How much debt should the coop carry?

In response to the news that East River is seeking to refinance its mortgage with an additional $5 million line of credit, one cooperator has passed along two articles that discuss underlying mortgages and how a coop can appropriately manage its debt burden.

The first is an article written in 2012 — when East River last refinanced and increased its debt from $15 million to $25 million with an interest-only mortgage. Real estate lawyer Pierre Debbas explained why, with low interest rates available, 10-year interest-only refinancing were very popular with coops:

The main reason is that your average shareholder owns their unit for approximately seven years and chances are there will be significant turnaround in units prior to the mortgage maturing.

If the board were to make principal and interest payments, it would result in an increase in maintenance, which would devalue the property and hurt most current shareholders in the building. Only future ones and those current ones who plan on staying in the building for far longer than seven years would benefit from a reduction in principal. Once the underlying mortgage is paid off, maintenance generally decreases significantly.

However, most boards do not desire to ever pay off their underlying mortgage in its entirety and view the mortgage as a way to fund capital improvement projects or replenish the reserve fund.

This seems to be East River’s current philosophy, as the 2012 refinancing funded the boiler conversion and facade refurbishment required by local law 11, and the current increase in debt is for expected repairs and maintenance. It would be interesting, however, to know whether that seven-year average is true for East River or if new cooperators are staying even longer, in which case there could be an argument made for amortization.

The second article specifically addresses whether interest-only mortgages are appropriate for coops. The author repeats some of the pros as the article cited above, that since coops tend to keep rolling over their mortgage, and since property values do, over time, increase, paying down the mortgage is not financially necessary. On the other hand, he also lists some reasons not to use these types of loans:

  • Modest amortization “assures that the debt on your building will not grow over time solely because of refinancing costs.”
  • “Interest-only loans saddle future shareholders with the entire burden of an ever-increasing amount of debt.”
  • “The size of your underlying mortgage as a percentage of your building’s overall value will affect the pricing of any new debt.”
  • Is it fair? “Interest-only loans afford current shareholders all of the benefits of the new funds, as well as the lowest possible monthly payment.”

I should note that this article was written all the way back in 2007, just before the real estate bubble burst. Opinions on the subject may have changed since then. If anyone has other more contemporary sources to cite that may shed some light on East River’s philosophy of increasing debt in order to avoid raising maintenance, please add a link in the comments below or email