Investing In-House

Eric Goidel couldn’t believe what he was about to tell the board at the Birchwood House, a 153-unit co-op in Jackson Heights, Queens. He was bluffing, but this was high-stakes poker for the board’s own good.

Myles Horn, a developer and the holder of the unsold shares of 12 apartments containing rent-stabilized tenants, wanted to sell those units in a bloc rather than holding on to them as a rental landlord and eventually selling them piecemeal. He decided his best option was to sell them to the co-op corporation itself. The co-op’s management company at the time, John B. Lovett & Associates, and Goidel, the board’s attorney, both agreed this seemed an excellent long-term investment for the co-op, which could eventually sell the units at a profit.

“I believe that the break-even point would be around five apartments,” says Goidel, a senior partner at Borah, Goldstein, Altschuler, Nahins & Goidel. “This would mean that half of the resales would be essentially pure profit.”

But the $1.3 million price tag back in 2010, when the sale was proposed, made the co-op board uneasy. “I almost had to shame them into buying the package,” Goidel recalls, “by telling them that if they didn’t want to do it, I was going to ask them for permission to let me put together a group to do it – which I honestly didn’t intend to do, because it would have been a conflict of interest. But I figured that was the way to get them to focus on it. If I thought it was such a great deal that I might find people willing to buy, then they should do it.”

Ed Callery, treasurer of the seven-member board, says with a chuckle, “You know, I actually remember him saying that.” The building had just drawn down its reserves for a mandated Local Law 11 facade project, and it would have had to take out a second mortgage in order to buy the 12 apartments. “We did what a board is supposed to do,” Callery says, “which is be skeptical and make sure that what we’re doing is in the best interest of the shareholders.”

Taking the Plunge

The Birchwood House board, despite its initial reluctance, considered the offer very seriously. “When you’re presented with an opportunity that you’re hoping pushes you into more solid financial ground, you have to really look at it,” Callery says. “What you’re hoping for is to get positive cash flow over the debt service.”

Buying those units meant the co-op would no longer receive the monthly maintenance that the apartments’ owner had been paying. Callery says the board tried to gauge, over the short term, whether the rent would cover the additional debt they would take on. Turns out it wouldn’t, but that wasn’t necessarily a deal breaker. “The differential between the rent-stabilized rents for the apartments and the maintenance that would have been paid by a shareholder was not in the aggregate too negative,” Goidel says. And long-term, the board projected that the apartments’ value would rise, returning more on the investment than certificates of deposit or money-market funds.

One thing working in the board’s favor was that apartments with rent-stabilized tenants sell for less than vacant apartments. In July 2010, after much discussion, the board approved the purchase of the 12 apartments for $1.3 million – just over one-third of their market value, according to Goidel.

“I remember everybody being in favor of it – but with cautious optimism,” Callery recalls. “It wasn’t just the numbers, because numbers are fungible. It was a combination of the numbers and the trust that we had in our advisers that allowed us to make that decision.” In addition to its attorney and property manager, the board was guided by its accountant, Rick Montanye, managing partner at Marin & Montanye.

In the decade since, Goidel says, the board has sold “four or five” of the dozen apartments, renovating and flipping them after rent-stabilized tenants left through natural attrition. The board has gone on to buy apartments from shareholders or their estates, plus one at auction following a shareholder eviction for nonpayment.

The building’s current 11 rental apartments – a mix of rent-stabilized and free-market units – constitute 7.2% of the corporation’s shares but provide 10% of the maintenance revenue, says Andre Kaplan, chief financial officer of the co-op’s current management company, Orsid Realty. The math gets even better. According to the current board president, Jacob Feldman, the average studio apartment in Jackson Heights sells for $250,000 to $275,000 and the average one-bedroom for $350,000 to $500,000. “So,” he says, “conservatively we’re looking at a combined value of $4 million to $4.5 million.”

Risk Management

But that’s only if – and it’s a big if – the apartments are vacant. The risk that any sponsor, developer or buyer runs is that a tenant could decide to stay for 20, 30, or 40 years.

To track its holdings, the board maintains a spreadsheet of the rental apartments’ leases. For the current five free-market apartment leases, which the board is not legally required to renew, the spreadsheet tells the board when apartments might be available in case of a need to sell.

“We’ve tried to spread it out over the course of the year, to allow us some flexibility,” Feldman says. “We don’t bundle them all in January. Should we have a major capital project coming up, we can target an apartment that we want to sell in case we need to raise funds. We haven’t had to do it yet, but we plan ahead for that.”

Since the sale, has the board considered offering rent-stabilized tenants a buyout to vacate? “We had a fairly good reserve fund at the time, and we had just refinanced the building mortgage, so we were in a strong cash position,” Goidel says. Horn, the holder of unsold shares who sold the apartments to the co-op, had already tried to buy out tenants, and failed. “So,” Goidel says, “it was unlikely that we would be successful where he was not.”

Due Diligence

Certain conditions have to be met before a board can buy apartments. “Have your counsel check the bylaws to make sure you can do this without shareholder approval,” Goidel advises. “You might need a shareholder vote to acquire apartments. Also, most co-ops have underlying mortgages, so you need to check the loan documents to see whether you have the right to do this without lender approval.”

Of course, boards must exercise due diligence. “You want to do a search at the DHCR” – the Division of Housing and Community Renewal – “to make sure the apartments have been properly registered by the seller and have been continuously registered every year,” Goidel says, “because there is the prospect of overcharge complaints. You want to be satisfied that the rents being billed are properly collectible.”

In the end, striking the proper balance is the key, according

to Goidel: “Buying rental apartments has a place in

terms of investment strategies, but you shouldn’t go overboard. It’s one thing maybe

to own 5 or 10% of your apartments. It’s another to own 30, 40, 50% of the apartments. That could be a disaster.”

Sidebar: Buyout Blueprint

By Frank Lovece

Your board has signed the deal to buy rent-regulated apartments in your building, and now you want to sell them at a profit. However, there’s a big hurdle: Tenants in those units have the right to renew their leases, and a family member who has lived there at least two years can take it over when a tenant relocates or dies. Eviction is possible if the tenants aren’t legally entitled to live there. (The state’s Division of Housing and Community Renewal has a registry listing all rent-regulated leases.) Otherwise, eviction is difficult, particularly under the COVID-19 Emergency Eviction and Foreclosure Prevention Act of 2020, which places a moratorium on residential evictions until May 1, 2021, for tenants who have endured COVID-related hardship.

But there’s always the buyout option – offering the tenants cash or other considerations either before or when their lease expires. Here are the three steps boards should take to complete a legal and amicable buyout:

1. Determine a reasonable price. “The real value of a buyout is avoiding litigation,” says Andrew Stern, a partner at the law firm Tane Waterman & Wurtzel, who suggests calculating the costs of court and attorney fees and using that as a baseline number for a buyout offer.

2. Approach the tenant. This is where boards must tread carefully. “You have to include a written component in order to demonstrate that you met the requirements of the anti-harassment laws,” Stern says. If there’s no response, follow up with an in-person visit. “When you knock on the door, bring someone who has a relationship with the resident, so that it doesn’t appear predatory in any way,” he says. “Explain that the board is interested in buying out the lease and would like to offer something in consideration, whether it’s cash, a waiver of rent arrears or whatever deal the board determines is appropriate.”

3. Inform of the right to refuse the offer. Stern goes a step further by directing tenants to the Department of Housing Preservation and Development’s “ABC’s of Housing” handbook. “What you’re really doing is inviting a conversation,” he says. “The resident may need an extra month or more to leave – or may want more money or another structure to the buyout deal. You want to arrange for a parting of company that’s acceptable to all.”