Surprising multifamily default in Manhattan - 5th Avenue

How does a predatory developers failure to evict rent-stabilized tenants to deregulate the units and bring them to market rate have anything to do with where this market is headed. Their defaulting on their mortagage because their plan to evict rent-stabilized tenants failed. So?

joepa: Basically, you're right. The owners used overly optimistic assumptions about deregulation in projecting future cash flow and debt coverage. If anything, the challenges associated with deregulating stabilized units will tend to keep supply tight, since rent-regulated apartments are effectively outside the market supply-demand equation.

If this situation is relevant at all, it's because of an inference. Deregulation can be done by sticks, carrots, or a combination of the two. Basically, an owner can kick a tenant out, buy him out, or threaten to kick him out to persuade him to accept a buyout. The more the property is worth (and the more the value is depressed by a regulated lease), the bigger the buyout can be and the more likely the tenant is to accept it. So, in this case, the owner's failure to deregulate units suggests:
(1) His stick was ineffective (not surprising, because few of the tenants probably make over $175K); and
(2) The market value of the apartments isn't high enough for him to offer big, juicy carrots.

Not much to go on, really.

BTW, I don't understand the reference to "rent-controlled Riverton Apartments". I thought rent control was an attribute of a tenant's relationship to a particular unit, not of a building.

West 81st, you're exactly right. The buildings are now a mix of market, rent-controlled and -stabilized units.

btw, this was built as a Jim Crow complex, an all-black development to parallel the all-white Stuy Town and P Cooper Vill.

joepa,

I think it quite clearly highlights the issue of being cash flow negative and making optimistic assumptions of future price appreciation. When prices are rising rapidly (as they were in the early part of this decade) being negative from a run rate cash flow perspective was managable because 1) borrowers could refi and take out the increase in appreciation via a larger mortgage or 2) sell the property at a gain.

With no appreciation and arguably depreciation in prices the hemorrhaging of cash month after month becomes a real problem. Tax loss carry forwards only help if you actually make money sometime in the future and if real estate is a business not a hobby.

Many condo investor/flippers are starting to face a similar situation where the rents they can obtain cannnot come close to covering the monthly outflows. These situations like the Riverton are unsustainable.

jake: All of your general principles are right, but you have picked an example that isn't directly relevant to your point. The salient risk in this case wasn't market risk. It was REGULATORY risk. Adverse market conditions are an aggravating factor, but they are not the central problem. The article states the fundamental miscalculation very clearly:

"Developers Rockpoint Group LLC and Stellar Management have told the mortgage's servicer that they made minimal progress toward their goal of converting half of the 61-year-old complex's units to market-rate housing".

The main problem isn't that the market is falling; the main problem is that the market isn't setting the price of these apartments at all.

First of all - as other have commented in support - I don't think this demonstrates an optomistic assumption about price appreciation so much as it does an assumption about deregulation. This is a case where the developer saw an opportunity to buy an undervalued property at a bargain with thought of being able to deregulate it and make a killing bringing the apartments up to market value. Problem was - he couldn't get rid of the regulated tenants. Whether the property appreciated or depreciated, the developer would have defaulted on its mortgage. Why would they refi and take out a larger mortgage on a project that clearly failed?

As an aside - by titling your post "default in Manhattan - 5th Avenue" - you made it look like some hoydy-toydy families on Central Park in the 70s/80s were defaulting on their mortgage. Isn't this project on like 138th street? A bit deceiving if you ask me.

As an aaide, Stuy Town/PCV is having similar problems, not deregulating as many units as they anticipated and spending way more on each buyout. On a smaller scale, Ben Shaoul/Magnum RE is having his own problems with the "East Village Portfolio" of buildings he bought from Extell. His "stick" approach isn't working, he payed a ridiculous amount of money for the buildings, and he can't get the rents he wants when he does renovate vacant units.

But joepa,
Why coundn't the developer get rid of the rent controlled tenants? They obviously thought they could.
Rent controlled tenants have a good deal. They need an incentive to give up their rent controlled apartment and move out. A new owner/developer offers an incentive to the rent controlled tenant to move out as a function of his own economics. That is as a function of 1) the difference between market rent and the rent control. The developer may also have ideas on converting the rent controlled building into a condo in which case the incentives offered to the rent control tenant may also be a function of the market price of the apartment as a condo.

The riverton failed because the assumptions about the econonomic incentives the developer could offer to the rent controlled tenants were overly optimistic and wrong. That is market rents and prices could not generate sufficent cash flow to provide adequate incentives to the rent controlled tenants to move out. Assumtptions about rents and prices were too optimistic. The developer, lenders and security holders will lose money because underwriting was too aggressive and assumptions were too optimistic.

The developer paid too much for this real estate. It's value today is lower than when it was purchased. If real estate values in Manhattan had gone up since the property was bought there would not be a default. This is clear evidence that real estate prices have gone down.

The project is on fifth avenue and it defaulted. I am not trying to deceive anyone by simply restating the facts. The editorial comment "surprising" was the quote from Trepp in the WSJ.

Jake: Again, read the article you posted:

"Developers Rockpoint Group LLC and Stellar Management have told the mortgage's servicer that they made minimal progress toward their goal of converting half of the 61-year-old complex's units to market-rate housing since obtaining the mortgage in December 2006..." Note: "DECEMBER 2006".

If their strategy was based on offering incentives to regulated tenants, why didn't it work in 2007, when the market was strong? Carrots may have been Plan B, but Plan A was evidently sticks: forcible deregulation and eviction.

Applying 20-20 hindsight, we can say it would have been smarter to offer juicy carrots in 2007. Maybe they did offer some, and the tenants simply weren't interested. I do agree that a tougher market makes it harder to offer big buyouts in mid-2008, assuming this was ever the owner's fallback plan. But there's no evidence to suggest that the owner's primary strategy ever depended on appreciation and buyouts. Most likely, his failure demonstrates a flawed reading of the regulatory environment.

Jake, I'm pretty bearish, but I think you picked a poor example to support your case.