Understanding Hidden Sacrifice

by Eugene Andrews

The ever-present challenge for management companies is to accurately forecast building financial operations and balance this against operational requirements so as to prevent financial or habitational hardship for building residents. Such forecasts, once formalized, are called budgets and are normally issued in yearly installments. They are fact-based, yet interpretative, documents that rely both on prior spending patterns and Management’s informed assumptions about future needs. Their highest purpose is to achieve a level of secure income that, while prudent and frugal, is accurate so as to operate the building without sacrifice, either overt or hidden, to its residents. When a building must make overt sacrifices to balance a budget, as for example by decreasing staff, decommissioning a freight elevator, delaying a façade renovation, etc., these are pre-determined choices developed out of board consensus and are easily communicable to building residents. The same cannot be said for hidden sacrifice, which is a category of sacrifice known mainly to management companies because of their data collection and comparative capability, and their broad multi-year experience over the entirety of building operational issues. The problem for Management is that because budgets are annual quantitative documents dealing wholly in income and expense, and not primarily in content or quality, they are generally balanced by making mainly quantitative determinations as to number and cost. The reality though is that due to the quantitative-only drive behind budgets and lack of synthesis of qualitative issues, the decisions they reflect may contain latent consequences whose impact on building operations far exceeds the budget’s 12-month expiration date and may require unintended (hidden) sacrifice years later.

The concept of hidden sacrifice is an understandably elusive one when juxtaposed against cold hard numbers, and it is understandable that there is confusion on the client’s part as to its meaning and ramifications. Some examples of non-quantifiable items that are hidden from public counting include the quality of an insurance portfolio, the terms of an elevator maintenance contract, the particular warranty for a roof installation, etc. Though not numerical per-se in nature, these are nonetheless crucial stabilizers of building operation and of the residents’ long-term habitability. Among the most important responsibilities of Management is to create accurate budgets that do not, intentionally or accidentally, cause hidden sacrifice, and to forthrightly communicate those areas of potential sacrifice in building budgets that possibly conceal possible future hardship or liability for a board and building residents. This is especially important when discussing the building’s insurance portfolio as was done recently at an Upper East Side Condominium managed by The Andrews Organization that debated the necessity for the insurance coverage of “Terrorism” and “Back-Up of Sewers and Drains”.

The normal building insurance policy is called a Commercial Package Policy because it provides, for one fixed annual cost, a compendium of risk coverage, both primary and non-discretionary (such as Property and Casualty) and subordinate coverage (such as “Back-up of Sewers and Drains”, “Terrorism”, “Water Seepage”, etc.), the costs of which can vary from carrier to carrier. In the instance of the Upper East Side Condominium the Board was presented with two insurance policy options, the first of which was marginally more expensive than the second because it contained greater breadth of subordinate coverage, including those mentioned above. Because the Board thought a terrorist act unlikely on a tree-lined street far from Mid-Town it did not understand the need to spend an extra $1500 annually for “Terrorism” coverage, until it was explained that such coverage insures not just primary damage of a terrorist act, but secondary damage resulting from it such as suspension of building essential services of water and power that may cause building damage and resident hardship. Likewise, because no one on the Board had ever experienced the environmental damage a sewage back-up causes and therefore considered the occurrence an unlikely one, they did not see the need for “Back-Up of Sewer and Drains” coverage, which would have saved another $1000 from the annual budget. The Andrews Organization was instructed to further explore the insurance market to try to locate an insurance program without such coverage. We advised the Board that the annual cost was minimal compared to the economic value inherent in these two types of insurance coverage. We had seen the damage caused by raw sewage many times previously and knew its devastating impact upon a property. Insurance is a hedge against probability and the age of the City’s underground sewage piping system increased such probability exponentially.

Our discussion proved informative and fruitful, and the suggested coverage was endorsed, even at a marginally greater budget cost. The meeting broke up, people resumed their normal lives, and the newly expanded insurance coverage was bound and then forgotten. However, within weeks on Prince Street, 80 blocks to the south, a 100-year old street sewer line collapsed back- flowing raw sewage into basements including that of a Landmark cast iron loft building managed by The Andrews Organization. The possibility of air-borne bacteria mandated lower floor evacuations and relocations to hotels and alternative domiciles, followed by extensive environmental remediation and physical plant reconstruction, including the building boiler, which had been partially submerged in raw sewage. The cost in total for this 12-unit property approached $800,000 dollars all of which, minus a $2500 deductible, was paid for by a little- known and inexpensive subordinate probability hedge.

Altering Building Paradigms

by Eugene Andrews

It is the responsibility of Management to operate a building in the most cost-effective manner and to consistently strive to share knowledge and ideas that would impact cost savings and efficiency, even if by so doing it sets in process tectonic shifts in the way a building operates. In this endeavor Management is often constrained within long-existing paradigms of building operations, services and necessities, so that its role becomes less innovative and more investigatory in an effort to locate hidden savings rather than to create new paradigms of building operation. Moreover, because most operating budgets sustaining habitational real estate are fixed instruments based upon core services and unchanging responsibilities over which costs Management has little ability to exert discretionary authority, the savings from prolonged investigation are frequently marginal and not strategic. Such budgets contain two main expense categories: (1) fixed and unchallengeable expenses: debt service, real estate taxes, water/sewer charges, electricity and gas; (2) relatively fixed expenses determined by limited markets and common agreement: insurance, payroll, professional fees and service contracts. It is common that these two categories combined, along with their ancillary variants, come to 90% or more of a budget, leaving little room for budget improvement, the employment of management ingenuity or the exertion of a building’s discretionary authority. Yet still, under the pressure of possible insolvency, a building may be forced to seek Management’s help to alter the paradigms governing its operation in hopes of restoring fiscal health. Rare though this situation is, when it arises it always presents great challenges for Management, as it did for The Andrews Organization at a Mid-Town cooperative apartment building. For this client, the spiraling costs, due to underlying mortgage debt and an outdated physical plant requiring constant repair, had resulted in making the apartments unaffordable and, hence, unsalable.

In this property budget flexibility resided both in the size and deployment of the building’s staff, whose total cost comprised 40% of the annual budget (by far the single largest expense item), and in the equity of the superintendent’s two-bedroom residence. Heretofore, building residents had enjoyed the luxury of a live-in superintendent and the security of two manually operated passenger elevators with epauletted union operators. Our analysis was clear but unfortunately harsh. The desperately-sought after reduction in annual operating expenses could not be acquired by tinkering with existing paradigms, but must come from “structural” adjustments to building operations, primarily to (1) diminish monthly debt service by paying down all or a significant portion of the underlying building mortgage, and to (2) drastically diminish maintenance charges by reducing annual payroll costs. To accomplish the first, we advised restoring and then selling the superintendent’s apartment to pay down structural debt, thereby depriving the building of live-in superintendent support. To accomplish the second, we advised converting both passenger elevators to automatic operation so as to retire the elevator operators. There was no other choice.

We projected that these incisive actions, working in concert, would inevitably yield, over three years, equally incisive savings, but at an unfortunate human cost. Building residents worried that a live-out superintendent, especially without the reassuring presence of 24/7 elevator operators, would deprive them of nighttime security as well as immediate response to the many plumbing leaks that plagued the structure both night and day. A segment of the building rebelled and held secret meetings. General meetings were tumultuous and harsh, and driven by bitter sentiments and accusations of board fiscal mismanagement, confiscation and human cruelty. It was understandable and, even, despite the internal hand-to-hand combat, commendable. The elevator operators in particular, with whom each resident was in close contact every day, and who provided them with their deepest sense of building security, garnered the greatest sympathy. Nonetheless, the momentum for economic rationality became unstoppable, but was also tempered by deeply felt human concern. Generous pay-out agreements were negotiated with the operators through their union and lay-offs were delayed until the 5 men found other work. The porter’s hours were re-structured to provide a partial nighttime presence in the building. The superintendent, near retirement, agreed to subsidized alternative housing in an outer borough residence he already owned. His basement unit, combined with another undeveloped unit, once sold, in combination with the eventual savings from the forced staff reduction, amply justified, at least in financial terms, the dismantling of a gracious, though unsustainable, residential paradigm.

Mining Hidden Resources

by Eugene Andrews

It is only natural that many buildings seek ways to offset their annual operating cost or even, in the case of cooperatives, reduce their underlying debt, by uncovering hidden income streams, or even economic windfalls that lie, undiscovered and untapped, within the environs of the building itself. It is only to be expected that such ancillary income is normally derived from the further monetization of a building’s real estate that a developer/sponsor initially began via a construction or development process, but did not bring to final completion. Normally, such additional monetization is in the form of rent of a building’s hidden real estate assets and is sourced from the closed market of its own residents, and not from an unfettered free market, thus restricting prices. Its most common form is the renting of limited basement space, for storage or bicycle racks, to residents. Frequently, it can also assume the form of public market competition for façade space for signage or billboards, roof space for cell towers, interior space for film and photo shoots, or basement space for coin-operated laundry vending machines.

However, there is occasionally the possibility for a more lucrative form of monetization-through- sale of a building’s physical space heretofore considered to be a constituent part of the common property of the Association, namely, an unused and unencumbered portion of the roof. Such an opportunity was embraced by a Soho Loft Condominium managed by The Andrews Organization that was in need of an infusion of capital. Subsequently, the Housing Association's Board of Managers voted to offer a portion of its roof space for sale to building residents for roof decking only. The Andrews Organization’s challenge was to construct and execute a logical sales process for roof real estate such that maximum value was achieved in an impartial, though tightly managed, bidding format.

There are two main forms of sale of roof real estate: (1) sale of buildable square footage for future development based upon the availability of FAR; (2) sale of non-buildable existing space for roof decking and recreational usage. Both have their appraisal strategies: for the former an approximation of square-foot free market cost, and for the latter, factoring for the substantially less-than-per-square-foot free market since it is a non-buildable area. In the case of the Soho loft, the sale was of existing unencloseable space and was purely for decking. The Andrews Organization’s involvement was as follows: (1) to physically identify the portions of the roof that could be sold that did not impede access to roof electro-mechanical systems, violate fire egress or contravene municipal ordinances; (2) to help determine space apportionment for maximum sales value ; (3) to liaise with the building accountant and attorney to develop a transfer strategy and recalculation of percentage of common interest; (4) to obtain an appraisal of the roof portion to be sold, as well as competitive sales data from other properties; (5) to prepare and distribute to building residents a preliminary “offering” of space for sale and act as an informal broker between residents and board in the event of unit owner bidding and counter-bidding.

Not everyone was happy at the prospect of the sale of roof space and the most resistance came from the unit owners situated just below it, who did not wish to purchase it but worried that a recreational use of a heretofore restricted space would jeopardize the quality of their home environment. Moreover, since the building elevator did not go to the roof, some residents worried at the security and liability implications of increased foot traffic in the building stairwells. We spoke to them and assured them to the contrary that their apartment habitability would be maximally respected and protected via the development of stringent roof use rules and procedures. Since the divestiture of communal space by the Housing Association requires a lengthy legal process as well as a unanimous vote of its membership, these unit owners could have created insurmountable obstacles, but chose not to, clearing the way for the purchase of deck space by a lower floor resident who did not object to a 4-floor walk to the roof and considered it an additional recreational opportunity.

Racing the Clock

by Eugene Andrews

The City, and its various municipal agencies that control and regulate residential real estate, rely upon process, and not exception, in their determination of the code compliance of building construction and repair. There are good reasons for this, the foremost being that availing the public of channels and procedures to skirt the, admittedly laborious, processes of construction filing and City evaluation of architectural plans would undermine the science of good building practice, which is the basis of the development and standardization of City Building and Fire Codes. However, sometimes building exigencies arise suddenly that can negatively affect habitation, or even lead to catastrophe, that need to be corrected immediately, yet cannot be done without the building owner first having to traverse a bureaucratic process of municipal filings and approvals, involving architects and expediters. Examples of this are the discovery of: (1) Lack of fire-stopping between floors; (2) the need to suddenly convert from an obsolete wooden sprinkler roof tank to a basement fire pump; (3) the need to expand sprinkler pipe coverage; (4) repairs to damaged building structural supports, etc.

Moreover, once a board discovers a building condition that contravenes City building or fire code it automatically assumes a legal obligation for correction and thereby begins to incur liability for non-correction, including a possible denial of the building’s insurance defenses in the event of a loss attributable to the non-code compliant condition. The City’s response to such discoveries (whether made by City inspectors or not) is consistent: (1) Private owners, and not the City, are legally responsible for correction and cost; (2) The City must grant prior approval for all work; (3) Severe building conditions require owner evacuation of the building rather than contravention of the City’s filing and approval processes. Fortunately, such conditions are rare and, when they occur, evacuation is perceived by residents as being in their best interest and is rarely challenged. It is in the case of less extreme conditions which, though not dramatic and unequivocal, create safety and liability conditions in buildings that present challenges for Management. Such a case was faced by The Andrews Organization at a Tribeca condominium when it was discovered that a contractor, while installing a new concrete sidewalk, had accidentally covered over the boiler fresh air intake, thereby trapping boiler gas emissions in the building’s basement.

Since the building was in a Landmark District, filings with, and approvals by, three municipal agencies were required in order to open the sidewalk and install a grill: (1) Landmarks Preservation Commission (LPC); (2) Department of Buildings (DOB); (3) Department of Transportation (DOT). Although the required sidewalk opening was small and the grill innocuous, skirting the filing process was never an option. The building architect was given the mandate to follow an aggressive filing procedure by personally contacting the LPC, whose prior approval is required by the DOB, and requesting expedited consideration for their filing. Due to an approaching holiday season and the City’s moratorium on plan approvals, the process was expected to take several months, extending the building’s legal liability, and setting its residents’ health at risk.

Merely filing and waiting was an insufficient course of action to protect the Board and building residents from both legal and personal risk of gas migration to upper floors. Unfortunately, the architect had determined that there were no viable alternative temporary solutions to bring fresh air into the boiler room, such as evacuating the boiler emissions through the building's chimney flue. Though the building had acted prudently by filing for correction and exploring temporary options, it had not yet fulfilled its final mandate: To maximize the use of annunciation systems and alarms so as to lessen the degree of danger faced by residents from an odorless toxic gas. The Andrews Organization made three suggestions: (1) Integrate a boiler room carbon monoxide alarm with a boiler limit switch to automatically shut off the unit; (2) Install such alarms in basement and lower hallway; (3) manually check the operation of each unit’s CO alarms. Once these were accepted, the Board had done all it could to respond to an emergency contained in a building firmly entrenched in a bureaucratic process.

Making Plays

by Eugene Andrews

Every building is a business, though a unique one which often requires consensus among a wide array of parties. Such consensus is usually sought at meetings: (1) Board meetings; (2) committee meetings; (3) staff meetings; (4) professional meetings; (5) vendor meetings, and many others meetings that consume a large portion of Management’s allotted time at a given property. Yet there is one meeting, the Annual Meeting of Owners or Shareholders, that stands out from the others in two regards: (1) it is generally the only such meeting of its kind to take place during the year; (2) its aspiration is macro-oriented rather than micro-oriented. The Annual Meeting is an opportunity to provide the collected body of owners or shareholders with an overview of the past year of building operations, and to inform them of consequential matters for the upcoming year. But it has another aspiration, a barometric one, which is to gauge the degree of rising or falling political pressure in the building body politic as a whole, pressure for change of policies, change of staff, change of professionals and service providers, even change of Board. Therefore, Annual Meetings, while undoubtedly possessing ritualized elements, can, in certain situations, present a substantive challenge for a Board and Management to address a sudden or long-standing increase in political pressure.

Often such pressure builds over the advent of a single unexpected event such as a costly capital improvement project, a City action in the neighborhood (a new prison for example, or a sanitary transfer station) that could decrease property values, a dramatic increase in monthly fees due to higher real estate tax assessments, etc. In situations of high political pressure in a building it is Management’s responsibility to help prepare and orchestrate an annual meeting that is maximally responsive to such pressure in the hope of defusing it. This was The Andrews Organization’s mandate at a Tribeca condominium that had recently been informed by its Board that a multi- million dollar exterior restoration was required due to sponsor-caused building defects (from obvious construction shortcuts) in the building’s development process. Compounding the issue, and sending the barometric dial to red, was that 3 years previously the Board had thought it had settled all open issues with the sponsor and given it a blanket Release in exchange for a modest, in hindsight, cash payment. Our challenge was to organize an annual meeting of sufficient depth and gravitas to mitigate ownership’s generalized anger, fear and suspicion, so as to achieve a moving-forward consensus on a highly resented, though absolutely essential, building-wide life- saving rehabilitation program.