The Last Great Deal

Times are tough and likely to get tougher, but that hasn’t stopped one Manhattan co-op from landing in some very deep clover. Through a combination of management foresight, board harmony, expert professional guidance – and a healthy dollop of good luck – the 167-unit co-op at 201 East 79th Street on the Upper East Side recently sold off the bulk of its ground-floor commercial space for the princely sum of about $20.5 million. Significantly, the sale was completed on September 12, 2008, a few days before the global economy started swirling down the drain.

Today, with credit increasingly tight and maintenance payments edging upward citywide, this co-op is enjoying a 24 percent reduction in maintenance, thanks to the deftly executed and timely sale.

“We managed to close a major transaction and get a new mortgage without a hiccup,” says the co-op board’s treasurer, Stanley Nasberg, unable to keep a tone of wonder out of his voice. With a shrug he adds, “It always helps to be lucky.”

But co-ops, like people, tend to make their own luck, and 201 East 79th Street is living proof of this maxim. To understand why, you need to know a bit of history. Built in 1964 and converted to a co-op four years later, this 22-story building operated for many years under a “ground lease,” meaning the corporation owned the building but not the land it sits on. When the lease came up for renegotiation in 1988, the board was eager to put an end to this expensive and undesirable arrangement. So, the co-op bought the land for $16.5 million. But freedom from rent brings responsibilities – in the form of a new $19.2 million mortgage that required a significant jump in maintenance. It was then that the board made the first of many farsighted decisions.

“They decided that since the maintenance was high, they needed to offer more services,” says Gerard J. Picaso of Gerard J. Picaso, who has managed the property for the past 20 years. “Their idea was to have Park Avenue services on Third Avenue.”

An elaborate upgrade was begun. A concierge shift was added, porter shifts were increased, and a gardening service was brought in to spruce up the portion of the garden that’s visible from the lobby. Also, a new resident manager (superintendent) was hired and charged with tight oversight of the 18-member staff. The lobby was renovated, the elevators were rebuilt, and the hallways redone. Handicapped and baby-carriage access was enhanced at the rear entrance on 80th Street. The property is kept spotless.

“This building has been very, very lucky,” says Picaso. “They’ve had astute boards that realized that in order to keep the value of apartments appreciating, you have to invest in the building all the time.”

Despite the constant upgrading, a major problem remained. The building’s commercial tenants – eight stores and a garage – were enjoying rents far below market value because the co-op had to conform with the so-called “80/20 law,” which stated that co-ops would enjoy certain federal tax benefits only if 80 percent of their operating funds came from shareholders and no more than 20 percent came from commercial rents.

About four years ago, Picaso began researching the benefits of selling the commercial space instead of collecting underpriced rents.

“He thought there was real value in the stores, and so did I,” says board treasurer Nasberg, who owns an accounting firm. He and Picaso sat down and worked up some “rough numbers” about what a sale might do to monthly maintenance payments. They liked what they saw.

Meanwhile, Picaso brought in Richard Siegler, an attorney with Stroock & Stroock & Lavan who has helped countless co-ops navigate the sale of their commercial spaces over the past quarter-century. Siegler, in turn, recommended a number of appraisers and brokers. The board hired Cushman & Wakefield as appraisers, and Douglas Elliman Property Management to co-broker the deal with Picaso. Siegler also secured an Internal Revenue Service ruling that would allow the co-op to convert commercial space into residential shares, with the understanding that the buyer would, as a member of the corporation, be free to use the space for either commercial or residential purposes.

“We had a lot of smart people on the board who understood finances,” says Picaso. “The goal was to maximize our equity by selling that space and at the same time paying off our $19.2 million mortgage, which we had refinanced a couple of times since the purchase of the land.”

One of the key decisions by the board at this time was to keep the process streamlined so that information flowed quickly and accurately between the various professionals and the board.

“The president at this time [the late Dr. Charles Nechemias] gave himself and myself the job of doing some due diligence,” says Nasberg, the treasurer. “Since I’m an accountant it was pretty easy for me to get a feel for the possibilities, and we presented those possibilities to the full board. We talked to Richard Siegler about what a sale would do from an 80/20 point of view. It became pretty obvious that selling the property made the most sense – if the price was right.” The price was likely to be very right – somewhere between $20 million and $22 million, according to the appraiser.

Then the 80/20 law was amended in late 2007, which, intuitively, might have made selling less attractive. But the appraiser’s number was so high that only stratospheric rents could come close to matching it. More importantly, a sale would allow the co-op to pay off its mortgage. Selling still looked like the way to go.

For potential buyers, Siegler drew up a long list of business operations that would be barred from the seven commercial spaces. Unwelcome were massage parlors, restaurants, bars, nightclubs, and liquor stores, to name a few. (The 67-space garage and a Chase bank branch would continue to rent their spaces from the co-op.) In April of 2008, just as the credit crisis was beginning to brew, a buyer was found: INT Realty. But even with the $20.5 million from the sale, the board was in for some more moments of anxiety. “I actually wondered, given what was starting to happen in the economy, if we were going to be able to secure a new mortgage,” says Nasberg.

His fears proved groundless. The co-op was able to secure a $3.5 million mortgage, which, combined with the proceeds from the sale, enabled it to pay off the existing mortgage, cover the $4 million prepayment penalty, and reduce maintenance by a whopping 24 percent, beginning January 1, 2009. “It is,” says Picaso, “a win-win situation.”

All parties involved agree that there were two keys to this remarkably smooth transaction: the nimbleness of the board; and the competence of the professionals the board brought in.

“I believe that keeping the committee small and sharing information with shareholders was crucial,” says Amy Steiner, a marketing executive who has served on the board since 2005 and became president in late 2007. (After Nechemias’s death, she joined Nasberg on the two-member committee.) “I believe boards should work with a small team and try to anticipate the needs of the shareholders. We did our homework. We solicited advice from shareholders on how to invest the proceeds of the sale.”

Nasberg agrees. “I think it was important that we kept the committee small,” he says. “If we had to bring in a significant number of other board members, this would have dragged on and the deal would not have gotten done.” But, he adds, a board is only as good as its professionals. “I give a lot of credit to Jerry Picaso and Richard Siegler for guiding us,” Nasberg continues. “It helps tremendously when you have good outside professionals advising you. There was a very high level of comfort.”

Picaso, a guiding force in the sale, can’t conceal his satisfaction with the way things turned out. “Reducing maintenance by 24 percent – that’s a huge number,” he says. “And it has a ripple effect. The apartments will become more valuable. Hypothetically, the value will increase by the amount of the maintenance decrease. Now it’s a full-service co-op with low maintenance and increasing value. You can’t go wrong with that.”

But don’t expect this bit of history to repeat itself anytime soon. With the old 80/20 requirement essentially gone and the market turning soft, fewer co-ops are likely to sell their commercial space, and those that do are not likely to see this kind of eye-popping sale price.

“I’ve been doing deals like this since 1983, but I suspect this is going to be one of the last ones,” says Siegler, the attorney. “A lot of co-ops will want to hang onto their retail space as a hedge against inflation.”