Understanding the history and purpose behind the Reserve Fund Law in NYC is necessary with so many Co-ops on the market. This article, recently published in the New York Real Estate Journal provides a good foundation to understand this requirement and offers reasons why there may be a need to change this law.
In the 1970s and 80s, conversions from residential rentals to cooperative ownership were common and sponsors normally did not make substantial upgrades to buildings as part of the conversion process. Virtually all tenants in buildings undergoing conversion were rent regulated with a right to continue in occupancy indefinitely. It was necessary to convince at least some tenants to buy, which required negotiating with their representatives in order to successfully meet the requirements to convert. The result would be low purchase prices for all tenants, as discrimination among tenants was, and is, prohibited.
Because of the low prices to tenants, there was little money available for improvements. Buildings were often converted as-is without money provided as a working capital or reserve fund for future needs. Moreover, advance payments made by sponsors for such items as insurance and taxes on the real estate often resulted in closing adjustments that could leave a cooperative in debt to the sponsor following the conversion.
With the poor financial position of some buildings following conversion, New York City needed a requirement to provide these newly launched cooperatives with some money for critical needs. That is the genesis of the statutory “Reserve Fund Law,” Local Law 70 of 1982, now Title 26, Chapter 8 of the New York City Administrative Code. The motivation for the Reserve Fund Law was to make sure that money was available after closing for cooperatives to make “capital repairs and improvements necessary for the health and safety of the residents.”
Much has changed. Condominium conversions have largely replaced cooperative conversions. Today some of the language in the statute seems antiquated and difficult to apply. Condominiums have no building-wide tax obligations that are adjusted with the building. Instead, adjustments with individual purchasers at closing are often far greater in the aggregate than building-wide adjustments. As a result, condominiums often have little or no debt.
New York City rent laws have evolved, and many tenants now pay market rents with no right to renew their leases. These tenants may be moved out when their leases expire early in the conversion process, so there is less incentive to give tenants significant discounts to purchase. To profit in the current market, developers make major upgrades to vacant apartments and the buildings themselves in order to sell at high prices. Whenever possible, they use an available credit against part of their reserve fund contribution. This makes it less likely that these buildings will be converted while needing repairs.
In this environment, the method of funding under the Reserve Fund Law hasn’t changed. It is based upon the price of units. Because of the evolving market, unit prices have escalated which may result in a bloated fund for reserves that will not be needed for years. Luxury conversions may be receiving a larger reserve fund than needed, which helps push prices even higher. Other buildings more in need, however, might be receiving the least money.
Under the assumption that funds might be misused, the statute provides for major restrictions on the use of the funds. The reserve fund may be spent for “capital repairs, replacements and improvements necessary for the health and safety of the residents.” Other than repairs and replacements, exactly what kind of improvement would be necessary for health and safety? It’s hard to imagine too many possibilities, short of modernizing elevator machinery or a remedy for a new hazard that is not yet understood.
These concerns might be compounded by how condominiums receive the money. There are two alternatives to funding. One is for the sponsor to contribute most of the money up front. The other can delay funding for years, possibly with very little paid initially. Although buildings under the second alternative may end up with more money later than those under the first alternative, some buildings that really need the money can’t have access to it, while others may have no immediate use for it. The Reserve Fund Law may never have been perfect, but it is showing its age. It’s obvious that some buildings get more money than others due to location.
Enforcement of the statute is given to New York City governmental authorities, although it appears this has never been attempted. In practice, only the New York State Attorney General has become involved in enforcement.
There are a number of ways this statute should be updated, such as:
1. Revise the funding formula to base it in the size of the building, or the age of the building-wide systems, instead of just the price of units.
2. Consider permitting a greater credit if substantial repair work is performed.
3. Simplify the alternative formula, and make sure that all buildings start off with at least some money, even if the maximum credit is utilized.
4. Do not restrict expenditures by the condominium to capital repairs, replacements and improvements “necessary to the health and safety of the residents” because this requires too much analysis and may result in disputes. It makes more sense to permit the fund to be expended for any purpose that is not in a normal operating budget for the building.
5. Rewrite the statute to clarify the language when it applies to condominium conversions. Terms like “the closing” should be redefined to state exactly what they mean in this context.
6. If the Attorney General is in reality the only government official willing to actually enforce this statute, as has been shown in the past, state expressly that it has the authority.
It is worth rethinking this statute to make sure it’s relevant to twenty-first century concerns, to fulfill its original purpose to provide funds for immediate repair needs at conversion