When Owners Become the Bank

As a rule, co-op and condo boards achieve fiscal security through conservative strategies and long-range planning. But occasionally a dash of creativity can help.

That has been the experience of the co-op at 90 Riverside Drive, which enjoys sweeping views of Riverside Park and the Hudson River, and an enviable financial profile. This 106-unit building, built during the Roaring Twenties and converted to a co-op in 1968, enjoys low maintenance and solid capital reserves. The shareholders have never been hit with an assessment.

But as the board got ready to refinance the mortgage, a round of mandatory Local Law 11 (LL11) repairs came due in the summer of 2012, a year before the board’s latest 10-year mortgage expired. Once the LL11 work began, unanticipated repairs and expenses arose. By the summer of 2013, with the mortgage about to expire, some sort of interim backup financing became crucial for the co-op to cover the unanticipated bills.

The board decided to heed the advice of long-term treasurer Euval Barrekette and turn to shareholders for short-term “bridge” loans that would ensure a healthy cash flow until the mortgage negotiations were complete. (With the newly refinanced mortgage, the cooperative would pick up extra funds for various needs.)

“Sometimes our cash flow has appeared to be tight just prior to refinancing our mortgage,” says Arthur Sachs, a financial advisor who moved into the building the year after the conversion and has been board president for the past 10 years. “We want to pay our bills, and shareholders have been more than willing to lend funds at an attractive interest rate to provide interim financing.”

Gauging Shareholder Interest

So the nine-member board took the same unusual step it had taken twice before. It sent a memo to all shareholders outlining the need and terms for interim financing, along with a promissory note signed by Sachs. The shareholders’ loans to the co-op were to be unsecured, and they could not be transferred, assigned, sold, or pledged. The interest rate was “significantly” above money markets’ current rock-bottom rates, according to Sachs, which made lending money attractive to those who were sitting on cash. The loans were to be paid off as soon as the co-op secured the funds from the renegotiated mortgage.

“It’s better for the shareholders than earning nothing in a money market account,” says Sachs. Besides LL11 repairs, other expenses contributed to the board’s need for a cash infusion, he adds. “We had to do an incredible amount of masonry repair work, and we spent a lot more money than we’d budgeted,” he explains. “We also converted from No. 6 to No. 4 oil, and we’re in the process of installing a new burner on our backup boiler. We’ll probably convert to gas eventually. And we’re going to redo the roof as soon as the weather warms up.”

(This unorthodox arrangement is not suitable for all buildings. It assumes that a sufficient number of shareholders or unit-owners have liquid money they’re willing and able to lend. Many buildings simply don’t fit the bill.)

Help From Within

The response to the loan request was stunning. Nearly one-fifth of the shareholders offered to participate – and they offered twice as much money as the co-op requested. “We were over-subscribed for the amount we wanted and had to prorate the offers by 50 percent,” Sachs says. “We also had to set a maximum amount per shareholder, so that we could make it available to as many shareholders as possible.”

Despite the steep cost of the unforeseen repair work, the shareholders’ loans and the reserve fund were enough to pay the bills. When the mortgage refinancing was complete, the board paid off the loans, principal and interest, by the end of October – two months ahead of schedule. The repair work to the building was finished by the end of January, and at long last the sidewalk bridges that had been up for a year and a half came down.

“It’s [an unusual] situation,” says the co-op’s property manager, Annette Loscalzo of Argo Real Estate. “I’ve been in the business 20 years and I’ve seen co-ops lend money to shareholders to cover an assessment, then charge the shareholders interest. But this building paid interest. If other buildings could do this, I think it would be a wonderful way to tide them over.”

For boards considering such a loan arrangement, Sachs advises them to have their lawyer draft the memo to shareholders and the promissory note. That way, the shareholders and the corporation are protected and all legal requirements are met. If the memo and promissory note are properly drafted, Sachs foresees little to no risk unless the co-op board is unable to refinance its mortgage in a timely fashion.

“We had a commitment from the bank for refinancing prior to asking shareholders for a bridge loan,” says Sachs. “It can take longer than expected to close on the mortgage loan, and you might end up with a higher interest rate. We closed earlier than the [mortgage] expiration and locked in a lower interest rate.”

For those that qualify, it’s an idea worth considering. In the current climate of low interest rates, the benefits tend to multiply. “In this latest go-round,” says Sachs, “we were able to put a lot more money into the reserve fund because of low interest rates – without any pressure on our operating budget. We got a bigger mortgage for about the same monthly payment.”

It’s as good a definition as any of a win-win deal.