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Down Goes Tishman: The Top 5 Repercussions of the Stuyvesant Town Decision

J-51: the most offensive three letter-number combination to New York City apartment building owners.

New York City’s J-51 program enouraged owners to upgrade their buildings, in exchange for tax exemptions and abatements.  New York’s highest court ruled 4-2 that the program had a catch: owners whose buildings received the benefit from the J-51 program are prohibited from removing those units from rent regulation.

Under normal circumstances, NYC rent-regulated apartments would be free of rent regulation once the combined income of its occupants exceeded $175,000, or when rents surpassed $2,000 through capital improvements or cost-of-living increases. But Met Life, the previous owner, had received $24.5 million in tax breaks since 1992 under the city’s J-51 property tax program.

The owners of America’s costliest apartment complex, comprising Manhattan’s Stuyvesant Town and Peter Cooper Village, did not know of this J-51 exception. In fact, they had no way of knowing since the City of New York did nothing to enforce, let along recognize, such an exception. The tenants who filed the underlying lawsuit against the Tishman Speyer-led ownership are seeking $215 million in relief from rent overcharges, as well as attorneys’ fees.

This is the last nail in the coffin for Tishman Speyer as owner.

And here is a copy of the hammer – the Court of Appeals decision:

Scribd

Even before the decision was handed down, the 80-acre property, bought for $5.4 billion in 2006, had a market value of about $2.13 billion, according to RealPoint. More recently, Deutsche Bank analysts pegged its worth at $1.89 billion, down 65% from its sale price. Talk of default has swirled around this project for months.

This 60-65% drop in equity will surely crater further.

This decision begs the question: Now what for the rest of us (in NYC)?

Here are the top 5 repercussions of the decision:

1) Lawyers get windfalls; tenants get paydays. Unsubstantiated estimates abound that approximately 80,000 apartment units in NYC got the benefit of J-51, and were also removed from rent control. Zealous and well-organized real estate attorneys probably had their class action lawsuits ready to download and print for this scenario. They and their clients can fight for treble damages and rent rebates.

2) Manhattan Apartment Building Values Further Drop In Value. As George Mason University economist Walter Williams has said, “Short of aerial bombardment, the best way to destroy a city is through rent control.” And that was before Uncle Walt knew about this decision. Foreign investors are among the first wave of folks venturing back in to Manhattan real estate. The dollar is taking a beating like Apollo Creed from Ivan Drago in Rocky IV. While real estate prices will recover eventually, Manhattan multifamily is now looking less attractive. Why should foreign money, old money, or any money for that matter buy multifamily in Manhattan when units may never be free of rent regulation? If you’re running a hedge fund, wouldn’t it make more sense to buy an office building, barring some steep discount on the multifamily front? Moreover, it is not altogether clear what buildings even have J-51 status. You can’t simply press a button, or find out in some central clearinghouse or website. One attorney I recently spoke with had a client who recently purchased a Manhattan apartment building recently. None of the paperwork in due diligence reflected J-51 status. The rent roll reflected that several units were taken out of rent regulation. Guess what? The building turned out to have J-51 status. Want to guess the tax benefit? $13! It’s not like owners can simply give back the J-51 tax money, and ask for the status to be rescinded either.

3) Outer Borough Multifamily Starts to Look a Little More Attractive. Contrary to what some provincial Manhattanites think, New York City has four other boroughs.  An allure of Manhattan apartment buildings was that once the buildings were “worked,” or improved, the below market units could generate rents in excess of $2,000. Once there, the units would be free of rent regulation. Rents in the outer boroughs are significantly less, as a general rule. Since so many of the rents are still three digits, or low four-digits, those buildings could still be worked, and have plenty of upside.

4) More rent regulation from Albany. The New York State Court of Appeals has ruled that you can put the toothpaste back in the tube. Or at least try. If units generating more than $2,000 in monthly rent can be put back into rent regulation, than it’s an easier sell for state legislators to raise the bar for decontrol from $2,000 to $2,700, or even $3,000. After all, there are more tenants than owners who vote, and Democrats control all three corridors of power in NY state government. Not if, but when the $2,000 floor goes up, #2 will be even more accurate.

5) Hail-Mary Pass to the U.S. Supreme Court. In the words of the late, great slimy mouthpiece Roy Cohn, “Don’t tell me what the law is. Tell me who the judge is.” Indeed, the J-51 law is a state law, and cannot at first blush be the subject of an appeal to federal court. Those who categorically reject the possibility of appeal are wrong. If defendants (and other owners) can show that a federal right has been violated by their decision, only four justices need to grant a writ of certiorari to hear the case. To answer Roy Cohn’s question, the judges are Thomas, Scalia, Alito, and Roberts.  The best theory in my mind invokes the Takings Clause of the Fifth Amendment: Private property shall not be taken for a public use, without just compensation. The owners can advance the novel argument that their money, and the value of their buildings, are being taken from them without being properly compensated. It’s a long shot, but with so much money on the line, somebody could turn this sow’s ear into a silk purse. An interesting and unintended consequence might create unlikely bedfellows: Both owners who support this argument, and detractors of the Atlantic Yards project cloak themselves in the Takings Clause of the Fifth Amendment. Opponents of  Atlantic Yards have protested the project in part because the City of New York has invoked eminent domain to take private property for a developer.

Here’s what won’t happen: Owners will let their buildings fall into disrepair. Vacancy rates are climbing, while rents are falling. It is a tenant’s market. Tenants can be choosy about where they live. If owners don’t keep up appearances, tenants will not stay. If owners let essential services go, tenants will file complaints. Apartment building owners, however, will now refrain from going the extra mile that allowed them to work the buildings for maximum profit. Buildings may not fall into disrepair, but the idea of owning one in Manhattan may fall into disrepute.