December 16th, 2008
WALL STREET TO CITY: DROP DEAD.by Joelle Panisch
The Specific (And Shameful) Subprime Loan Crisis in NYC Housing and the Looming Inevitability That Buildings Will Default.
Before 2006, ‘tenant harassment’ was not part of the common vernacular. Maybe landlord A disliked tenant B. The landlord gave the tenant a hard time; the tenant felt harassed, drank a few beers and moved. But since 2006 there has been a massive pervasion of physical, legal, and psychological harassment amongst low-income and rent stabilized households. How odd. Did landlords A, B, and C all get together, grease their mustaches and come up with a devious plan to oust their tenants, or is the shift indicative of a larger presiding force?
In May of 2008 the Association for Neighborhood and Housing Development (ANHD) released a study about the surge in tenant harassment and the subsequent loss of rent stabilized apartments. The report found that the spike coincided directly with an increase in developers backed by private equity investors. These investors were banking on the uncertain prospect that they could illegally evict tenants to convert buildings to market rate, and high mortgages reflected this hope. Sound familiar? Perhaps like a certain economic crisis fueled by greed, the despicable exploitation of average citizens and disregard for the laws of accounting that resulted in poisonous securitization? In a follow up report released in October the ANHD found that the investment in subsidized housing made by these “predatory equity” firms (as they were dubbed) is just New York’s version of “ninja lending” and 60% will probably result in likewise defaults. It turns out New Yorkers and Joe Plumber-Six-Pack have more in common than they realized.
What lead to New York’s unique subprime crisis has much to do with its unique real estate, which has been reshaped drastically over the last 35 years. In the 1970’s the economic recession (including an oil crisis, the ’73 and ’74 stock market crash, a lending crisis, and bailouts–once again, sound alarmingly familiar?) proved incredibly destabilizing for New York City and lead to a fiscal lending crisis, soaring crime rates, and deteriorating public services. In response, 10% of the city’s population migrated, resulting in neighborhoods and real estate values that were carved and distinct. Do you remember when Alphabet City and the Meatpacking District were considered seedy?
It wasn’t until the 1990’s economic growth that real estate gained the kind of competitive vigor that it has today. Central industries boomed and neighborhoods within a short public transportation distance of the financial district overflowed. Gentrification proliferated in formerly undesirable neighborhoods. In 1996 vacancy decontrol laws weakened rent control regulations by allowing rent stabilized apartments to be repossessed by landlords at market rate after tenants moved out.
About nine years later–despite 9/11, the Iraq War, and a slowing economy–the real estate bubble was still expanding and values rose to record rates as available housing in attractive neighborhoods dwindled. Private equity funds in competition for leasing companies were fighting to increase their portfolios, and desperately looking for fresh real estate. And then one day it dawned on them–subsidized real estate is extremely undervalued and the potential for profit is immense.
Prior to the “predatory equity” swell, low-income real estate in working class neighborhoods was in relatively low demand. It wasn’t a lucrative capital investment, returning a modest profit of about 8-9% per year. Earnings were relatively non-liquid, static and were taken by landlords as income. Tenants in regulated apartments had the right to renew their leases, which could only be raised by a limited amount. And with the turnover of rent stabilized apartments to market price only at a natural rate of 5%, hope for any kind of short-term gain was low. Buying subsidized housing was considered fairly unsophisticated by big developers who invested in land lots to build.
So the 90,000 units purchased by private equity backed developers since 2004–10% of all rent-regulated housing suggest an investment strategy that either defies these figures or maliciously targeted low-income residents. The ADHD’s investigations suggest the latter. They found that the private equity firms who backed these developers had business plans that promised 15-20% profit, double the realistic rate of return. These projections can only be actualized if landlords are able to evict the rent-stabilized tenant.
Proof of this can be found in the language of agreements. In a document filed with the Securities and Exchange Commission (SEC) by Vantage Properties and their entourage of predatory financiers, Apollo Real Estate Advisors and Column Financial, it was stated that Vantage “anticipates to recapture approximately 20-30% of the units [within the first year], and 10% a year thereafter” in order to pay the debt service on their loan.”
These are ambitious projections, with drastic implications all around. Success means thousands of people are displaced, most likely priced out of the neighborhoods they had lived in for decades, and communities are changed. Initially, the slimy landlords were successful in evicting 50% of rent-regulated tenants in the Lower East Side the first year, in what was referred to as the “reign of terror.”
However in the past two years tenants got organized and refused to leave. Community groups such as the Good Old Lower East Side (GOLES), Chelsea Housing Group/Tenant Action Committee, Rent Stabilization Association group, Chinatown Neighbors Committee, and many more have united to educate and represent tenants in danger of being displaced. In March 2008 Mayor Michael Bloomberg signed legislation establishing penalties for tenant harassment.
However, even if the bad guys lose and tenants are no longer harassed to the point of eviction, it doesn’t mean the communities will be better off. If landlords fail to evict tenants, there will still be severe consequences. These predatory equity deals were financed as balloon mortgages on the thin ice of an idea that they could alter natural projections with a business plan that was unethical and only questionably legal. To hedge the risk, the loans were pooled, securitized, mixed with special purpose vehicles and then asset backers were thrown in. Essentially the deals had the same recipe as subprime mortgages, only bigger.
“As it turns out most of these guys are not getting the turnover they thought,” said Benjamin Dulchin, Deputy Director of the ANHD, “They weren’t hedging the risk, (which) was spreading the risk like a virus.”
With harassment legislation in place and tenants refusing to leave, the landlords’ inability to “recapture” apartments at the rate they expected is bad news for financial institutions. Some of the predatory landlords are now unable to make their mortgage payments, and are defaulting on their loans. Big loans. For instance, the infamous Peter Cooper Village & Stuyvesant Town sale to Blackrock realty reported that the net profit or the net operating income (NOI) was $111 million dollars in 2006 and projected it would be $333 million in 2011, an almost 300% increase in 5 years. Based on these hyperbolic appraisals, the assumption that they would be able to “recapture” rent-regulated apartments, and the overvaluing of market rate real estate, they made the biggest real estate deal of a single property in modern times at $5.4 billion. Two years later the trajectory of the NOI is nowhere at the rate they thought it would be and Blackrock and their mortgage-backers (including COBALT, Merrill Lynch, and Wachovia and their underwriters) will either have to take a loss or default.
According to the ANHD’s report an astronomical 60% of the units bought by predatory equity firms are on a watch list for buildings expected to default. That’s 54,000 apartments!!
Blackrock is likely to absorb the projected billions of dollars in loss. But others are not in a position to do so. One of the especially high-risk complexes is the Riverton Houses in Harlem from 135th to 138th streets, containing 1,230 units. Owners Stellar Management and Rockpoint Group have told their mortgage servicers that they have made little progress in converting units to market rate, turning only 10%–their goal having been 53% by 2011. And as a result they are having trouble making payments on their $225 million dollar mortgage.
In August, Stellar sent residents a notice telling them not to worry but the recent buzz has them on edge. “To rent me an apartment based on these measures is totally irresponsible,” says market-rate Riverton resident Amirah Parker. “Not to mention unethical. I wish I knew this before I moved in.”
What will happen to tenants if these buildings default is uncertain. Rent regulated units are protected, though market rate tenants have fewer rights. After foreclosure a receiver is appointed to manage the building until a final purchaser is found, though with “predatory” properties it will likely be prolonged due to the many mezzanine lenders who have the option to adopt the mortgage. Generally defaults lead to a halt in repairs and a deterioration of building standards, which affect communities as well. In a worst-case scenario, real estate values decline, buildings are abandoned, and homelessness and crime rates increase, as seen in neighborhoods in the 1970’s.
John Mollenkopf, Director of the Center for Urban Research at CUNY, doesn’t think the defaults will have as severe an impact. “The 1970s were devastating for NYC neighborhoods. The current period of subprime mortgage foreclosures is less challenging than that period, but probably the most serious challenge we have faced since then.”
However the ANHD doesn’t think the city can afford to take chances, and is urging the New York City Department of Housing Preservation and Development (HPD) to tighten their belt on code enforcement and “proactively target these buildings before [deterioration] becomes severe.”
In spite of such fears, many see these defaults as having a potentially positive impact on communities. A heightened public interest in affordable housing issues is likely to unveil corruption and generate the political pressure needed to make legislative changes. However, as the economy continues to plunder, funding for public housing will disappear and the preservation of the affordable housing that we still have will be the pressing issue. Educating at-risk tenants, cracking down on fraudulent landlord claims, and supporting preservationist buyers are among the immediate solutions the ANHD advocates. Further, any business practice that gets dubbed “predatory” should most likely be evaluated and addressed. “Clearly, we need a coherent city-wide approach to this problem,” says Mollenkopf. Clearly we do.