PROTECTING YOUR RESERVE FUND, P.2

For years, my building's board carefully set aside funds for capital improvements and for the long-term goal of paying off the mortgage. Then a new board took control. Most of its members had no intention of staying in the building long-term, so they raided the reserves, subsidizing operating income with periodic withdrawals, and in a few short years wiped out the reserve fund. Then all those board members sold their apartments and left the problem to their ex-neighbors. As a result, maintenance was raised 35 percent in one year, capital improvement projects were deferred and the hard job of rebuilding reserves began again.

Rule 7: Enough Is Never Enough

How big should your reserve fund be? That depends on the age of your building, how many basic systems you must replace in the next decade, whether your can easily borrow money, and how tolerant your residents are to large, unexpected assessments.

Generally, condominiums have more difficulty than do co-ops in borrowing money for capital improvements. Many condo bylaws contain organizational restrictions that require unit-owner votes for major renovation projects or special assessments. Conversely, while most cooperatives are able to borrow money easily, they were generally conversions from rental buildings and the previous landlords often failed to address capital improvements adequately.

You need to always remember that since most buildings must address one major-system rehabilitation once every five years, and since high-rise buildings must also deal with a Local Law 11 repair project in that same timeframe, the capital needs in many buildings require $100,000 to $200,00 annually.

Rule 8: Develop a Strategy

There are many ways to create or augment a reserve fund. The most common are:

• Small periodic assessments. Many buildings assess the shareholders or unit-owners either one extra month common charges or maintenance each year or assess an amount equal to the shareholder's co-op/condo tax rebate and/or STAR refunds.

• Borrowing. Cooperative corporations are able to take advantage of low-interest rates and borrow extra money when their mortgage is refinanced. For example, if the mortgage interest rate is 5.1 percent and the co-op can invest the excess funds in CDs earning 5.5 percent, the cost of the excess money for the reserve fund is only 0.4 percent, which is tax deductible for the shareholders. Actually, some tax planners argue that, effectively, the entire 5.5 percent is deductible and that the entire 5.1 percent interest income can be sheltered by depreciation or operating losses on the building. But watch out for Regulation T.

• An apartment-transfer fee, colloquially called a flip tax.

Some examples of more creative solutions are:

• Right of first refusal. Most condominium associations have a right of first refusal to buy units when they are offered for sale. Co-op boards should consider adopting an amendment to their proprietary lease to allow this right. Several of our buildings earn significant income from buying and flipping apartments that owners offer for sale at a below-market prices. One of our co-ops actually purchased the sponsor's remaining unsold apartments and funded $6 million in capital projects out of the resale profits.

• Selling assets. These spaces include unneeded common areas (hallway dead ends, rear yards, rooftops), garage/parking spaces and professional or superintendent apartments. In each case, the sales proceeds of each are earmarked for the reserve fund.

• T ax refunds. The periodic settlement of tax certiorari proceedings offers an opportunity to dedicate the refund to future capital expenses.

• J-51 Benefits. When reserves are spent for capital improvements, many cooperatives are able to secure a New York City J-51 tax abatement. Discipline is required, but the savings can be dedicated to future capital improvements rather than to reducing the monthly maintenance.

Rule 9: Get Fidelity Insurance

Many buildings rely on the manager's fidelity bond or insurance policy to protect their reserves from theft. This is inadequate. First, even if your managing agent maintains your reserve accounts (which it should not), your loss from theft by an employee of the managing agent may not be covered. You should insist upon a special endorsement confirming that theft of your association's money by an employee of your agent is covered.

Second, what insurance company covers a loss caused by a theft from an officer or director of your housing company? While such losses are rare, they can involve millions of dollars. Your board should insist on its own fidelity policy.

Rule 10: Review Bank Statements

More than one board member should receive the monthly reserve-fund statements directly from the bank or investment firm. A copy should be sent to all board members, the managing agent and the accountant.

Rule 11: Trust, but Verify

Require two or more signatures for reserve-fund withdrawals. Both signatories should be board members.

Finally, your treasurer should not look at questions about expenditures and investments as a test of his or her integrity. All board members have both the right and the obligation to understand the expenditures and investments. Questions should be encouraged — because they help protect your building's most valuable asset.

James Samson is a partner in Samson, Fink & Dubow

Illustration by Danny Hellman

Adapted from Habitat February 2007. For the complete article and more, join our Archive >>