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CO-OP UPDATE
Challenges and Solutions:
Long -term Financing for Co-op Corporations and Multi-Family Borrowers

By Gregg Winter, President
Winter & Company Commercial Real Estate Finance


During the last year or so while interest rates have been at their lowest point in decades, and as of this writing in November 2003 rates have again dropped to near-historic levels for 30-year fixed-rate co-op underlying mortgages and apartment building loans. Even in the wake of the rapid run-up in rates during July 2003, many co-op boards and owners of multi-family properties are weighing the pros and cons of locking in the rate on their new mortgage for 15 or even 30 years (rather than the more typical 5 or 10 years).

There are typically seven people on a co-op board, and after 14 years of attending board meetings and working through the various issues with co-op boards, I can certainly report that the debate over whether to choose a 5 or 10-year mortgage vs. a 15 or 30-year mortgage is one of the most contentious that you will ever see. It is a decision where only certain empirical pieces of information are available (i.e., no one knows where rates will be in 10 or 15 years when a balloon would need to be refinanced, etc.), and emotions tend to run high over the inevitable questions faced by the borrower:

1. Do we want the lowest possible monthly payment on a shorter-term loan (and then face a balloon and an uncertain interest rate environment),

Or

2. Will we accept a slightly higher monthly payment on a 30-year fully amortizing loan knowing that we will not ever face a balloon payment and not have “the rug pulled out from under us”?

Of course there is no right or wrong answer. Each borrower’s needs and time frame are different. Borrowers have different tolerances for interest rate risk. The difference in pricing between a 10-year and a 30-year term will be between 60 and 75 basis points (as of today that might equate to 4.88% for the 10-year product and 5.5% for a 30-year fixed-rate mortgage). Clearly the differences are very real. There are, however, some absolute guidelines for those who choose to go with 15, 20, 25 or 30-year fixed rate financing:

The one inevitable rule of real estate is that money needs to be spent to repair and improve it throughout the years. Roofs, windows, pointing, boilers, hallways, lobbies, sidewalks, etc., will all need renewal from time to time. This litany of typical real estate expenditures is well known to both co-op boards and owners of apartments buildings. So how can you lock in a 30-year fixed rate mortgage yet also be prepared for the inevitable stream of expenses that will need to be faced in years 4, 12, 17 and 26? Presumably you either have a healthy reserve fund, or you will borrow some extra money to establish one. However that will only take you so far into the future. Certainly you can’t put money aside now for the entire 30 years.

There are three critically important elements needed to successfully structure long-term financing (meaning 15, 20, 25 or 30-year mortgages), and to avoid feeling the need to refinance the entire mortgage part of the way through the loan term. The advice of a good commercial mortgage broker can add significant value to achieving all three of these “add-ons”, without which any borrower is likely to feel constrained as the years go on and the need for additional borrowing inevitably arises. The following should all be planned for and should be structured into your loan documents when you refinance:


1. Get a well-priced credit line, unsecured if possible, to use for short-term borrowing needs. (In New York State an unsecured line will save you $27,500 in mortgage recording tax per million borrowed). These credit facilities are typically for a period of only 5 or 10 years, so a credit line alone will not adequately address all your future needs.

2. Make absolutely sure that your lender can and will provide secondary financing (second mortgages, third mortgages, etc.) during the loan term. These facilities can, for example, provide a fixed-rate second mortgage in year 3 that will amortize over the remaining 27 years of a 30-year loan term.

3. For 20, 25 or 30-year loans, structure them so that the prepayment penalty (typically yield maintenance) will drop significantly after a certain period of time. This will give you maximum flexibility in the later years of the loan term if you decide to refinance.

These three basic precautions are ESSENTIAL when financing any co-op underlying mortgage or multi-family property for more than 5 or 10 years. The longer the loan term, the more carefully you must plan for the future in choosing the lender and structuring and negotiating the loan terms.

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