12,000 units are already gone!

November 7, 2007

A new type of real estate owner has dramatically changed the landscape for the preservation of affordable housing in New York City. These new investors are able to tap the world’s biggest pools of investment capital and pay unheard-of prices for New York City apartment buildings housing low- and moderate-income tenants. But in order to get access to this capital, they must promise higher rates of return on investment.

The only way they can deliver on their promises is to raise rents to levels that the current tenants can not afford – resulting in the inevitable replacement of those tenants with a new, higher-income group. That is why these “predatory equity” investors are so dangerous to the affordable housing supply.

This new type includes private equity groups as well as other investors who obtain capital on the competitive market.

1. Entrepreneur identifies a building as an “underperforming or “underutilized” asset. This means that the income that the building produces is significantly lower than it could be – because people with low and moderate incomes are living there instead of people with higher incomes, who could pay higher rent.

2. Entrepreneur obtains “equity capital” by promising other investors a high rate of return – generally 20 percent a year. Investor then obtains “leverage” by borrowing more money – six to ten times more – from banks or other lenders.

3. Entrepreneur buys the building and begins working to increase its income. Often the entrepreneur and the equity investors are willing to see income go down – or even to lose money – for a few years before it actually goes up.

* In the case of a Mitchell-Lama buyout, this enables them to immediately suffer the loss of subsidies, along with huge interest payments on the borrowed money, while waiting for rental income to increase over a period of years as the original tenants move out and new tenants move in and begin paying higher rents. 4. If the entrepreneur is a private equity group, it will sell the building to a new investor after three to five years – as soon it can show that the property’s income is going up enough to justify a significantly increased price. Other entrepreneurs may prefer to sell or to continue to own and operate the building. Either way, many or most of the original tenants must be replaced with higher-income people by this point, or the investment will be judged a failure.

Predatory equity investments are a serious cause concern for tenants and affordable housing advocates for two reasons:

1. These investors must significantly increase the profitability of the assets they buy in order to reach their expected rates of return (or even just to avoid losses). When the asset is low- and middle-income housing, this can only be accomplished by raising rents significantly, so that the tenants in place are replaced by a new group of higher-income tenants.

2. The speculative prices paid by these investors, and the high degree of leverage in their deals create the risk that income from the property will not be enough to support debt service, which can lead to inadequate maintenance, deteriorating conditions, and possibly foreclosure.

In short, speculative investments place both tenants and the buildings themselves at risk.

Riverside Park Community, better known as 3333 Broadway, is a former Mitchell-Lama rental building in West Harlem. In 2005, it was removed from the Mitchell-Lama program and sold for about $85 million to an international real estate investment group called Cammeby’s International. Then in 2007, it was sold again for $277 million to Urban American Management and City Investment Fund, a private-equity group backed by the New York City and New York State public employee retirement systems, among other investors.

This chart shows how the building’s finances were probably affected by the changes – roughly estimated based on an analysis of information from public agencies and the news media. (These estimates ignore inflation.)

(1st number = ML in 2003)
(2nd number = Ex-ML 2005)
(3rd number = Ex-ML 2007)

Rent income $7.8 million $8.4 million $10.2 million

Subsidy $5.3 million $18.6 million $16.8 million

Total income $13.2 million $27.1 million $27.1 million

Operating $7.5 million $7.5 million $7.5 million

Property tax $0.8 million $7.5 million $7.5 million

Total costs $8.3 million $15.0 million $15.0 million

Net income $4.9 million $12.1 million $12.1 million

Debt service $4.7 million $4.8 million $15.0 million

Net cash flow $0.2 million $7.3 million LOSS of $2.9 million

There are a few things to note here:

• First, that the amount of subsidy to the building soared in 2005 – the result of the issuance of enhanced vouchers to protect tenants.

• Second, as a result of that subsidy increase, the buildings still made money after the building’s sale and removal from Mitchell-Lama.

• And third, the building now appears to be losing money, due to the huge increase in debt service. Why would private equity investors (backed with state and city employee pension money) pay $277 million dollars to lose money? Only so they can make money later.

This deal only makes sense if the building can either be resold after a few years for something well over $300 million or be converted to condos for $400 thousand or $500 thousand per apartment. Either way, it only works if the tenants of 3333 Broadway are rapidly replaced with higher-income tenants.

This is a perfect example of how predatory equity investments endanger tenants and place valuable affordable housing assets at risk.

We know of five Mitchell-Lama developments in New York City that are currently seeking or preparing to seek approval for a transition of ownership: Tivoli Towers in Brooklyn, General Sedgwick in the Bronx, Trinity House in Manhattan, Meadow Manor in Queens, and Castleton Park in Staten Island.

Three of these developments (Tivoli, Meadow, and Castleton) are being pursued by Laurence Gluck, a real estate investor who often partners with the Rockpoint private equity group. Gluck has already purchased 16 Mitchell-Lama developments in the city and removed all of them from the subsidy program. Sedgwick is being pursued by Mark Karasick, who is a major player in commercial real estate.

In addition, we have identified 24 buildings in the city, totaling nearly 10,000 units, that have already been purchased and removed from the Mitchell-Lama program by Gluck, Cammeby’s, or Karasick.

In most of these cases, the initial sale of these properties occurs while the buildings are still in the Mitchell-Lama program and therefore subject to government oversight. The supervising agencies, including the federal Department of Housing and Urban Development, the state Division of Housing and Community Renewal, and the city Department of Housing Preservation and Development, are therefore in a position to determine if the sales terms are placing either the tenants or the assets at risk. Despite the massive public investment and the clear statutory authority to do so, none of these agencies have clear and consistent practices and policies with regard to vetting sales of subsidized projects.

1. Public employee investment funds should not invest in private equity or other highly leveraged investments in formerly or currently subsidized or regulated housing without the assurance that the buildings will be kept in their affordability programs.

2. At a minimum, we call on all regulatory agencies that supervise Mitchell-Lama developments to enact and codify procedures which mandate careful scrutiny of sales of these projects to ensure that neither tenants nor the assets are being placed at risk.