclosure action to collect the arrears, we have to do what’s necessary.”

Hovering over all this is the recognition agreement, which the shareholder and the co-op each sign when the shareholder gets the mortgage. This agreement obligates the co-op to notify the bank in case of arrears to give the bank an opportunity to protect its lien.

“That doesn’t mean we don’t act like human beings,” says Goldstick, who adds: “Every meeting we go over the arrears report. If somebody had a death in the family or was sick, and the board knows about it, the board will be sensitive to issues of, ‘Well, he just got out of the hospital and let’s give him a month to get back on his feet.’ But those are few and far between.”

In general, “Before we serve a legal notice, we’ll either call or write the shareholder and give them the opportunity when they’re less than three months in arrears to try and work something out. But if they don’t call and they don’t pay, or if they call and don’t offer something reasonable, we have no choice but to turn things over to the co-op’s lawyers.”

By “work something out,” Goldstick means a payment plan. Gerard J. Picaso, president of the management firm Gerard J. Picaso Inc., describes one recent case “in a very good building where the owner of the apartment just went off his rocker a little bit and didn’t pay his bills. His wife separated from him, she moved out, and he just went to hell in a handbag. He stopped paying maintenance. We contacted him, he gave us a check, and the check bounced. We contacted him again, he got his attorney involved, and we made an agreement for him to pay off his five months of maintenance in three monthly installments. He made the first payment, then no others. That’s when we knew there was trouble, and our attorney started handling it.” The shareholder eventually sold the apartment, and the arrears were paid.

For Closure

In either condo or co-op, the procedural path to auction is straightforward. The building’s attorney “officially gives notice of the default, accelerates the note with the lender, and does a judgment-lien search for city, federal, and state tax liens that have to be noticed,” Mannion says. “In a co-op situation, you can basically go from zero to auction in 45 days, since you’re not going through the courts for a ‘judgment of foreclosure and sale’” as condos must.

The next step is to publish auction listings that will hopefully draw a crowd to the auction. “There’s no central place for this,” says Mannion, but real estate regulars know where to look. “A lot of these listings are placed in the New York Post, which is the least expensive of the major dailies,” he says. “That’s how all these [print and online] newsletters compile their information, by searching newspapers for listings,” and then adding details through public records searches.

Make sure the legal notice specifies the sale is “contingent on outstanding charges,” says Davis of Profiles Publilcations, “meaning that the successful bidder would have to pick up any unpaid arrears.”

Once foreclosure is a given, your building faces some rare opportunities. The biggest comes from buying the apartment and flipping it for profit to beef up the reserve fund.

Samson offers some hypotheticals. “Let’s say a condo that was bought for $200,000 is now in foreclosure by the bank.” he says. “You have three ways to attack it. One, buy the loan from the bank. The bank would love to sell you the loan – they really don’t want the apartment. It’ll maybe cost you $50,000. Now, you’re the one foreclosing. Two, go to the foreclosure auction and bid. You’ll maybe get it for $80,000 to $90,000.” In either scenario, if the ostensibly $200,000 apartment goes for even as little as $125,000 or $150,000, the building makes money. “And number three,” Samson says, “is you exercise your right of first refusal. No matter who is buying, match the offer if it’s a good, low offer.” If it’s low enough, you can sell the place at a profit. If it’s a little higher than that, the building can rent the apartment until the market improves.

The danger, cautions Saft, “is that you could misdiagnose the market and wind up having to carry the apartment for an extended period of time, so make sure you understand the [apartment’s] value before you do this.”

That holds true as well for a method called a “short sale.” That, says Slack of PropertyShark.com, is when “an arrangement is made with the lender to give them less money than they’re owed on the property.” And why would the lender accept that? “In order to facilitate transfer to an owner who could make payments.” A bank doesn’t want to be in the real estate business, after all. “So, say an apartment is worth $1 million, and the owner owes $1.2 million” because he or she had taken a home-equity loan and then market got depressed. “A savvy investor will say [to the owner], ‘We’ll negotiate with your bank,’ and the bank would reduce [the amount owed] to 82 to 88 percent of the value, so in this case $820,000 to $880,000. This gives a new buyer an incentive” – since he or she can get a million-dollar apartment for less – “and the bank has an incentive to keep the property out of foreclosure,” where the bank risks getting less at auction.

“Banks will cut deals; they will cut their losses,” Samson concurs. And a board, he adds, can even bypass the bank entirely. “Let’s say it’s a co-op loan for $100,000 on an apartment worth $190,000. You can go to the shareholder and say, ‘You’re about to get closed out, but we’ll buy it for $110,000.’ The shareholder – who won’t get anything if the apartment goes to auction – makes $10,000, and the building gets an apartment worth $190,000.” None of these hypothetical numbers figure in attorney costs, filing fees, and so forth, but you get the idea. “Half the auctions I schedule never occur,” Mannion says.

John Miller, board president of the 12-story, 41-unit co-op at 465 West End Avenue, agrees in principle that buying the apartment would be the way to go in foreclosure case. “This building would have the resources to buy the apartment and resell it. We would not be happy with the bank owning an apartment.” Miller says he was unaware that an 11th-floor apartment at 301 West 82nd Street/465 West End Avenue – a single building, according to the Department of Buildings – was scheduled for auction on January 9, carrying a lien of $190,510.

One board president who’s had experience with something similar, Lee Moskoff, is in her sixth year of heading up the 88-unit co-op at 3515 Henry Hudson Parkway in Riverdale, The Bronx. Her building did very well, she recalls, when it bought and sold an apartment, albeit in this case not through an arrears situation. “We bought it from the son of the deceased owner,” Moskoff recalls. “It was a question of the relative being not from the city and wanting to sell the apartment.” Alhough the son had kept up the maintenance fees, the principle worked the same. “Because the price was so low,” says Moskoff, “we bought it, and we were thrilled that [after flipping it] we ended up adding money to the reserve.”

Head ’Em Off at the Passbook

The best offense, however, is a good defense, to invert the old phrase. You want to watch for warning signs that will let you protect your building at the earliest instant. An arrears report should be part of every board meeting. And the board should be ready to raise revenue if a unit goes into arrears. Most co-ops and condos “have very small reserves and save them for emergency repairs,” says Saft. “If a condo [unit] goes into default and stops paying common charges, then the other owners have to pay more. If five percent of the budget isn’t being paid, you can’t discontinue five percent of the lights and electricity, five percent of the building staff.”

The most important preventive step a board can take, Saft suggests, “is to examine its bylaws in the case of condos and the proprietary lease in the case of co-ops” and make sure they include a right of first refusal in case of foreclosure, as well as a provision to recover foreclosure-related legal fees and expenses. “Most of these documents were written years ago when sponsors weren’t thinking of default. That’s something they should do today.”

Otherwise, just keep doing what co-ops especially are famous for doing. “Co-ops, in general, are very, very strict as far as financials are concerned,” says Davis, “and even if a bank were to say, ‘We’ve approved so-and-so for a mortgage,’ that doesn’t necessarily mean a co-op would approve that person’s finances. A co-op would be very unwilling to take someone with a sub-prime mortgage. Condos are actually tightening up a bit on what they require, as well.”

Some would-be buyers may get teed-off, but any way you slice it, that kind of approach will help minimize your building’s risks. For the sake of the many, it’s the fair way.