Not everybody on a co-op or condo's board is an accountant (or can even balance their own checkbook, for that matter.) Handling the money for an entire building is a big responsibility, however, and residents rely upon their board to make good financial decisions on behalf of the entire community and to protect its individual and collective assets.
Although the terminology is different, and the dollar amounts and orders of a much larger magnitude, at a fundamental level, managing the finances of a building is not so very different from managing your own finances. What is prudent for the latter is prudent for the former, and the mistakes people make managing their own money—using credit cards to pay for fixed expenses, for example—are the same ones board members often make.
Here are some financial basics, as well as a few common mistakes boards make when dealing with their proverbial pocketbooks—and how your board can avoid them.
What Am I Looking At?
"The financial statements of a co-op or condo contain the same basic information as that of a commercial business," says Carl Cesarano of the Manhattan-based accounting firm Cesarano & Khan. "The statements include the balance sheet, statement of revenues, expenses and accumulated surplus or deficit—also known as retained earnings—statement of cash flows, and notes to the financial statements. Building boards should use these financial statements in conjunction with a well-organized management report."
According to Cesarano:
• A balance sheet reports assets, liabilities and the difference between the two, which is referred to as stockholders’ equity (condos use the term "fund balance" or "members’ equity"). Assets are presented in order of liquidity, and liabilities are presented in order of maturity.
• The statement of revenues, expenses and accumulated surplus or deficit reports present information about revenues (maintenance or common charges, special assessments, interest income, administrative fees, etc.) and expenses (wages, real estate professional fees, taxes, etc.) The statement of revenues and expenses should also report the excess or deficiency of revenues over expenses for the period as well as a reconciliation of beginning and ending accumulated surplus or deficit with results of operations for the period.
• The statement of cash flows is a reconciliation of the balance of cash at the beginning of the year to the balance at the end of the year. It provides an analysis of the excess or deficiency of revenues over expenses to cash flows operating, investing and financing activities. In short, it measures changes in the balance sheet, as well as the bottom line from operations to account for the change in the entity’s cash balance from one year to the next.
• The notes to the financial statements provide additional explanations to certain line items on the financial statements as required by Generally Accepted Accounting Principles (GAAP). Some that are required by disclosures include the organization or legal form (corporation or association) of the entity, the location and number of units, summary of significant accounting policies, restrictions on cash or other assets, the components of property and equipment, mortgage information (including pledged assets), commitments and contingencies, and income tax filing status (including income tax liabilities and credits.)
In > Out
In the plainest possible terms, the amount of money coming into a building community's coffers must exceed the amount of money going out. The concept couldn’t be easier to grasp, and yet many boards get in trouble when the black turns to red. If you make $5,000 a month, and the combined mortgage and maintenance fees on your condo are $5,001, that deficit is eventually going to become problematic. Ultimately, you have but two options: you can A) make more money, or B) move. Co-ops work the same way, but instead of a salary, the lion’s share of their revenue comes from the people who live in the building, through either maintenance charges or assessments. These must—must—be high enough to pay for the costs of operating the building.
“One of the most common mistakes [buildings make] is maintaining the monthly charges or common charges at a level that's not sufficient to cover operating expenses,” says Abe Kleiman of the Brooklyn-based accounting firm Kleiman & Weinshank. “Board members need to realize that they need to cover day-to-day operating expenses with revenue.”
Again, this is not rocket science. The math of it is easy to understand. It’s the politics that make it difficult. Having the requisite collateral of a cooperative complex, boards actually have an option C: they can take out loans.
“In a co-op, we often see that boards are reluctant to assess, or raise the maintenance, so they have to borrow money,” says Victor Rich, a director with financial consulting firm RSM McGladrey in Manhattan. Borrowing money for a large expense that comes up four times a century is one thing. Borrowing to pay the electric bill and the super’s salary? That will catch up with you.
Ideally, the maintenance fees collected from residents are enough to cover operating costs, plus add a bit each month to the cash reserves. “For operating reserves, somewhere around two percent of the monthly budget,” says Richard Montanye, of the accounting firm of Marin & Montanye LLP in Uniondale. Cash reserves are vital, in the event of emergency, and also to avoid having to resort to assessments for every little problem that crops up.
“A sufficient reserve should be set aside for future repairs and replacements,” Kleiman says. This way, “you don’t have the peaks and valleys. Try to flatten out the cash flow.”
With stricter controls being mandated by Fannie Mae and Freddie Mac, Montanye says, banks are keeping a watchful eye on the financial health of co-ops and condos in the event they have to sell the mortgages to the government. Lenders used to concern themselves solely with the creditworthiness of the borrower. “Now,” Montanye says, “they’re looking at the financial condition of the building,” especially the money held in both operating and capital reserve.
Shareholders may grouse about a maintenance increase, especially in the current economic climate. But over time, an increase now will save the building—and those same grousing shareholders—money, because loan interest will be minimized.
Watch the Store
According to the financial professionals, another big mistake board members make is not paying close enough attention to the inner workings of their building’s finances. Maybe they don’t have the expertise to go through a budget line-by-line, or maybe terms like “receivables” go over their heads. Maybe money matters just don’t interest them. No matter. A board member should be armed with some basic information so at the very least, they know when something seems fishy and can ask intelligent questions about it.
“I think there are boards out there run by people with egos rather than adequate experience,” says Rich. When board members are more concerned with power and influence than credit and debit, the entire building community suffers.
Rich suggests that board members ask themselves a few key questions to make sure the finances are humming along: “Are the people paying their maintenance fees on time? Are a lot of people in arrears?” This is especially relevant now, with the effects of the recession still very much visible. There will always be a certain percentage of units in arrears, just like unemployment will never be at zero, or literacy at 100 percent. But if a big swath of units are behind in paying their fees, that can herald a disaster—especially in a smaller co-op where the shortfall can’t be spread out among hundreds of owners.
“Do you have an ‘approved vendor’ list? The board should approve all vendors,” Rich says. That may sound like nitpicking, but he goes on to say that unapproved vendors may turn out to be overcharging the building and kicking back money to a board member. It happens more often than you think.
Also, “Do you have a backlog of accounts payable?” Just like in a regular house, a stack of unpaid bills is never a promising sign. And just as the heads of a household should be in the loop about that household's accounts payable, all shareholders—not just board members—should look at the annual minutes. Can this be dull? Sure. But if everyone leafs through it, problems will be spotted.
Another issue: the revenue items on the budget. During the real estate boom, boards factored revenue from flip tax collection into their budgets. As the market cooled off, Montanye says, that revenue stream has slowed to a trickle or dried up entirely. In the face of the recession, relying on a flip tax is magical thinking—Enron accounting.
“If the minutes are thorough for the monthly board meetings—if there are monthly meetings, which there should be—and those minutes are complete and accurate,” says Rich, “you should get a good idea of what’s going on.”
There is also a document generated by the accountant once a year that many shareholders don’t realize they are allowed to see, Rich says, “the year-end independent auditor’s report, which talks about controls that exist and don’t exist.”
And making that kind of information isn't just polite—it's the rule. In addition to the basic financial statements and notes mentioned above, Cesarano says that the American Institute of Certified Public Accountants (AICPA) requires co-ops and condos to disclose supplemental information about the estimated remaining lives and replacement costs of the property and the funding of future major repairs and replacements. This analysis is crucial for boards in meeting their fiduciary duty and preserving their building. It is also their responsibility to decide how to fund the cost of future projects. Inadequate funding can negatively impact the ability of owners to sell or refinance their units, because of the concerns of prospective buyers, or because of the difficulty of obtaining mortgages—especially now that the FHA has significantly tightened its purse strings. Finally, Cesarano adds that having a clear picture of its financial landscape allows boards to budget wisely and avoid having to levy burdensome assessments on residents to pay for large projects.
Transparency and openness—within reason, of course—fosters a climate where accounting errors are caught early on and corrected, helping to prevent the kind of accounting sleight-of-hand that can lead to the third common mistake.
Keep Track of Valuables
The best way to prevent fraud is to eliminate the temptation. After all, the kid won’t take cookies from the cookie jar if there are three other adults in the room with an eye on the counter, and one of those adults has an advanced degree in watching cookies. Most buildings hire accountants and lawyers, but if yours doesn’t, “You certainly should,” Rich advises. “Don’t look to save a few dollars on legal and accounting fees.”
For one thing, the accountant doesn’t live in the building, and as such, doesn’t have an emotional interest in the goings-on there. “It’s someone independent overseeing what’s done,” says Rich. “Otherwise, it’s very easy for negligence, or even fraud to take over.”
And while most of the managing agents running buildings in New York City are seasoned professionals and above reproach, not all are. You don’t need a special certification to be a property manager, after all, so anybody could do the job. "Some boards don’t pay attention to what’s going on with their managing agent,” Rich continues. “They simply assume that since it’s an actual agent, everything is, 1) on the up and up, and, 2) being done on an accurate basis.”
Which goes back to the importance of disclosure, checks and balances, and transparency. "Make sure monies are not commingled,” Rich advises. Each co-op or condo should have its own individual building bank account via the managing agent; all the funds from a manager's client buildings should never be dumped into a single, central, (for example, off-shore or overseas) account.
The take-away message is that while relatively rare, fraud does happen. “A lot of frauds in co-ops don’t come out because buildings don’t want the publicity,” Rich says. “They remove the people involved and it gets swept under the rug.”
This might sound intimidating, but really, finances are all about doing some homework to familiarize yourself with your building's financial profile, planning ahead with the help of experienced, competent professionals, and keeping things clear and well-supervised whenever money is concerned. With a conscientious, committed board and a group of competent professionals, managing your building's finances can be as easy as 1-2-3.
Greg Olear is a freelance writer, novelist, and a frequent contributor to The Cooperator.