Fiscal Fitness

It’s what separates the co-ops from the condos and gives co-op boards both their fiercest reputation and their biggest responsibility: vetting a prospective buyer’s financial fitness. It’s an area fraught with pitfalls. Be too strict, and you get labeled a “difficult” building, which can hurt sales. Be too lenient, and you risk allowing in shareholders who may go into arrears.

“Boards have a fiduciary duty to make sure an incoming shareholder is financially viable and able to pay” the monthly carrying charges, says attorney Geoffrey Mazel, a partner at Hankin & Mazel. But how do you do that? Is there some statistical formula a board can plug numbers into that will pop out the answer – whether or not to recommend approval?

Sadly, no. There are no formulas, but there are guidelines, says Jesse Berger, an associate broker with Douglas Elliman Real Estate and the treasurer at his own co-op. Such guidelines differ from building to building, but they usually have room to be flexible. “It is rare for a co-op board to be absolute,” Berger says. Bruce Robertson, a broker with the Corcoran Group, suggests that boards take a holistic approach. “They should ask themselves, ‘What’s the big picture? How do we put the puzzle together?’”

“Some co-ops don’t even have set rules of thumb,” observes Stanley Greenberg, president of the 32-building, 1,024-unit Le Havre co-op complex in Whitestone, Queens, and a professional accountant for other co-ops. “It’s not a free-for-all,” he notes, saying there are commonly used guidelines. But different co-ops apply them differently. “Some co-ops have leeway,” he says, “and with others, if you don’t make the number, you’re out.”

Even if a buyer has qualified for a mortgage (technically, a co-op loan), it doesn’t mean he or she is automatically viable. “When I see they’ve been approved for a mortgage, that’s nice,” Greenberg says, “but we use our own criteria.” After all, ultimately, the board has to live with the buyer. The bank doesn’t.
How do you make sense of it all? What guidelines work? Are they purely mathematical, or do they also reflect a co-op’s culture? And how do you work up guidelines that make sense?

A Trio of Terms

First, don’t be put off by the responsibility or the number-crunching. It’s a lot simpler than it seems. And besides, says Mazel, boards usually have professional management, an accountant, and an attorney. “They’ll help with the process,” he notes.

Second, there are really only three terms a board member absolutely needs to know: down payment, debt-to-income ratio, and post-closing liquidity. The most familiar is down payment, that initial cash portion the buyer pays the seller, with the remaining amount to be financed by a bank or other lender. The down payment is an essential first hurdle. “If someone can’t come up with a down payment, it’s a non-starter,” says Berger. “Co-ops want owners to have equity in their homes.”

A down payment of 20 percent is typical but not universal. “For a plain-vanilla co-op, 20 percent is semi-standard,” says Berger. “Some places since the [2008 real-estate] crash raised it to 25 percent.” High-end buildings, like those on Park and Fifth Avenues, want at least 50 percent down; a few insist on all-cash purchases, with no financing allowed.

But that’s a rarefied realm. At Berkeley Towers, a 442-unit co-op in Woodside, Queens, president Gennaro Massaro says his board requires only a 15 percent down payment. Mark Ulrich, a CPA who is board treasurer of the 800-unit Bell Park Gardens complex in Bayside, Queens, finds 20 percent an unrealistic bar that discourages home ownership among young people.

“Twenty percent is from back in the day when co-ops cost a lot less,” Ulrich says. Fifteen years ago, an apartment in his neighborhood cost from $80,000 to $90,000. “But now with a $300,000 co-op, 20 percent is 60 grand. A lot of younger people may have good salaries, but early in their careers they don’t have that kind of savings. We’ve had so many young families come in putting 10 percent down that would not have been able to buy a home otherwise. We’ve been able to give them that opportunity. There’s no impact on the co-op if someone puts 10 percent down. All that does is trigger an insignificant amount of mortgage insurance” – typically done with down payments under 20 percent – “and that just factors into the debt-to-income ratio.”

Debt and Income

Which brings us to the second side of the triangle: debt-to-income ratio. This is simply the amount of a buyer’s monthly debt divided by his or her monthly income.

Let’s says the buyer grosses $10,000 a month after taxes and similar deductions. The mortgage and maintenance total $2,500, and a student loan and credit-card minimums total $500. So that’s $3,000 in monthly debt. All you do is divide 3,000 by 10,000 and you get 0.3, or 30 percent. Simple.
For most co-ops, the permissible debt-to-income ratio tops out at 25 to 30 percent. “But it does actually depend,” says Berger of Douglas Elliman, “because most boards also look at the overall financial picture. If someone is on Social Security and bringing in only $2,100 a month from that but has $10 million liquid in the bank, the debt-to-income ratio might not to be an issue.”

Such extenuating factors aside, anything up to 36 percent is a viable debt-to-income ratio at Le Havre, says Greenberg. At Berkeley Towers, notes Massaro, “we try to keep it around 25 percent, but in today’s world, 30 percent is more realistic since housing costs have really increased.”

Ulrich at Bell Park Gardens agrees. “We go with a 30 percent debt-to-income ratio,” he says. “But I’ve seen buildings accept up to 35 or 40.” The federal Consumer Financial Protection Bureau notes that 43 percent is, in most cases, the highest ratio a borrower can have and still get a “Qualified Mortgage,” a standard type of regulated loan.

Cash on Hand

The third side of our triangle, post-closing liquidity, is the amount of readily available money a prospective buyer still has after making the down payment. Robertson of the Corcoran Group offers typical examples: cash in the bank, a money-market fund, a stock fund, a stock portfolio. Even Treasury bills and certificates of deposit are considered liquid, since they can be cashed in early, albeit with possible penalties. IRAs and other retirement accounts are not considered liquid, nor are life-insurance policies, unvested shares of stock, or personal property such as real estate or artworks.

How much post-closing liquidity should a prospective buyer have? The old-school rule of thumb is two years’ worth, meaning the buyer has enough cash on hand to pay the mortgage and maintenance for two years in case his or her income ends for some reason, such as a job layoff or an illness. But again, that’s simply a guideline.

“It’s kind of arbitrary,” says Ulrich. “We don’t have a specific savings requirement. In the end, the co-ops are protected anyway; it’s not like the person’s going to take the apartment and walk away with it.”

“We do look at the amount of savings,” says Massaro, but he cautions to also check the average daily balance. Sometimes people borrow money to give an inflated picture of their savings. “Maybe someone floated them $200,000, and their average daily balance last month was $30,000 and this month it’s $230,000.”

“Boards sometimes will settle for one year liquidity and one year placed in escrow,” says Berger, a tactic that allows a prospective buyer to raise escrow cash by selling illiquid assets ahead of time. “Putting money into escrow is one way of curing questions in the minds of boards,” Robertson says. “Sometimes boards can let [buyers] draw down from it in the second year.”

For all three parameters, some boards make their numerical requirements known ahead of time to brokers and buyers, so as to avoid the time and trouble of vetting people with little chance of hitting those targets. Conversely, other boards might have no exact requirements, preferring to judge case by case. Or they may have requirements and, to keep their flexibility in decision-making, not make them known. A typical time frame from application to approval is two to three months, Greenberg says.

Find the Facts

Whatever your co-op’s way of doing things, the documentation in the buyer’s application – the “board package” – is essentially the same. Attorney Mazel and others recommend that boards verify a buyer’s employment through a letter from the employer, which will confirm position, salary, and dates of employment. A board might ask to see pay stubs. A board also needs to see tax returns, bank and brokerage statements to verify assets, and a credit report from one of the major reporting agencies. The report will reveal credit score, whether the Social Security number and current address are valid, any outstanding lines of credit, collection-agency activity, and other red flags.

“We used to send a letter to the bank saying that with the person’s permission we’re inquiring as to their accounts,” says Massaro. “But a lot of banks don’t want to do that anymore. They’re getting very difficult as far as verifying funds – they’re afraid of such consumer fraud as identity theft.” In that case, he says, the potential buyer must produce a bank-certified copy of their account statement.

With self-employed individuals, boards should substitute an accountant’s letter for the employer’s letter. It should state the job, the years of self-employment, and the person’s income history. “I look at the Schedule C on their tax returns and take the net number, not the gross reported on the board package,” says Greenberg. “Let’s say you made $250,000 but your expenses were $75,000. So then, to me, your income would be $175,000 for the debt-to-income ratio.”

Bonuses are a gray area. “A banker makes $300,000 but can get a million-dollar bonus,” says Robertson, the broker. “Is it guaranteed? No. No bank or company is ever going to say ‘guaranteed bonus’ or ‘indications are good he’ll get about the same as last year.’ If it really matters in order to push the person to a better-qualified status, that’s where we’ll supply a bonus history, which boards take into consideration. They may discount it a little bit if the economy’s down.” Some boards also check for criminal history. But beware: not all background agencies are completely responsible in expunging records when a conviction is reversed, or not mixing up the applicant with a different but similarly named person. “Some convictions might be 40 years old and meaningless,” says Mazel, “like a joyride in a car in the ’70s.” But if something seems relevant and serious and could negatively affect the co-op’s quality of life, he advises rejecting the application.

How do you factor in when a buyer’s parents or others make a gift of the down payment? “Whenever there’s a source of funds that aren’t the candidate’s own, that’s something you have to look at very carefully,” says Ulrich. “It may not be a gift but a loan that’s expected to be repaid. We don’t mind a gift as long as it’s documented with a gift letter,” containing signatures of the giver, the recipient, and a bank officer, plus a copy of the canceled check and, usually, a copy of the bank statement of the gift-giver to make sure the check cleared.

Don’t ask for a photo of the applicant or a marriage license, since that opens boards to claims that a rejection may have been based on race, gender, marital status, or some other protected class under federal, state, or city anti-discrimination law. An application form’s purpose should only be to have the requested financial data boiled down into one place for convenience. Any such form should be carefully drafted to make sure there are no questions that expose the board to liability, advises Mazel. And after a decision has been made, make sure the documents are destroyed. Boards can be liable if an applicant’s Social Security number or other sensitive data are misused.

Meeting But Not Greeting

The standard advice for co-op boards is to accept or deny the applicant before you get to the face-to-face admissions meeting, at which point it generally requires some extraordinary, unpredictable personal act to cause rejection. Financial fitness alone doesn’t mean an applicant will automatically win board approval. But a solid financial background is the single biggest factor, and the financial picture can be reveal surprising things, Ulrich says. “One applicant said in his initial documentation that he was single,” he recalls. “But on his tax return, he was married and filing jointly.”

After the board inquired about the discrepancy, the applicant said he was not married but was living with the mother of his children and was “practically married,” so they filed jointly. The board rejected the application. “It’s about ethics,” Ulrich says, referring to lying to the IRS. “Will that person make apartment alterations using a licensed contractor or someone off the books? The financial documents give you not only a financial picture, but speak a lot to character.”

Indeed. Massaro recalls one applicant who had all the right numbers on paper but was still rejected. “We don’t know where he was getting his money from,” says the president. Was he a loan shark? A hitman? A mobster? “We had no idea what he did for a living.”

“What do you need?” the applicant asked conspiratorially.

“We don’t need anything!” Massaro replied. “Thank you very much!”

Sometimes, a co-op board has to go with its gut.