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Bronx Burns Over Failed Multifamily Deals

Linda Kemp remembers when the hallway floors at Robert Fulton Terrace were waxed regularly, when tulips, not weeds, bloomed in the garden, and when mold wasn’t growing in the bathrooms of apartments in the 18-story complex that once was the envy of the Morrisania section of the Bronx. “We were always considered the Building on the Hill,” says the 51-year-old president of the tenant council, who has lived in Robert Fulton since she was 8. “It was a place to live with pride.”

That was before April 2007, when New York real estate investor Mark Karasick spent $44 million to acquire the building and its sister property two miles north, Fordham Towers. Tenant leaders suspected that Mr. Karasick, whose deals are often seeded by San Francisco-based private equity vehicle SFF Realty Fund, had grossly overpaid for his prize and that income from the two buildings’ 490 rent-regulated units would not come close to covering expenses.

Canada-based bank CIBC lent Mr. Karasick $36.5 million for the deal in 2007 and recently insisted the purchase price was “well justified,” even though a securities filing shows the mortgage approval was based on a monthly operating cost of $301 per unit, less than half of what the former owners spent. In a letter to Bronx Rep. Jose Serrano last October, the bank’s general counsel called tenant concerns “unwarranted.” But cuts in service—maintenance staff was slashed from nine to three—had immediately followed the sale. Then, this past May, the tenants’ prediction came true: Robert Fulton and Fordham Towers fell into foreclosure.

A CIBC spokesman would not comment, since the bank sold the loan to J.P. Morgan Chase, which in turn packaged it as part of a commercial mortgage-backed security that includes more than $3 billion in loans for apartment buildings, office complexes and retail strips. A J.P. Morgan spokesman declined to comment.

Steve Holm, a lawyer for Mr. Karasick, says his client still hopes to restructure the mortgage and hang on to the Bronx properties. “Everyone was planning for the debt service to be covered by operating income,” he says. “Unfortunately, that didn’t take place.”

Now, hundreds of other rent-regulated buildings in New York City purchased at the height of the real estate boom may end up in similar distress. Optimistic underwriting enabled investors, often backed by private equity, to snap up rental buildings at bloated prices in highly leveraged deals. In many cases, the new landlords had unrealistic expectations for raising rents, and now some 70,000 units are in jeopardy. That’s left government officials seeking ways to stem what some are calling the greatest threat to the city’s neighborhoods since the widespread landlord abandonments of the “70s.

“It’s a looming disaster, and if it explodes to even half the level of the prediction, it’s going to be a huge problem,” says Emily Yousouf, an ex-investment banker and former president of the city’s Housing Development Corp. who is consulting for the Partnership for New York City and the Rockefeller Foundation on the issue. “It’s not only the tenants who suffer and the buildings that go downhill, but suddenly the neighborhoods deteriorate as well.”

Already, 3,200 units in dozens of affordable housing complexes have gone into foreclosure, an analysis by advocacy group Urban Homesteading Assistance Board shows. Another 11,100 are in immediate danger of going under, the organization contends, citing such factors as the properties’ depleting reserves and high debt burden. As many as 55,000 additional units are considered overleveraged and in jeopardy of foreclosure as their loans mature. All told, the estimated debt load on the properties is $6 billion, though it is impossible to say what portion of that amount is supported by buildings’ income.

Among those already in foreclosure is a portfolio of 10 Bronx buildings with 550 units bought in 2007 by Los Angeles-based investor Milbank Real Estate. On its Web site, Milbank says it thought the Bronx buildings were a good investment because of the borough’s potential “to undergo significant gentrification” and the prospect of an “improved tenant base.” The company did not respond to a request for comment.

Similarly sunny scenarios are darkening throughout the city’s neighborhoods. A January study by the Association for Neighborhood and Housing Development of securities filings from a sampling of 10 multifamily affordable-housing portfolios in the city showed that owners are on average producing only 55 cents in income for every dollar of debt they owe. Some of the most recognizable affordable-housing stock in the city was studied, including the Riverton Houses, which Stellar Management and the Rockpoint Group defaulted on last year.

Deutsche Bank predicts in a separate report that the commercial real estate “refinancing crisis” will reach an unprecedented level around 2013, as loans that were made during the boom in 2005, 2006 and 2007 mature and are unlikely to qualify for refinancing without substantial infusions of equity.

Finding new buyers

The distressed properties remain valuable and could be attractive to a wide range of new owners—at the right prices. Housing advocates and city, state and federal officials would prefer buyers with track records preserving affordable housing. But so far, that end has proven elusive. Banks would first have to restructure mortgages to levels that can be covered by the buildings’ income, which would probably mean huge write-downs in the value of their portfolios. It’s something many banks have thus far been unwilling to do.

“The biggest challenge in all of this is the debt on these properties has to be written down,” says Priscilla Almodovar, chief executive of the state Housing Finance Agency. “But this is a private-sector transaction, and we have no stick. That’s the frustration for everyone. If you’re not working with a motivated lender or owner, what do you do?”

Help can’t come soon enough for the Robert Fulton Terrace tenants, who have grown weary of contending with broken intercoms, dirty elevators and roving rats.

“It’s considered worse than the projects now,” Ms. Kemp says, pointing to several public housing complexes at the bottom of her Bronx hill. “That’s the reality: The projects are maintained better than Robert Fulton Terrace.”

WHAT’S BEING DONE ABOUT IT

GOVERNMENT OFFICIALS, from the feds on down, are pursuing potential solutions to confront the overleveraging of the city’s affordable-housing stock.

* The city’s Housing Preservation and Development department is redoubling efforts to track data on code violations to more quickly identify buildings falling into disrepair. HPD Commissioner Rafael Cestero also wants greater power to enforce liens on properties where the city is forced to conduct emergency repairs—a potential stick when negotiating with lenders.

* State officials have proposed a bill that would allow the State of New York Mortgage Association to insure the refinancing of certain multifamily affordable-housing loans that have been deemed overleveraged.

* Rep. Nydia Velázquez recently inserted a provision into what’s been dubbed the TARP for Main Street bill that would use $2 billion in dividends from bailed-out banks to help restructure financing on apartment properties.

* The U.S. Treasury Department is considering a proposal to blunt the accounting impact of any mortgage write-down or foreclosure on banks’ books in exchange for promises to keep the properties affordable to tenants.

Source: Bronx is burning over failed deals, Daniel Massey, Crain’s New York Business, 8/16/09