Fighting Predatory Equity

When predatory equity investors take a gamble on multifamily housing, it's the tenants who suffer -- whether from harassment or crumbling buildings. Advocates and tenants in New York have won the fight to get some of these buildings into responsible hands, but many are still in limbo, and some are reentering the cycle of speculation.

Image shows front of apartment building; predatory equity
Photo courtesy of Urban Homesteading Assistance Board

In July 2007, the Ocelot Capital Group, a New York real-estate company backed by an Israel-based private equity firm, purchased a portfolio of 25 rent-regulated buildings scattered across the Bronx. They were home to 780 low-income, working-class families.

Less than a year later, tenants in those buildings were facing, among other things, a lack of heat and hot water, ceilings caving in, bursting water pipes, and health problems from a toxic mold outbreak. City records show that the portfolio had accrued a total of 13,590 housing code violations, nearly 3,000 of which fell into the most serious class of violation, posing serious health and safety risks.

Eventually nearly half of the buildings were placed into the New York City Alternative Enforcement Program, an initiative that provides emergency repairs to buildings that the agency considers the most physically distressed. By early 2009, Ocelot had essentially abandoned the properties, and at least one foreclosure proceeding was underway.

Distressed housing, particularly in a place like the South Bronx, is not a new phenomenon. Yet even the most seasoned housing advocates were stunned by the conditions and pace of deterioration at Ocelot’s properties. During a visit to one of the buildings, organizers found a single mother caring for three small children who had been living without a working bathroom for more than three months. Her makeshift toilet consisted of a bucket and a hose she managed to connect to the leaky kitchen sink. She explained that she had not moved out because the local housing authority that provided her monthly rental assistance subsidy would not approve her for a transfer to a new apartment.

Before the purchase, tenants had grown used to a nonresponsive management company and unanswered complaints, but they have a clear and collective awareness of the day, less than a year after Ocelot’s purchase, when virtually all services came to a complete stop. “When Ocelot bought the buildings they collected rents but they didn’t do anything,” says Carmen Rodriguez, a tenant leader at one of the Ocelot buildings. “We lived with no gas, no heat, and for long periods of time many of us were without running water.” The property management company closed its on-site offices, and tenants were told to mail their rent checks to a PO box somewhere in Manhattan.

Advocates began the familiar routine of forming tenant associations, contacting politicians and media outlets, and analyzing the underlying finances on the portfolio in hopes of shedding light on how a once decent, safe, and affordable housing resource had been so utterly destroyed so fast.

The Other Housing Crisis

In order to understand what transpired at Ocelot’s buildings, one needs to consider how the real-estate boom and subsequent bust played out in a hot rental market like New York City, where unlike most places, 70 percent of families rent apartments as their primary residence. During the early part of the decade, rents in New York were increasing at a steady pace, and once-marginalized neighborhoods were starting to gentrify. The tight rental market, combined with loopholes in New York’s rent regulation system that allow for substantial rent increases when an apartment has been vacated, created a climate in which investors and real-estate speculators saw multifamily rental housing as a premium opportunity for short-term, high-return investment.

At the height of the market, between 2004 and 2007, dozens of private equity firms with access to large pools of privately raised capital purchased dozens of apartment buildings across the five boroughs. Betting that property values would continue to rise and that rents could be increased, buyers openly participated in bidding wars, paying astronomically high prices. The banking industry was a willing accomplice, providing buyers with mortgage loans accounting for as much as 80 percent of the total acquisition cost of each deal.

The enormous mortgage obligations left many of the portfolios saddled with debt that far outweighed what existing rent rolls could support. By the time the global economy started to spiral downward, hundreds of buildings in New York City had been purchased at prices that, without tremendous increases in rental income, were financially unsupportable. By 2009, the city’s department of Housing Preservation and Development (HPD) estimated that there were more than 110,000 apartments in the city financially at risk.

Stages of Grief

The first wave of pain came in the form of targeted harassment campaigns aimed at rent-regulated, and particularly low-income, tenants. New York’s rent regulatory system allows rent increases of up to 20 percent when tenants permanently vacate their apartments. Private equity companies, now acting as landlords, believed that their properties were ripe for gentrification and looked for ways to force low-income tenants out in order to make way for higher-income families. A review of public documents revealed that some investors openly projected they could displace 30 percent of occupied units over a 12-month period, despite New York City Rent Guidelines Board statistics that show annual turnover rates in rent-regulated housing are closer to 5 percent.

Some relied on subtle harassment tactics—losing rent checks and refusing to make apartment repairs were popular—while others engaged in full-scale warfare, inundating tenants with baseless eviction threats month after month. No one knows for sure how many families voluntarily gave up or forcibly lost their apartments, but many advocates believe there is a direct correlation between the harassment epidemic and the all-time high number of families living in homeless shelters that The New York Times reported in June 2009.

On the other hand, a surprising number of families across the city dug in their heels and refused to give up their apartments. Eventually, thanks to a combination of effective organizing, political advocacy, and a global shift in the economic forecast, the majority of investor-landlords halted displacement campaigns and began to grapple with the reality that their chance of recouping their investments was becoming slim.

Buckling under the pressure of inflated mortgage payments and with limited ability to increase rents, a number of investors attempted to fend off foreclosure by drastically cutting their expenses, reducing maintenance in some cases slowly, in others brutally quickly, and in many cases walking away entirely.

By summer 2009, more than 5,000 units of housing were in foreclosure as a result of speculative investment in just upper Manhattan and the Bronx. A large percentage of those units were already in severe physical distress, the Ocelot portfolio among them.

Advocates and tenants have fought back, but it’s a long, hard road. Of the Ocelot portfolio, 14 buildings have been rescued; 5 went into bankruptcy proceedings; the remaining 6 are still struggling and now on their third owner.

The Rescue

As the Ocelot buildings became nearly uninhabitable, mortgages on 14 of the buildings went into default and the lender moved to foreclose. The outstanding debt on this piece of the portfolio was roughly $29 million, though advocates estimated that a supportable debt level considering the actual rental income should have been closer to $15 million. Factoring in the enormous repair needs, that estimate plummeted to just a few million.

The question of value became the biggest point of contention between the tenants, their advocates, and the mortgage lender, which, for this group of buildings turned out to be Fannie Mae. Like most financial institutions, the government-supported enterprises Fannie Mae and Freddie Mac were struggling to minimize losses and remain economically viable. Nonetheless, both Fannie Mae and Freddie Mac were created, in part, to carry out a social mission that includes expanding affordable housing opportunities for low- and moderate-income families. Faced with a $29 million investment outstanding and low-income tenants suffering unthinkably bad conditions as a result of that investment, Fannie Mae was struggling to reconcile its dual mission.

It could sell the portfolio through a competitive process to the highest bidder in an attempt to make back its money, but this would surely open the door to additional speculation and reduce the chances of a sustainable renovation. Advocates were pushing instead for a sale to a qualified affordable housing provider at a supportable price that would include a comprehensive rehabilitation plan; this would require Fannie Mae to acknowledge a significant loss on its balance sheets. The choice was made more difficult when, quite surprisingly, a large number of private equity companies lined up to bid on the Ocelot portfolio.

Tenants, desperate for relief, mounted a sustained public relations campaign in an effort to stop another round of speculators from betting on their homes. They organized guided tours for politicians and members of the press showcasing the most deplorable conditions. They placed bright yellow signs with bold black lettering reading “DON’T BUY HERE — YOU’LL REGRET IT!” in their windows and in common areas in hopes of scaring off potential buyers. Eventually they engaged Sen. Charles Schumer and Rep. Jose Serrano who publicly urged Fannie Mae to assist the tenants. The city housing agency offered to invest substantial city resources to offset the cost of renovations in exchange for a discount sale to a preservation buyer.

With speculators still waving piles of cash in front of the agency, Fannie Mae decided to sell the Ocelot portfolio to a responsible buyer at a realistic price. In the end, the decision was an internal one, made out of a sense of moral obligation and corporate responsibility.

Advocates and elected officials unanimously endorsed Fannie Mae’s decision. As Sen. Schumer sees it, “Lenders, be they Fannie Mae or private banks, who enabled these predatory equity investors by lending them money have an obligation to make sure the tenants are not penalized…. Fannie Mae set a precedent on how to address predatory equity in New York City.”

In June 2010, the 14 buildings were transferred to Omni NY, a reputable affordable housing group with plans for a multimillion-dollar gut renovation of the properties. Omni will sign a regulatory agreement with the city of New York that will govern future rent increases and require that apartments remain affordable for a period of 40 years. The loss Fannie Mae accepted as part of the sale was never made public, but insiders close to deal confirm that it was upward of $20 million.

The One That Got Away

Unfortunately, for a different group of the Ocelot properties — six buildings serving 260 families, with mortgages held by Dime Savings Bank of Williamsburg — the same happy ending did not materialize. In May 2009, Dime transferred the properties to Hunter Property Management, a speculative real-estate company backed by a Japanese private equity fund. Despite the horrible conditions, neither Hunter nor Dime Savings planned a tangible renovation component as part of the transfer. Dime’s mortgages were conveyed on an “as-is” basis, meaning the debt remained at the same level it had been under Ocelot, despite the fact that the excessive debt level was what arguably drove the buildings into disrepair in the first place.

Not surprisingly, things only got worse following the transfer. Hunter began to sink under the weight of the inflated mortgage and further reduced spending on the physical upkeep of the properties. Living conditions became nearly intolerable and many families chose to move out. A fortunate few were able to find apartments elsewhere in the Bronx, but for many, doubling up with family members or taking up residency in the city’s homeless shelters was the preferable alternative.

In a desperate attempt to get repairs made, one of the tenant associations, assisted by Legal Aid and a pro-bono private law firm, brought a case against Hunter in local housing court. After Hunter ignored a court order to repair the most hazardous conditions for months, a judge issued an arrest warrant for the head officer of the Hunter group. Eventually, he was apprehended at his midtown office and served more than 20 days behind bars.

Today, these six buildings are close to one-third vacant. In July 2010, the properties went into foreclosure. In August, a private equity firm called the Bluestone Group, new to the New York City real-estate market, purchased the distressed mortgages from Dime Savings Bank for an undisclosed amount. Bluestone has made some verbal promises about repairing the portfolio, and they have started some work, primarily in the vacant apartments. However, as of this writing, there are still more than 1,291 outstanding code violations on the portfolio, 367 of which accrued since Bluestone came on the scene.

The Reckoning

Though the overleveraged multifamily crisis has played out most visibly in New York City, a number of public reports now indicate that the trend is starting to manifest in several cities across the country. In February 2010, a congressional oversight panel chaired by Elizabeth Warren issued a report about the future of commercial real estate. According to the report, “Between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are at present underwater, that is, the borrower owes more than the underlying property is currently worth.” The scale and severity of the problem raise a number of difficult but vitally important public policy questions.

With investors and landlords fleeing, housing advocates are struggling to determine who is responsible for rescuing this housing stock. The capital costs required to bring livable conditions back to many of these portfolios will unquestionably exceed the resources of most local governments. For obvious reasons, advocates are looking for help from those who helped create the problem and now control the purse strings: the banks and their partners on Wall Street.

But negotiating with financial institutions about the need to preserve affordable housing is a little like trying to communicate in a foreign language that you haven’t quite mastered; people appreciate your attempt, but no one totally understands what you’re saying. The lending community remains somehow disconnected from a sense of its own culpability in creating the housing crisis. Its primary objective is to preserve the “value” of its loans and keep losses to a minimum. Unfortunately this end goal is in direct conflict with preservationists, who view the need to reduce debt obligations as the key to repairing and restabilizing the housing stock.

The conflict is compounded by the near deafening silence coming from Washington, D.C., which has yet to mandate a code of conduct as to how banks that lent irresponsibly during the boom years should help bring restitution to the millions of families struggling through these dark financial times. In the absence of such a directive, the affordable housing community, despite limited resources, will be forced to keep fighting it out at the grass-roots level, one portfolio at a time.

For some this will mean victory; for others, sadly, the struggle goes on.

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