A Second Chance Eleventh Hour Rescues of Failing Co-ops

While the real estate market today is going strong, there are still buildings facing financial troubles. Many of these are victims of the collapsed real estate market of the late 1980s and early ‘90s. The market may have dropped after the conversion of a building, and subsequently the sponsor was not able to charge the rents necessary to meet his maintenance obligations. Eventually the sponsor defaults. It’s then up to the co-op to make the payments, but they are in no better position than the sponsor was. With no cash to refurbish empty units for rental or to do even basic building repairs, the situation worsens. It can be almost impossible for a co-op to pull itself up by its bootstraps once it’s headed for foreclosure.

The situation may not be beyond hope, however. While the co-op itself may not have the resources it needs, outside investors with money, connections and creative deal-making abilities may just have what it takes to pull a building back from the edge, and make some profit for themselves along the way. These investors are often known as "White Knights," and here are a couple of their stories.

To The Rescue

The Orchard is a 480-unit garden apartment development in East Windsor, New Jersey that was built in the ‘70s. It has a pool and bright, airy apartments that look out over 35 acres of lawn and trees. But until a "White Knight," Jules Reich, chief executive officer of Somerset Investors Corporation (SIC) of Great Neck, New York showed up, the place was run-down, vacant units were a mess and could not be rented, and about 300 shareholders faced the loss of their equity.

Originally converted in 1985, problems arose in the early ‘90s when the real estate market took a downturn. The sponsor was unable to cover payments, and ended up walking away from the project. The co-op then tried to cover payments, but there was a shortfall, and they couldn’t increase the maintenance. As tenants moved out, they did not have the funds to refurbish and rent the 170 apartments eventually left vacant.

Rehabilitating abandoned apartments is an expensive undertaking. "First you have to take out the broken furniture and such that was left," says Reich. "Then, without remodeling–we’re talking new carpet, plaster and paint–$4,000 to $6,000 can be spent in a heartbeat." People in the co-op can’t cover maintenance payments on those apartments, that is, the sponsor’s maintenance, plus the refurbishing costs and so on."

Between 1992 and 1999, the co-op restructured its debt with the lender three times. The downside to that was, each time the lending institution agreed to lower the interest rate, the difference was accrued, increasing the back-end debt. Finally, the co-op’s bank called on Reich, and offered to sell him the underlying mortgage at a discount provided he agreed not to foreclose on the co-op. Reich was amenable, and proceeded along with SIC’s In-House Financial Analyst Jeffrey Bookman to work out a plan that not only saved the co-op and allowed for major renovations, but actually lowered maintenance payments.

Adding Value

Reich was able to buy the mortgage of $12.8 million debt for $8.2 million. For this, the co-op gave him the original sponsor’s units, of which there were 170, mostly vacant. Because of the savings in interest payments on this reduced debt, the shareholders’ maintenance payments were lowered by $65 to $95 a month, depending on the size of the unit. SIC, through its contacts, was able to find a lender for the co-op so that it was able to pay off the original loan and the closing costs of the new one, and leave over a half million dollars in the corporation’s reserve fund. Further, SIC added value to the development by taking care of necessary renovations.

"We were able to make a win-win situation," says Reich. "The co-op was interested in 1) making the place nice, 2) lowering the maintenance, and 3) not being foreclosed! We were able to refurbish and rent at market value. The place is now very stable, with new roofs and lots of concrete work done. People feel a lot better–they have value now. We have been able to bring in end-loan lenders, banks that lend to individuals. They didn’t have that before because they were in default on their underlying mortgage."

Restructured and Affordable

George Filoupolis has been credited for saving the equities and homes of hundreds of people when he has come to the rescue of co-ops facing foreclosure. "Obviously I’m in business to make money, but the people element is a big plus," he acknowledges. Now 31 years old and in real estate over a decade, he has proved to have a talent for closing complex deals. In 1996, he formed his own real estate investment firm, Metrovest Equities, Inc. in Astoria, Queens.

One of his recent "saves" was Metropolis Towers, originally named Gregory Park, a 770-unit complex consisting of two 21-story high-rise buildings in Jersey City. Well-located in an area of tremendous growth and development, the complex was built as rentals using HUDfinancing in the early ‘60s and had good layouts. In this case, it wasn’t the market collapse that brought it down. Filopoulos explains, "The complex’s demise came about because it was organized improperly in the beginning." The sponsor defaulted on the payments. HUD took over and offered residents the opportunity to form a limited equity co-op in 1986; they had restrictions on resale values and on their ability to collect maintenance. Eventually, about 40 percent of the shareholders were unable to continue making maintenance payments.

The building fell into substantial arrears on its mortgage and its physical condition deteriorated. Most of the shareholders in arrears abandoned their apartments. In 1998, after ten years of non-performance on the mortgage, the 11th hour arrived. Unable to reach any financial resolution over all that time, HUD was finally forced to forclose. The building was set to go up for auction, and 420 shareholders were about to lose their equity.

The co-op had virtually no way to save itself. To begin with, the HUD loan was at $25 million with past due interest. While the co-op had assets in the form of 200 empty apartments (the other 150 apartments were rented), they didn’t have the money to rehabilitate and rent those apartments; they weren’t even meeting their mortgage. As Filopoulos describes it, "It was the equivalent of an eight-cylinder car running on three or four cylinders." He further explains, "It’s a chicken and egg situation. The co-op has units, but no one will buy them because the building is in foreclosure and people would be buying something that could disappear. And the co-op can’t find new financing because it doesn’t meet requirements. It needs someone to come in."

Enter Filopoulos. The first thing he did was have the co-op declare bankruptcy, which halted the foreclosure proceedings. Next he made a deal with HUD to pay off the mortgage at a discount, and brought in The Dime Savings Bank to finance the new underlying mortgage. He reconverted to a free-market co-op and issued new shares and leases to the shareholders.

Next, he worked with the board to determine how to enhance the value of the complex. He put about $8 million into renovations, including the repair of balconies and the exterior façade; the installation of new elevators and a new air conditioning system; and the refurbishment of lobbies, hallways and vacant apartments.

The deal was closed in December 1999. The shareholders have been able to keep their equity, and their maintenance payments were not raised. The apartments held by Metrovest are now completely occupied by people paying less than market value rents, as stipulated by HUD. Metrovest will recoup its investment in another year or so. And Filopoulos has the satisfaction of walking into lobbies that look very different from before and seeing people that are happy.

Thanks to "white knight" investors, many cooperators have been able to see their homes weather financial turmoil. Such investors can turn things around by negotiating financial restructuring, making necessary capital repairs, restoring the property’s integrity.

Ms. Goodman is a freelance writer living in Westchester.

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