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America’s Most Expensive Multifamily Deal: Who’s Going Down the Tubes, and How The Big 4 Banks Won’t Suffer a Similar Fate

The most expensive apartment complex in the history of U.S. real estate, Manhattan’s Peter Cooper Village and Stuyvesant Town, will probably default on its mortgage within the next few months. As of the end of September, it had $33.7 million left of the $400 million in interest reserves set up to service its debt, according to the people familiar with the matter. At its current burn rate of about $16 million per month, the reserve could be depleted before the end of the year, the people said. Others have said the venture could avoid default until February. According to WSJ:

Lenders who financed the deal first projected the complex’s net operating income would triple to $336 million in 2011 from $112 million in 2006…[b]ut net income is projected to be $139 million this year…

Underwriters for the deal expected vacancy rates to be 10% or more, which perhaps rested on the fanciful assumption that mass quantities of plutonium would be discovered in the complex’ Oval Courtyard. In fact, NYC vacancy rates over the last few years have hovered between 2.5% and 3%, occasionally veering up to 3.5% in the interim. Underwriters did not sufficiently factor into their spreadsheets the possibilities that:

1) rents would decline

2) vacancy rates would increase

3) the entire economy would lurch right into the toilet.

Underwriters appeared to have made a then reasonable assumption that once rents were raised beyond $2,000, those units would no longer be subject to rent regulation. A recent court decision throws that assumption to the wind: it held that all units of buildings receiving J-51 tax abatement benefits were subject to rent regulation, regardless of monthly rent amount. The New York State Court of Appeals just heard arguments, and will decide this matter in the next few months.

Many of the folks who ponied up the dough to finance this project will never see a dime of their investments again. Notable losers include the California Public Employees’ Retirement System (Calpers)($500 million), Florida State Board of Administration ($250 million), and the Church of England ($70 million). [If this won't be a Happy Chanukah for Shaya Boymelgreen, it definitely won't be a Merry Christmas for the Church of England.]

While these private lenders will be wiped out, large financial institutions who hold second mortgages on residences still retain lien leverage. The “Helping Families Save Their Homes Act of 2009″ gives banks immunity from prosecution and liability when they modify loans, specifically first mortgages. The Big Four banks — Bank of America, Citibank, JP Morgan, and Well Fargo — service these loans, but do not own them. They generate billions of dollars in fees. On the other hand, the Big Four own about $400 billion in second mortgages. Banks therefore have the motive of self-preservation, and the benefit of immunity, to reduce others’ first loans in order to save their hides on the second loans. This goes against long-held jurisprudence in this field. On the other hand, it provides juicy material for a final exam question in either business or legal ethics.

In the words of the slimy but brilliant mouthpiece, Roy Cohn, “Don’t tell me what the law is. Tell me who the judge is.” The Big Four know who the judge is — biblically. Their campaign contributions paid off handsomely. If only Calpers and the Church of England had friends at the Big Four…

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