Month: November 2019

Co-op Mortgages

Options for Co-op Boards When Refinancing Underlying Mortgages

Many articles are written about cooperative (co-op) mortgages from a shareholder’s perspective.  This article discusses the basics when it comes to refinancing the underlying mortgage of a residential co-op building.  Having this understanding will help you and your fellow co-op board members navigate the many refinancing options that are available to you and your fellow shareholders. 

What makes co-op purchases unique? 

When you buy a co-op, you are not directly purchasing real property, you are purchasing shares in a corporation that owns real property.  In addition to receiving shares of stock, you receive a proprietary lease for the unit you are purchasing.  When you purchase shares in a co-op there are typically two mortgages that need to be paid. 1) Your personal mortgage (money received from your bank to buy the shares of stock) and 2) An underlying mortgage that the corporation owes to a bank or other lending institution. 

Why Co-ops Have Mortgages

Many co-ops have underlying mortgages because one of the basic principles in real estate is leverage, meaning using other people’s money (OPM) to increase returns.   Just like people go to a bank to borrow most of the purchase price to buy real estate (or co-op shares), builders and investors of residential properties must borrow money to build and/or buy their properties.  When a co-op comes into existence this underlying mortgage, from the builder/investor, or prior rental property owner (if your building was converted from a rental building to a co-op) is transferred to the co-op corporation.  The building is used as security for this underlying mortgage. As with any other mortgage there are monthly payments on this debt.  Since all cooperators own shares in the corporation (co-op) all shareholders must share in the payment of the debt.  A portion of the monthly maintenance charges that are paid by the shareholders is used to repay the underlying mortgage debt. 

Lending institutions offer a variety of mortgages. Cooperatives have the option to choose the type of rate, loan amortization length, when principle is due, and several other options.     Let’s discuss a few of the options available.

Options Available for Coop Mortgages

The menu of options allows you to customize a loan to your cooperative’s needs.

What factors affect your choice of mortgage?

Before committing to a mortgage it’s important to understand why you are refinancing your mortgage and how each of the options above helps you achieve your objective.

For example, if your objective is to keep your monthly maintenance charges as low as possible you may choose an interest only mortgage or a 30-year amortized loan paid for over a period of 10 years with a balloon payment after the ten years.  The upside of these two options is that your monthly mortgage payment will be lower than a 30-year fully amortized loan (monthly payment of principle and interest) but there is a downside.  The lower monthly payment options will leave you with debt at the end of the mortgage term.  Your cooperative may find itself having to refinance the unpaid principle during a period of high interest rates. 

The chart below will help you determine how each option effects your monthly payment and remaining debt at the end of the mortgage term.

Yield Maintenance

One term you may come across when looking to refinance the underlying cooperative mortgage is yield maintenance.

Yield Maintenance is a prepayment penalty.  What makes yield maintenance so intimidating to non-financial board members is the complexity of the prepayment penalty calculation. 

The calculation computes an amount that the co-op must pay, in addition to the unpaid principle balance, that allows the lender (bank) to attain the same investment return (yield) as if the co-op had made all scheduled mortgage payments under the terms of the loan agreement.

In other words, if after 6 years your co-op decides to refinance its 10-year, 6% loan, from Bank A, and replace it with a 4% loan from Bank B.  Your yield maintenance prepayment penalty will be an amount when added to your  unpaid principle  balance (you still owe the bank principle since you have 4 years left on your mortgage) that will ensure Bank A earns the same return as if your co-op made all your payments over the full 10-year loan term.  The yield maintenance calculation assumes that Bank A will invest all the funds in US Treasury instruments.  The calculation of the yield maintenance requires present value calculations that you typically find in finance courses. 

Other, more simple prepayments penalties involve a sliding percentage as you get closer to the maturity date.   For example, a 5% prepayment penalty with five years remaining until maturity, reduced to a 4% penalty with four years remaining until maturity, reduced to a 3% penalty with three years remaining, and so on.

It’s important to understand your prepayment penalties because excessive penalties may hinder your ability to refinance your mortgage in the future.   

Line of credit

We recommend that in conjunction with the refinancing of your underlying mortgage cooperatives should obtain a line of credit (LOC).  A line of credit gives your cooperative access to additional cash on top of the net proceeds of a refinance.  With LOCs you only pay interest on the money you borrow.   There is an annual fee to keep the line active.

Summary

Many major banks and insurance companies offer refinancing of the underlying co-op mortgage.  Your co-op should have no problem finding money when you need it for major capital improvements or refinancing of existing loans that are about a come to the end of their term.  Understanding your choices will allow you to customize your loan to meet the needs of your co-op. 

Air Conditioning Basics

Understanding Real Estate Building Components

As a real property owner, it’s important to understand the basics of every major structural component of your property.  This article discusses the fundamentals of air conditioning. 

A basic understanding of your air conditioning system impowers you with the ability to make an informed decision about one of the major components of your real estate; such as whether to repair or replace the system.  At the very minimum, having basic knowledge of air conditioning will limit the ability of unethical HVAC (heating, ventilation & air conditioning) companies from taking advantage of you.  If they see you have knowledge of the major components, and how they contribute to the process it may give them pause if they are considering ripping you off.

To make things simple we’re going to break the process down into small bite size chunks.  We’ll start with the Objective, then move to the Components, then the Science and we’ll pull this all together.

The Objective

Air conditioning systems fill a fundamental purpose, to cool an area inside your real property.  Contrary to what some people believe, air conditioners don’t bring cool air to an enclosed space.  Air conditioning systems take away hot air.   The cycle of an air conditioner is to capture heat from one area (inside), transport and release the heat somewhere else (outside), and then repeat the heat capturing, transporting and releasing processes again and again. 

Science plays a major role in the process of capturing and releasing heat.  So take an hour, or two, look for those high school science text books (they may be a bit dusty) and I’ll wait until you get back. Just kidding, we won’t need them.

Before we discuss the science let’s look at the major components inside the air conditioning system.  

The Components

The major components of an air conditioning system are:

  • The Compressor – A pump that pressurizes refrigerant gas and moves it to the condenser.
  • The Condenser – Removes heat from refrigerant. This heat removal from the refrigerant transforms gas into a liquid.
  • The Expansion Valve – Regulates the refrigerant flow into the evaporator
  • The Evaporator – Liquid refrigerant transforms to gas and absorbs heat from the surrounding air causing the air to cool.  A fan blows the cool air into the room.    

The diagram below illustrates how these components form a circular system.

In addition to the major components there are also other components that are noteworthy.  They include:

  • Fans – Work with the evaporator to blow cool air into the room.  Work with the condenser to blow hot air into the outside environment.  
  • Thermostat – Used to regulate temperature in the indoor space.

The Science

The “secret sauce” of an air conditioning system is the Refrigerant.  This is where the science comes in. 

What is a refrigerant? A refrigerant is a substance that changes from liquid to gas (and gas to liquid) during the air conditioning cycle. 

The science behind the refrigerant is what is called phase conversion.  Phase conversion is when a substance changes from a liquid to a gas (for example, heating a pot of water and converting the water into steam)  or when a gas changes into a liquid (for example, water that drips from your mirror after taking a hot shower). 

During phase conversion heat is either absorbed or released by the refrigerant.  When a refrigerant changes states from a liquid to a gas the refrigerant absorbs heat from the surrounding air.  That’s why steam burns are more painful than burns from boiling water .  There is more heat content in steam.  Conversely when a refrigerant converts from a gas to a liquid the refrigerant releases heat into the surrounding air. 

Unlike water that converts into gas at a temperature of 212 degrees Fahrenheit, refrigerants used in air conditioning systems boil at temperatures between 40-50 degrees Fahrenheit.   This ability to boil at such low temperatures means that the refrigerant can be converted from a liquid to a gas at room temperature.   

The Air Conditioning Cycle

Let’s put the components and the science together and create our air conditioning cycle.

  1. The first stage of the air conditioning cycle starts with the compressor pulling in the refrigerant (in the form of gas).  The compressor is called compressor for a reason.  It literally compresses the refrigerant gas.  Think of taking a bicycle pump and adding more air to your tire.  The more you pump the more the air in the tire gets compressed.  Also note, if you continue to add more air to the tire the pump gets hotter.  This heat is absorbed by the refrigerant.
  2. The hot, high pressure (compressed) gas is moved to the condenser.  The condenser is located outside of your property.  The purpose of the condenser is to discharge heat from the refrigerant. This removal of heat is caused by the natural movement of heat, which moves from hotter areas to colder areas.  That’s why you can feel the heat if you stand next to something hot.  Hot things give off heat to the colder surrounding environment.  The hot gas from the compressor is hotter than the external temperature.  As the hot gas begins to cool  it starts the process of phase conversion.  The refrigerant changes from a gas to a liquid.  If you ever stand outside a condenser you can feel the hot air being blow from it.
  3. Next this liquid/gas refrigerant mixture moves to the expansion valve.  Here, the expansion valve starts the process of lowering the pressure of the refrigerant thereby allowing the refrigerant to expand into a gas. 
  4. The final stage of the process is the evaporator.  In the evaporator the liquid/gas refrigerant mixture becomes a gas. Remember, the unique quality of air conditioner refrigerants is their ability to boil and turn into a gas at low temperatures (40-50 degrees Fahrenheit) .  At room temperature the refrigerant can boil and convert from a liquid to a gas.  If you recall the science of phase conversion that we discussed above; when a substance changes from a liquid to a gas it absorbs the heat around it.  In the evaporator, cool air is created by the refrigerant taking the heat away from the surrounding air.  A fan is used to blow cool air away from the evaporator into the room that you want cooled. 
  5. The cycle is complete when the gas from the evaporator is sucked in by the compressor (step 1 above).  The cycle repeats itself until the system is shut off.

There you go.  You now have the basics of a conventional air conditioning system.  Variations of this system occur depending on the size.  For example window air conditioners have all the components contained in a single location (the air conditioning unit) while central air conditioners have the compressor and condenser outside of the house.   In large buildings some components are located on the roof and others in the basement.  No matter what system you have use your new found knowledge as a springboard to a better understanding of your system