Author Topic: "It's not debt, it's leverage!"  (Read 5062 times)

freya

  • 5 O'Clock Shadow
  • *
  • Posts: 42
"It's not debt, it's leverage!"
« on: December 31, 2014, 08:50:32 AM »
I've been fuming over my coop board's decision to refinance the underlying mortgage, and it was the final straw that made me decide to sell and get the heck out of here.  What do you all think of this financial move?

My building had an amortized underlying mortgage at 8% interest that was due to be paid off in 2019.  At that point, it would have been a financially solid building with very low maintenance, and many of us had taken on the relatively high maintenance with that understanding.  (I know...face punch me for buying into a coop with debt to begin with, but I know better now.)  Enter the coop board director who was jonesin' to redo the hallways...

The solution?  Refinance the underlying mortgage and take out extra money to pay for the hallway redo.  With a commercial mortgage, though, there's a catch:  you have to pay all the interest you were going to pay over the next several years ("yield maintenance fee") plus a hefty prepayment penalty.  No problem, just roll that into the new mortgage, along with all the free cash the board could possibly want. 

The result?  A $5M debt at 8% interest instantly became an $11M debt at 4.5% interest, with monthly payments only slightly less.  The new debt is amortized over 30 years, but it's set up as a 10 year term with a balloon payment due at the end.  The board at least had the grace to look nervous when talking about what might happen at that time if mortgage rates were to go up.  To be fair, we did get two capital improvement projects plus a small increase in reserve fund contributions out of it, but at the cost of a 14 year debt setback and now permanently high maintenance.

In case you're wondering, the board refused to consider a line of credit for the hallway redo because one of the board members' mother had a bad experience with one.  Oh, and they never consulted with a past board president who is a mortgage loan officer at Citibank. 

When those of us with basic math ability challenged the board on this decision, they gave the precious response in the title of this message.  Of course, you have to carry debt!  Debt is good!
 

Gone Fishing

  • Magnum Stache
  • ******
  • Posts: 2537
  • So Close went fishing on April 1, 2016
    • Journal
Re: "It's not debt, it's leverage!"
« Reply #1 on: December 31, 2014, 09:16:11 AM »
Yep, some folks just can't keep their hands out of the cookie jar.  Hopefully the improvements added to the value of your ownership that you may be able to recoup when you sell.  As an elected board, they should represent the majority of the owners, if the general consensus of the members is to borrow, there isn't much you can do about it.  If the board went against the majority of them members there may be some fraud somewhere.  Is the ring leader related to the contractor or the banker? 

Elderwood17

  • Pencil Stache
  • ****
  • Posts: 527
  • Location: Western North Carolina
Re: "It's not debt, it's leverage!"
« Reply #2 on: January 01, 2015, 07:50:33 AM »
I was on a church board once and a similar situation arose to "spruce up the building". Dramatically more debt funded many years further out.  Fortunately it was shot down but there were many who didn't understand what the problem was if the payments stayed roughly the same and the property was improved. 

Syonyk

  • Magnum Stache
  • ******
  • Posts: 2827
    • Syonyk's Project Blog
Re: "It's not debt, it's leverage!"
« Reply #3 on: January 01, 2015, 11:36:09 AM »
Well, given that the normal education on debt (at least in America) is driven mostly by the lenders, where the "education" is limited to, "If you can afford the monthly payment, you can afford it!" what do you expect?
My random project blog - ebikes, DIY, fans, and more: http://syonyk.blogspot.com

marty998

  • Magnum Stache
  • ******
  • Posts: 4899
  • Location: Sydney, Oz
Re: "It's not debt, it's leverage!"
« Reply #4 on: January 01, 2015, 01:50:11 PM »
Just curious.

How does the Co-op debt affect the sale price of your place. Do you sell for (value - your share of debt)?

Also should this not have gone to a general vote?

bacchi

  • Handlebar Stache
  • *****
  • Posts: 2185
Re: "It's not debt, it's leverage!"
« Reply #5 on: January 01, 2015, 01:53:40 PM »
I'd love to live in shared housing (condo, co-op, townhouse) but it's always scared me that the neighbors could be a bunch of consumer suckers who want the latest shiny floor/lights/landscaping.

freya

  • 5 O'Clock Shadow
  • *
  • Posts: 42
Re: "It's not debt, it's leverage!"
« Reply #6 on: January 12, 2015, 08:13:11 PM »
Just curious.

How does the Co-op debt affect the sale price of your place. Do you sell for (value - your share of debt)?

Also should this not have gone to a general vote?

High debt -> high maintenance -> reduced value of apartment.  I'll undoubtedly take a bit of a hit when I sell, but it's better than sticking around and continuing to pay through the nose for the Board's financial mistakes.

Coop boards in general don't need to ask permission of shareholders to do whatever they want, but they are ultimately answerable to shareholders and can be voted out (and also subjected to considerable peer pressure by their neighbors) if they screw up.  The problem in my building is there is a much larger percentage of renters than I was told initially, because the bylaws allow unlimited subletting.  That sounded really good until I realized what it meant:  perennial investment apartments.  Only about half the building is owner occupied.  The rest are landlords or pied a terres who don't attend the shareholder meeting.  Instead, they do what the Board asks every year and send in their proxies.  These proxies are designated as votes for the incumbent Board.  So even if there's huge turnout of resident shareholders, it's mathematically impossible to vote out existing Board members.    The Board further protects itself by appointing new members mid-year, instead of allowing vacant spots to come up for election at the annual meetings.

Long saga, but if any of you are considering buying a coop, you now know what questions to ask.  Coops have lots of advantages, but the risk is that your Mustachianism is at the mercy of your neighbors' idiotic consumer behavior.

Rosbif

  • 5 O'Clock Shadow
  • *
  • Posts: 80
Re: "It's not debt, it's leverage!"
« Reply #7 on: January 13, 2015, 05:35:02 AM »
I'd love to live in shared housing (condo, co-op, townhouse) but it's always scared me that the neighbors could be a bunch of consumer suckers who want the latest shiny floor/lights/landscaping.
That's pretty much my issue, it's a common thing in Europe. We have a 25k water bill, and pay a 5k contract for some guy to come check taps/toilet cisterns for leaks. I pointed out that he can't possibly be saving us 5K a year in leakage -- that would be 1,500 cubic METRES of water.

I've been trying to get the board to vote the contract off. No chance. We also have flowerbeds that are re-done once every four weeks.

Numbers Man

  • Guest
Re: "It's not debt, it's leverage!"
« Reply #8 on: January 13, 2015, 10:20:36 AM »
I would GTFO under those conditions.

Bob W

  • Magnum Stache
  • ******
  • Posts: 2958
  • Age: 58
  • Location: Missouri
  • Live on minimum wage, earn on maximum
Re: "It's not debt, it's leverage!"
« Reply #9 on: January 13, 2015, 03:37:05 PM »
Run Forest Run!
Better living through math.

Beric01

  • Handlebar Stache
  • *****
  • Posts: 1157
  • Age: 27
  • Location: SF Bay Area
  • Law-abiding cyclist
Re: "It's not debt, it's leverage!"
« Reply #10 on: January 13, 2015, 04:00:55 PM »
Run Forest Run!

*Ahem*. That would be "Run Forrest Run!" ;)