How the buyer due diligence process works for co-ops.
When you’re buying a co-op how does the due diligence process work? We’ll break
down what’s involved and explain what the goals are.
My name is John Moss, an attorney and partner at Moss & Moss LLP, a law firm started by
my family in 1997. A large portion of our work is residential real estate transactions,
and let’s dig in.
Unlike most other jurisdictions, real estate contracts in New York City do not have a recission
period or an attorney review period, meaning that once you sign the contract generally
speaking you’re legally bound to buy the property. But obviously you as the buyer need
to do your due diligence review…so the review actually happens before you sign the contract.
To give a little context, in the course of the transaction the broker will be handling
the negotiation of the big ticket items: such as, the purchase price, the approximate closing
date, whether the contract is contingent on the buyer getting their financing, and a few
other details. Once the offer is accepted, the attorneys pick up the ball and the seller’s
attorney issues the contract for the buyer’s attorney to review.
While the attorneys are reviewing and negotiating the details of the contract, the buyer’s
attorney is also reviewing the due diligence materials.
The due diligence review for an apartment in a cooperative corporation consists of four
basic elements: (1) reading the past year or two’s worth of minutes of the coop board
meetings, (2) asking follow-up questions or submitting a more extensive questionnaire
to the managing agent based on the review of the minutes; (3) looking over the financials
of the building; and, (4) glancing at the offering plan and the by-laws. I should note
that due diligence of newly constructed buildings consists primarily of reviewing the offering
plan, but that’s a different subject for another time.
The coop board meeting minutes generally describe how the coop board runs the building and what
they’ve been working on. The minutes typically describe what major capital improvements the
building has undertaken to date and what they have considered starting on in the near future.
The minutes also usually talk about how the board interacts with the shareholders, reporting
on disputes and litigation, if any, as well as other requests or inquiries. There is some
financial information in the minutes, but – since we’re also reviewing the financial
statements…more on that in a minute – the financial information we really want to focus
on is how often the board has increased the maintenance. Lastly the minutes usually report
on approvals or disapprovals of incoming purchase requests, sublet requests, and alteration
applications.
The reason I keep saying “typically” or “usually” is because the minutes for each
board are somewhat idiosyncratic. Some minutes have lots of information and details, some
are very bare bones. However, even the style of the minutes can tell you a lot about the
building.
The purpose for looking at the minutes is three-fold. Firstly, we want to know the condition
of the building in general and the apartment specifically. Secondly, we want to know what
major capital improvements are coming soon so that we can determine whether you as a
buyer will need to make extra financial contributions to the building in addition to your monthly
maintenance. Thirdly, because the coop board has such a huge impact on how you use your
apartment, we want to know if the board is super-hands off or incredibly nit-picky…for
the record, boards are usually somewhere in between, but we want to make sure. Even if
there isn’t a lot of details in the minutes, it still can give us a sense of how they conduct
themselves.
The review of the board meeting minutes historically happened at the managing agent’s office
and the minutes were closely guarded confidential documents that never left that office. With
COVID and remote working, that may be changing, and it’s an open question on how boards
will handle things in the future. For now, it’s probably safe to assume that your attorney
will continue to review the minutes and then report back to you, rather than be able to
provide you with the text of the minutes directly.
I will say that one of the useful things about going to the managing agent’s office was
that I usually have a chance to ask the managing agent questions when I’ve finished reading
the minutes. Those questions usually involve specifics about the condition of the apartment
or the line that the apartment is in, like if there have been any leaks or any instances
of bedbugs. Sometimes that leads to emailing follow-up questions to the managing agent.
Another common solution is that buyer’s attorneys will submit written questionnaires
to the managing agent. Sometimes the managing agents charge a fee to respond, however, and
in other instances there isn’t enough time for the managing agent to reply before the
seller wants the signed contract back. While it’s always preferable to get these answers
in writing, this is discretionary and something you should talk about with your attorney.
The financial statements of the building are the next item of review. These are audited
by the coop’s CPA and are freely disclosed by the building…and most attorneys will
provide a copy to the buyers. The specific information we’re looking for in the financials
are … what are the cash reserves of the building, how much cash do they have on hand
in their operating account, and whether the budget more or less balances…that is, does
the monthly income generally cover the monthly expenses of operating the building. There
are obviously details and footnotes and your attorney will need to explain the nuances
of the financial statements to you, but generally we want to know if the building has a reasonable
amount of money on hand, and a reasonable amount of money to pay for whatever capital
improvements we found that they’re undertaking when we reviewed the minutes. Is the board
managing the coop’s money well and are there any red flags, such as out-of-the-ordinary
line items or litigation costs. For my part, I’ve rarely seen a buyer not go forward
with a transaction because of the financials, but it has happened.
The real world consequence of the financials not looking too great is that a buyer may
have to expect regular monthly maintenance increases or a special assessment. By way
of explanation, a special assessment is an extra charge that the shareholders pay to
the corporation in addition to the monthly maintenance. It’s usually paid on a monthly
basis for some specific period of time (like 18 months or 3 years), and it’s usually
for a reasonable amount. To give context, as an example, a buyer might see a monthly
assessment for … let’s say … 24 months in the amount of about $150 or $200 as against
monthly maintenance charges of about $1200 or $1500.
Moving on, if the building is recently built, your attorney may want to review the Offering
Plan, which is a several hundred page document that the developer gave to all the new buyers.
Once the building is operating for a few years, the Offering Plan becomes less relevant. However,
included in the offering plan, among other things, you can find the by-laws of the coop
corporation…and these are relevant to the on-going operation of the board. Generally,
though, the by-laws are pretty standard so again your attorney is really just looking
for things that are out of the ordinary.
Some clients ask if a property inspection or, specifically an engineer’s inspection,
is a required part or even just helpful for due diligence. Generally, in New York City,
the answer is no. For a coop, the coop corporate itself is largely responsible for the systems
in the apartment (meaning the plumbing, electrical, and HVAC), and of course the corporation is
also responsible for making sure the building is structurally sound. Absent a specific point
of inquiry, these are the things that a home inspection would generally look at. If you
as a buyer want to pay for an inspection, you’re welcome to, but it’s not necessary
and it’s not usually done in New York City.
To wrap up, in general, the larger the building that the board manages, the more involved
the board minutes will be, and the more substantial the financials will be. If you’re looking
at a small coop, on the other hand, you shouldn’t necessarily expect for the board to have multiple
millions of dollars in the bank. What we’re really looking for here is to make sure, again,
that there are no red flags…that there’s nothing that is way outside the norm. For
this, you will need to have an experienced attorney who has done a lot of transactions
and knows what to look for. In my practice, I generally provide my report on the due diligence
to my clients in person or by phone at the same time that we review the final version
of the contract. That way, we can go over things in as much detail as the client wants
and I can ensure that my buyers have an extensive opportunity to ask all their questions and
to make doubly sure that they are fully informed about the property they are buying.
Ultimately, the goal of the due diligence review is for the buyer to know what they
are getting into and to feel comfortable with the purchase. If ever there comes a time when
you’re buying real estate and don’t feel like you know what’s going on, that’s
that’s the point when you need to call your attorney and start asking questions.