Yesterday’s Numbers Forecast Tomorrow’s Expenses

All you can safely predict about numbers on a future budget is this: they’re going to go up. Too many variables can throw off any prediction. We’ve experienced dramatic events in the past decade that have affected the way buildings operate. The events of 9/11, the economy, the real estate bubble, the global banking crisis, health care costs, changes in the Internal Revenue Code; all have had an impact on the operations of properties.

It should also be pointed out that co-ops and condos are unique; each has individual characteristics, history, and an operating style that affects the way it functions and deals with increasing costs. To repeat: the only safe prediction one can make is that operating costs will continue to increase. However, no one can predict by how much. As a rule of thumb, I often recommend that maintenance/common charges should be increased by an average of five percent per year, which may be too high for some and too low for others. Although my rule of thumb may have worked in the past decade, boards must closely monitor their operating costs and design budgets that are realistic and cover their operating costs.

That said, one way to see into the future is to examine the past. And that means taking a look at the budget. (To simplify our discussion, I will use the acronym “CIRA,” which stands for Common Interest Realty Association, to refer to cooperative housing corporations, condominium associations, homeowners’ associations, time share associations, etc. It should also be understood that our discussion is focused on New York City CIRAs.)

A basic tool of management of a CIRA is the budget. On an annual basis, usually around September or October, board members and managing agents get together to project the CIRA’s operating costs for the following year. This is the basis for determining the level of common charges to be paid by the owners or members of the CIRA.

Creating an annual operating budget for a CIRA is straightforward. Most costs are relatively fixed; the board has limited control over a major portion (80 to 90 percent) of the annual operating costs. The board and its managing agent have a great deal of financial and operating data and information available, along with reasonable estimates, to develop cost projections for the large expense categories (e.g., real estate taxes, payroll, mortgage, etc.) in the annual operating budget.

In an effort to predict future operating budgets for CIRAs, I compared CIRA financial statements from 2011 to those of 2001. I looked for changes, trends, and patterns of the expense categories that had a material impact on CIRA operating budgets over the past decade.

Real Estate Taxes

While most readers understand the differences between a co-op and a condo, it should be pointed out that the major difference in the budget of a co-op is that it includes the expenditures for real estate taxes on the property, and in most cases, principal and interest on an underlying mortgage. For New York City co-ops, these costs generally account for 40 to 50 percent of their annual operating budgets. In a condo, those costs are paid directly by the unit-owners, and therefore are not included on the operating budget of the condo association.

The past decade has seen dramatic increases in New York City real estate taxes. Because these represent one of the largest expense categories for a co-op, the impact of this increase has been most pronounced. Most co-ops have seen their real estate taxes double, with some tripling in the past decade. Of the co-ops I surveyed, such taxes represented 26 percent of their total operating costs in 2001, while in 2011, real estate taxes grew to 36 percent of total operating costs.

This increase is the result of a combination of (a) the increased value of the city’s real estate and (b) the increase in the tax rate. Given the state of New York’s fiscal needs, it appears that real estate taxes will continue to increase, hopefully at a slower pace. In the short term, the New York City Cooperative and Condominium Property Tax Abatement Program, which has provided a partial tax abatement (17.5 to 25 percent) for most CIRA owners since 1996, is scheduled to expire June 30, 2012. Many real estate professionals are concerned that the abatement may not be extended or may be reduced. The expiration of the tax abatement may force an immediate increase of 5 to 10 percent on co-op maintenance charges because most co-ops have been offsetting the pass-through of the tax abatement to shareholders with an assessment to cover operating costs.

Payroll

Overall, payroll and related expenses of CIRAs have increased by approximately 50 percent in the past decade. If we drill down into the components, wages increased by about 35 percent and the biggest increase has been in the cost of health and pension benefits, which have more than doubled. In 2001, union health and pension benefits were roughly 18 percent of wages. In 2011, union health and pension benefits grew to approximately 32 percent of wages. The escalating cost of health insurance and the need to fund union pension plans are not only a CIRA problem. The cost of health benefits continues to increase, and union pension plans are underfunded. It’s anticipated that the cost of health benefits will continue to grow. The best we can hope for is slowing down the growth. We can also assume that wages will continue to grow to keep up with inflation.

Heating

Many CIRAs use oil to operate their heating plants. As we have all seen, energy costs have exploded over the past several years, with crude oil prices hitting a record high of around $150 a barrel at one point. Many CIRAs have been aggressive in implementing energy savings and improvements in an effort to contain energy costs. Heating plant components have been replaced to improve efficiency, dual-fuel systems have been installed to enable switching from expensive oil to cheaper gas, new windows have been installed and exterior repairs have been made to prevent heat loss, etc.

Unfortunately, conservation has not been enough to hold down heating costs. A comparison of 2011 heating costs reveals a huge increase, in some cases increasing by 200 to 300 percent over 2001 costs. I don’t think anyone expects a decrease in energy costs in the future. The problem is global; demand for oil is greater than the supply. In addition, oil prices are affected by events in the Middle East, arguably the most unstable region of the world. To add to the problem, New York City has mandated the phaseout of No. 6 heating oil and conversion to a cleaner fuel alternative by 2015, which will probably mean higher heating costs for CIRAs.

Insurance

CIRAs have also experienced astronomical increases in insurance premiums in the past decade. Many CIRAs have experienced 100 to 150 percent increases, some have seen 200 to 300 percent increases, and a few have had increases that are almost 400 percent. In the aftermath of 9/11, insurance premiums for CIRAs skyrocketed as insurance companies attempted to deal with the risks associated with terrorism, especially in New York City. The past several years have seen insurance premiums level off. Hopefully, such premiums have stabilized, with modest inflationary increases in the future.

Mortgage Costs

Finally, we have a category where costs have decreased in the past decade. Interest rates have plummeted in the past several years to historically low rates. In some cases, co-ops have been able to refinance their underlying mortgages at interest rates that are around four percent, and many refinanced for interest-only mortgages. The low interest rates have enabled some co-ops to borrow additional funds for building improvements without increasing their monthly expenditures for debt service. Instead of accumulating or assessing for major repairs and improvements, they’ve borrowed and deferred payment into the future. ?I fear that in the future, interest rates may not be as low and the cost of borrowing will be significantly higher; eight percent interest rates are not far-fetched. For CIRAs that took advantage of the low interest rates and increased their debt, the increase in interest rates will be more painful when they need to refinance. They may be paying higher interest on more debt.

So what, in the end, do we learn from all this data? While certain cost components of the CIRA budget experienced drastic changes, overall, CIRA operating costs increased by an average of approximately 60 percent over the past decade. The increases vary depending on the type of entity (co-op costs increased by about 62 percent, condos by approximately 56 percent), location (some CIRAs in the outer boroughs had only 30 percent increases, while some Manhattan CIRAs had 90 percent rises), size of property, number of employees, level of amenities, and so on.

Think about that.

Abe Kleiman, a certified public accountant, is managing partner at Kleiman & Weinshank.