When you’re buying a condo or co-op in New York City, an important part of your due diligence is to look at a building’s financial health. Your starting point will be the building’s financial statement—of course it’s not the most fascinating read, so you may be relieved to know that the responsibility for making sense of it will fall largely on your attorney once you’ve put in an offer.
Still, you can take a look at financial statement any point in the process and understanding what you’re seeing can help inform how much you bid and might also give you an indication of whether a lender will be comfortable with your purchase.
Recent changes to borrowing guidelines by Fannie Mae mean banks are increasingly less likely to lend if the building you want to buy in has low reserve funds to pay for structural repairs, among other risky scenarios.
[Editor's note: A previous version of this post was published in March 2019. We are presenting it with updated information for December 2021.]
What you’re looking for in the financial statement includes consistency year over year, a healthy reserve fund, and whether or not there is any major work planned. What you find will tell you whether or not you might get hit with a large assessment in the near future. For additional reassurance you might also want to get your accountant or financial planner to look at the numbers.
What is the ratio of assets to liabilities?
A building’s financial statement typically opens with a list of assets, followed by a list of liabilities. You want to focus on current assets and current liabilities, says Michael Esposito, a certified public accountant with Wilkin Guttenplan, who has years of experience working with condos and co-ops in New York.
Often the building value of a co-op that was converted many years ago will be calculated in the low millions—this can be misleading because it is based on historical cost and depreciation that bears no resemblance to current market value.
Comparing current assets versus current liabilities gives you a better sense of the building’s cash flow—so that would be cash, receivables, and prepaid expenses versus accounts payable, any real estate tax abatements due, and accrued wages.
“You should have at least a 1:1 ratio, meaning you have enough current assets to meet your current liabilities,” Esposito says. This is typically called the working capital ratio.
“Anything better is great, but I would accept 1:1,” says Steven Wagner, an attorney and partner at Wagner, Berkow & Brandt (and a Brick Underground sponsor).
Is there a reserve fund?
A reserve fund is a co-op or condo’s rainy day fund—it’s the money the building has in the bank if a structural issue is uncovered, such as the roof starts leaking. It’s typically itemized on a financial statement as “other assets” and the industry standard is to have three months of carrying costs in reserve or a quarter of the annual operating costs.
While reserve funds have always been important in signifying a well-run building, the collapse of the Surfside condo tower in Miami has sharpened lenders’ focus on the aging infrastructure of buildings and the importance of having money available to address any issues that arise. A recent rule change by Fannie Mae prevents buyers from purchasing in buildings with reserve funds under 10 percent of the operating budget or where repairs have been deferred or unsafe conditions have been identified.
Previously condos were allowed to show lenders a reserve study for a building but now that’s not going to be enough to satisfy the requirements for conforming loans. As a result buildings may start increasing their maintenance or common charges in order to meet the new minimum reserve fund level.
To the untrained eye, details about the reserve fund might not be obvious in a financial statement. Sometimes it is rolled into the working capital fund. Attorney Shaun Pappas, partner at Starr Associates, says depending on the statement, you might not see anything. That’s when your attorney will need to take a look and figure out what the balance is.
“The buildings are really not generating income so the balance should be what the condo holds year to year, which sometimes gets increased by the fact that there’s additional contributions over the years or monies held over from one year to the next,” Pappas says.
Are operating costs consistent year over year?
Ideally, you’ll see financials for the two most recent years. (If not, which could happen depending on when in the calendar year you’re buying, you can request a projected budget.)
How specifically expenses are itemized in this section of the statement will vary (some documents get into the nitty gritty in the notes section), but you’ll see line items for things like administrative expenses, operating expenses, and repairs and maintenance.
The main thing you’re looking for is consistency year over year. Obviously budgets increase and costs can increase but Wagner says the numbers from one year to the next should be fairly similar, within 2 percent. “It’s a hallmark of good management and reflects planning,” he says.
Pappas says boards spend a lot of time negotiating their service contracts and their insurance costs to keep finances consistent. As a prospective buyer, that’s what you want to see in the financial statement.
If there’s a significant increase in operating costs between one year and the next you’ll want to determine why, Pappas says. “Maybe there was a big capital improvement that was done, maybe there was an assessment made.”
What are the maintenance and repairs itemized?
Under the cash flow analysis, you’ll find details of the money being spent on capital repairs. This will typically identify the capital projects that are being worked on as well as repairs and upgrades carried out in the recent past.
Tara Brown King is an agent with Corcoran and says one of the biggest expenses for a co-op or condo is complying with Local Law 11, which deals with the facade. Finding out about repairs—including Local Law 11—is important.
“You need to know if you’ll be paying for that through an assessment or was it just done a year ago, in which case—hallelujah!—that’s a nice bonus for you as an incoming buyer,” she says.
If you see commitments, you’ll want to see how they will be funded. “Is the building going to refinance and increase the debt on the building?” Esposito asks.
A financial statement is a look at the past but it will also account for everything through to the date the statement is issued. “If they enter into a contract or a commitment for capital work by that date, like say an elevator, we have to disclose it,” he says.
How to interpret losses
It’s not uncommon for a building’s financial statement to identify losses. This isn’t necessarily a red flag but is one reason you’ll want your attorney or accountant to take a look at the books.
For example, the building may be characterizing an expense as a loss for tax purposes.
The biggest thing, Esposito says, is seeing whether the maintenance is efficient.
“If you look at the financial statement and you are generating large losses, that means your maintenance is not enough. The next year expenses go up but the maintenance is already short—you are going to see huge increases in maintenance,” he says.
What do the notes tell you?
The notes are what Brown King calls a “gold mine” of information. The notes will explain some of the numbers you’re trying to make sense of and also add some color about the building. For starters, the notes tell you the year the co-op or condo was founded. If it’s young, you’ll want to figure out if the board is used to running a building. Has the building settled and construction quirks been worked out?
The notes can also tell you if the building is involved in any litigation. This might not necessarily be a deal breaker, but you’ll want to know what it’s about and the amounts involved. For example Brown King asks, “Has someone slipped and fallen and is suing the building? If so, is there proper insurance for that?”
Other information in the notes might relate to commercial space owned by a co-op. Brown King says if retail space is owned by a co-op, it means the shareholders are getting the income from the lease.
“If that lease is Chase and they just renewed at market rate that’s probably having a very positive impact to the financial health of the building so you might have less carrying costs as an owner,” she says.
Other times you might have someone who is not paying rent and you’ll want to know that.
An audited financial statement is the highest level of service and would give you the highest comfort level. Esposito says most bylaws require audited financial statements, however, he works with an eight-unit co-op in Brooklyn that didn’t have a mortgage for years, and didn’t necessarily see the need for an audited statement.
On the other hand, he also works with a four-unit condo where the owners have known each other for years and ask for an audited financial statement every year.
—Earlier versions of this article contained reporting and writing by Mimi O’Connor.
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