As a co-op or condo board member, how has your team funded capital projects during Covid-19? Has the pandemic hurt your ability to get projects completed? From a banker’s point of view, after a brief lull during the first quarter of 2020, that outcome doesn't appear to be the case—many of our clients restarted plans for projects right away. In fact, our lending business to co-ops and condominiums has been strong over the past twelve months. What's more, we have not seen much of an uptick to date in the number of delinquent homeowners within our existing loan portfolio due to Covid.
Even still, is there anything we as an industry should be concerned about related to capital planning and Covid? The short answer is yes. Read on for the financial impacts of Covid lenders and borrowers alike should be on the lookout for.
Concern #1 — Negative Return on Reserve Cash
As most property managers and boards have probably noticed, interest rates offered by banks for reserve deposits are now significantly below 1.00 percent—often closer to zero. That's because the Federal Reserve has created a zero-interest-rate environment in response to the unprecedented economic impact of Covid. This situation is expected to remain for the foreseeable future.
Why is this important? The cost of labor and materials for many projects a board may undertake has and will continue to grow at a much greater rate. Some estimates predict a 3 to 5 percent or more increase per year depending upon the project type.
So let's say you are on a board that has set aside $75,000 to tackle a boiler repair. By this time next year it could cost you $78,000 (based on 4 percent labor/material inflation) and yet the cash reserves would have only grown to $75,750 (assuming the average 1 percent earned on a CD). In this scenario—and countless others of its ilk—you would lose around $2,250 annually.
And what if your board or community, like most, does not have 100 percent of the funds needed to complete capital projects over the next few years? That deficiency will further compound the matter.
Concern #2 — Delayed Impact on Residents
Covid-19 has had a significant and sudden impact on income levels for a great many people. The Mortgage Bankers Association estimates 4.2 million U.S. mortgages (8.36 percent of the total) were in forbearance by May 2020. The Census Bureau’s Household Pulse Survey suggests one in every five renters nationwide is behind on rent. As such, state and federal governments have created mortgage forbearance and rent collection relief programs.
Again, what does this mean for you? It points to a possible delayed impact to communities as many of these programs continue to be extended. Similar to during the great recession, a spike in loan foreclosures and short sales would cause an increase in delinquencies that would take a few years to work through. Buildings with a higher concentration of investor-owned units could be especially impacted.
How can we mitigate these risks when planning for reserve projects?
To address Concern #1:
• Utilize a portion of your current annual reserve contribution for loan repayment to address necessary projects right away. Record-low interest rates means the cost of borrowing money is often lower than project-related inflation as earlier explained.
• Kick the austerity mindset out of the board room and increase maintenance and homeowner fees annually based on input from engineers, contractors, and your property manager.
• Get a reserve study and digitize the information so it can be managed annually as projects are completed and additional funds are contributed.
• Hire an engineer to review the property with the goal of augmenting the basic reserve study inspections and determine if there are any looming projects not yet identified by the study.
To address Concern #2:
• Audit the current owner vs. sublet or rental ratio of the community to see if you may be at higher risk of future delinquencies due to added economic strain on rental units.
• Partner with a collections or law firm to ensure any efforts to collect from residents are done timely and in accordance with state and federal law.
• Continue to monitor the situation and be prepared to adjust upcoming budgets accordingly.
Even before the pandemic, creating a separate operating contingency fund (or "rainy day fund") was and remains a worthy best practice. Just as every personal financial planner recommends having a few months’ worth of expenses set aside at all times in case of emergency, you should do the same for your community. Remember—reserve funds should not be used for operating expenses.
These are indeed unprecedented times, but you are not alone. The firms who specialize in providing services to co-ops and condominiums are working with boards and managers every day. We are here to help.