No Escrow: Co-op Boards and Buyers Are Adjusting to New Norms

We all know what they used when they paved the road to hell. And while good intentions were at the heart of the state’s Housing Stability and Tenant Protection Act of 2019 – it sought to protect renters from unscrupulous landlords – the consequences have been hellish for co-ops. That’s because the law has lumped co-op boards with landlords since co-op boards have a landlord-tenant relationship with the shareholders in the corporation. The law put limits on evictions, late fees, credit-check costs and application fees, among other things.

Now another unintended – and unwelcome – consequence is playing out. By limiting security deposits to one month’s rent, the Tenant Protection Act has robbed co-op boards of a trusted tool when dealing with purchase applicants whose financial credentials are somewhat marginal: the escrow fund. Before the law went into effect, many boards negotiated an arrangement that granted purchase approval to marginal buyers if they put an agreed-upon amount of maintenance into an escrow account. Under some of these agreements, the money was refunded after a specified amount of time if the shareholder made timely payments; in extreme cases, the co-op held onto the money until the apartment was resold. If the account had to be drawn on to cover arrears, the shareholder usually agreed to replenish the account. All that is gone. 

“It’s definitely a problem,” says Steven Sladkus, a partner at the law firm Schwartz Sladkus Reich Greenberg Atlas. “I was just dealing with a 50-unit Manhattan co-op where the buyer was borderline qualified. The board liked the applicant and wanted it to work – if the buyer agreed to put a year’s worth of maintenance in escrow. I told them they couldn’t do it.” The upshot? “They’re still mulling over what to do.”

One workaround is to secure a guarantor who agrees to cover any arrears if the shareholder comes up short. “That might alleviate some concerns,” Sladkus says, “but the guarantor doesn’t put up money the co-op can put its hands on. Having another person on the hook is certainly nice, but it doesn’t put money in the co-op’s pocket.”

“It’s really a big problem,” agrees Daniele Kurzweil, a licensed sales associate at Compass. “The law was trying to level the playing field for renters, but it backfired. The unintended consequence of the limit on security deposits is that co-op boards are suffering. It’s a gray area. Technically, if someone who’s marginal is trying to buy into a co-op and offers to put up a year’s worth of maintenance in escrow, the board legally can’t do it. A lot of co-op boards aren’t doing it because of this gray area.”

Another unintended consequence of the Tenant Protection Act, according to Kurzweil, is that many co-op boards are beginning to realize that they’re working with “outdated numbers” on such things as minimum down payments, the buyer’s liquidity after purchase and debt-to-income ratio, and the percentage of income that goes toward housing costs. “We’re seeing co-ops changing their requirements, making it easier to qualify,” she says. “Instead of demanding a 50% down payment, for instance, they might be demanding 30%.”

Boards are adapting in other ways. Instead of considering only the applicant’s salary, Kurzweil says, some boards are taking into consideration bonus history if the applicant works in finance or other fields where annual bonuses are frequently far larger than salaries. Similarly, a new generation of buyers with extensive stock portfolios prefer to make smaller down payments and keep their investments intact – while taking advantage of low interest rates by financing more of the purchase price. Some boards are willing to listen. Kurzweil adds that the coronavirus pandemic – and the rising unemployment that came with it – have led some boards to put more weight on applicants’ job security than on their income.

So far, the changing landscape has not derailed sales, Kurzweil says, but it has forced her to more rigorously pre-qualify applicants before she shows them apartments and before they prepare their application packages.

One lawyer went beyond deriding the Tenant Protection Act for its “unintended consequences” and declared that it has turned co-op boards into “unintentional roadkill.” That may be a stretch, but Kurzweil believes the law, coupled with the fallout from the pandemic, has changed the game for co-op boards: “What was once the norm is now being reconsidered.”