Real estate’s bright (and not so bright) ideas

<i>The best and worst policies and proposals floated to get NYC's market back on track</i>

New York’s real estate market is at something of a crossroad. For more than a year now, the industry has been dealing with the fallout from Wall Street and the credit crisis, leaving brokers, developers, city officials and everyone in between groping for strategies to keep financially afloat. While it’s hard to fault real estate professionals for throwing any ideas they have at the problem to see which ones stick, some of those approaches have worked better than others. This month, The Real Deal dissected some of the biggest policies and proposals that are being used — or considered — to help shore up the industry.

The goal was to see which ideas have helped get the market moving, and which have fallen flat, and to examine how much promise the ideas being bandied about now have.

The strategies evaluated were selected based on interviews with real estate professionals, research and new reports from the past year, and an informal survey.

None of them provide a “silver bullet” answer to the extremely complicated economic reality of solving problems like the massive wave of foreclosures or trying to sell condo projects that penciled out during a different era of spending and lending. And no one strategy alone will save the struggling New York market, which is suffering from declining prices and reduced deal volume amidst the highest unemployment levels in more than a decade.

But here is a sampling of some of the most noteworthy attempts, including the flops.

Hurts: Appraisal reforms

The new appraisal guidelines for Fannie Mae and Freddie Mac that went into effect nationwide in May, called the Home Valuation Code of Conduct, or HVCC, are so unpopular that many jokingly pronounce the acronym “havoc.”

The code was designed to prevent appraisers from being coerced into overvaluing properties by requiring a third party with no stake in the sale to select them. Previously, appraisers were picked by the mortgage lender or real estate broker.

As The Real Deal has reported, many brokers in the five boroughs have complained that the appraisal management companies (AMCs) that have increased their market share as a result of the reforms routinely select out-of-town appraisers who are uneducated in the nuances of New York City’s housing. They say these appraisers have come back with figures up to 40 percent below the contract price, sabotaging deals in an already struggling market.

New York appraisers further complain that these AMCs — essentially middlemen who take a hefty fee for each job — pick the lowest bidder instead of the most qualified one, contracting out jobs at half the market rate.

“You’ve got people from Albany that will drive down and crank out a dozen appraisals in 24 [or] 48 hours, and then drive home,” said Jonathan Miller, president of the appraisal firm Miller Samuel. Based on the paperwork he’s reviewed after an appraisal, Miller said he suspects some properties are being valued sight unseen.

“It’s physically impossible to do meaningful research or develop any understanding of the value of property at that pace.”

In a survey, the National Association of Realtors found that 86 percent of realtors and appraisers nationwide felt that the quality of appraisals has decreased since the new code took effect.

The agreement is set to expire sometime between July and October of next year, but it will remain in effect at Fannie and Freddie unless it is amended. Industry leaders are, however, lobbying to change it.

“At a minimum, it should strictly prohibit ‘broadcast ordering systems’ that hire appraisers for all the wrong reasons — this cram-down fee and fast turnaround time that is not conducive to appraisal quality,” said Bill Garber of the Appraisal Institute. Garber also noted that the newly passed Truth in Lending Act officially outlaws the type of collusion HVCC was meant to discourage.

Helps: Condo to co-op conversion

Developers and lenders of struggling condo projects seem to have few options these days other than taking huge losses on their investments.

But there may be hope for them yet.

Douglas Heller, a partner at the law firm Herrick Feinstein, is proposing a yet-to-be-tested idea that he argues could help lenders and sponsors at least break even.

While it may seem counterintuitive, in an article he coauthored with Assistant Attorney General Erica Buckley for last month, Heller proposed converting troubled condo projects into co-ops.

In today’s tough lending environment, Heller said, buyers could simply take a share of a co-op’s debt rather than securing outside financing for their purchases. Buyers would essentially be getting an apartment at a wholesale price, and the lender and other investors could break even instead of taking a loss.

“The most obvious reason that a cooperative structure might relieve pressure on lenders is that if they keep the mortgage in place, they can restructure it as a typical underlying co-op mortgage with a term of five to 15 years; the loan would become performing. This alone would increase the likelihood that the lenders would recoup their investments,” Heller wrote in the article.

“The major portion of each purchaser’s price will be included in the underlying cooperative mortgage,” he continued. “This essentially represents the transfer of what would have been individual condo-buyers’ debt to the cooperative entity. The purchaser could pay an equivalent monthly amount but would not have to apply for financing.”

Heller told The Real Deal that since the article was published, he’s had “significant discussions” with about 10 lenders or developers. “At this point, they are still evaluating it with respect to specific projects, and some suggested interesting variations,” he said.

The article said the attorney general’s office would likely waive at least a portion of the filing fee when the offering plan is refiled as a co-op.

The condo to co-op conversion would not work for every struggling new project (buildings where the offering plan has been declared effective and some of the units have closed would clearly be hardest), but it could help save some new projects from big losses.

Co-ops certainly have their faults, least of which may be their notoriously finicky boards. But Heller contends that co-op board rules can be written leniently, more akin to the rules that govern condos.

Hurts: FHA explosion

Loans insured by the Federal Housing Administration exploded in popularity in New York after Congress boosted loan limits last year to as high as $729,750.

Under the program, buyers can get a mortgage with a credit score as low as 580, putting only 3.5 percent down — possibly even less when other credits are factored in.

In the wake of tightening lending practices that require at least 20 percent down and pristine credit, the new FHA loan limits were seen as a saving grace for struggling luxury condos.

Between January and March, the number of FHA-backed loans in the city leaped to 2,315, up from 995 in the same period of 2008.

“The more buildings that can get FHA approval, I think, the faster the absorption of the current inventory will be, which will help the whole market,” said Stephen Kliegerman, executive director of development marketing at Halstead Property.

Union Square Mortgage, started by president David Maundrell and banker Ross Weinstein, has worked to get dozens of new condos approved for the program.

But only a year after FHA effectively took over the subprime lending market for Fannie Mae and Freddie Mac, analysts are warning that it could become the next housing giant to require a federal bailout.

In testimony before a congressional committee last month, FHA Commissioner David Stevens acknowledged that 20 percent of FHA loans insured last year, and 24 percent of those issued in 2007, face problems including foreclosure, according to a report in the New York Times.

FHA now insures roughly 5.4 million mortgages with a combined value of $675 billion, and those loans have been bundled into mortgage-backed securities guaranteed through another government-owned corporation, Ginnie Mae. If large numbers of these mortgages default, taxpayers will be responsible for paying back investors.

Stevens has repeatedly said FHA won’t require a bailout. Meanwhile, in an effort to protect the program from the mass foreclosures that have helped take down the nation’s economy, Congress introduced a bill last month to increase the program’s required down payment from 3.5 to 5 percent, seen as a protection against default because buyers are less likely to walk away from a loan they have a significant financial stake in.

Helps: Buyer incentives

The condo glut and credit crunch have dovetailed into new buyers’ incentives that would have been unheard of during the boom.

Free cars, buyback guarantees, rent-to-own and “live free for one year” deals are among the tactics developers have used to set their projects apart.

While some of them have borne little fruit, others have helped developers meet critical sales benchmarks.

A recent analysis by The Real Deal of the city’s best-selling condo projects found that many of the top sellers were offering incentives beyond price cuts. Price cuts are, of course, the most compelling “incentive,” but can be difficult to initiate when other buyers are in contract for peak prices.

The “live free for one year” program Toll Brothers implemented at Northside Piers in Williamsburg and at 5SL in Long Island City covered all costs associated with condo ownership for 12 months, helping those projects move units.

Also in Long Island City, the View at East Coast offered buyers a five-year buyback guarantee in which developer TF Cornerstone promised to repurchase units in five years if the seller couldn’t get 110 percent of the purchase price.

“It was employed to get us over the [15 percent sold] hump so the [condominium] could be declared effective,” said Leah Bassknight, director of sales at the project.

She said the firm is confident that the “apartments are going to be valued at the guaranteed amount,” adding that the incentive worked and is no longer available.

TF Cornerstone, one half of the former Rockrose firm, used the same incentive to quickly sell 20 units at the rental conversion 99 John in the Financial District, said sales manager Brad Ingalls. He said there are also 95 people who came into the 442-unit building on a “rent-to-own” basis.

In Long Island City, the L Haus is offering 90 percent financing and a “price protection” program that gives buyers a rebate if someone in the building “purchases a two-bedroom, two-bathroom home, and a similar two-bedroom home within the same grouping is sold at a discounted price within 90 days of closing,” said Melinda Starr of Prudential Douglas Elliman.

Flashy incentives can also help grab buyers’ attention. Three of the six buyers at 868 Metropolitan in Greenpoint took the developer’s offer of a free Vespa with purchase. “I believe it brought people in the door. But it was not a deal-maker, just a bonus,” said Christine Blackburn of Elliman.

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Hurts: Extend & Pretend

Banks are holding the city’s real estate market captive as they delay dealing with distressed assets.

“The fundamental reasons for the limited amount of transaction activity are simple: Buyers are seeking distressed pricing, owners do not want to sell at distressed pricing, and lenders have largely withdrawn from the market,” said a recent report by CB Richard Ellis Group.

According to the report, only three Manhattan office buildings priced at more than $30 million sold in the first half of 2009, compared with an average of 32 in the first half of each year over the past five years. And while the city and Long Island have a combined $10.6 billion worth of distressed assets, according to Real Capital Analytics, only a handful have changed hands this year.

Meanwhile, Dan Fasulo, the firm’s managing director, estimates that $50 billion has been raised to purchase this property.

Peter Hauspurg, CEO of Eastern Consolidated, said that over the past two years, banks have been marking down the values of properties incrementally instead of all at once to avoid the appearance of huge write-downs on their quarterly reports.

The practice is widely known as “extend and pretend,” and many believe that it’s prolonging the downturn by holding up trades on properties that lenders are pretending are worth more than they really are.

But, he said, “in the last few months, since July, there’s been a market uptick both in the number of deals and the size of the deals.” He attributed that to the fact that more assets have been written down to their true value, and banks are seeing enough sales to get a sense of today’s pricing.

“It’s still happening in a number of cases, but you can clearly see that lenders are now actually making deals,” said Hauspurg. Indeed, statistics show that there was an increase in Manhattan building sales in the third quarter compared to the previous quarter, but that transactions are still drastically down from the height of the market.

And, there are still many lenders opting to “extend and pretend,” a reality that some say will only worsen the industry’s problems (see “Lenders get more help with “extending and pretending” with commercial mortgages“).

“That ability to continue to extend is allowing developers to hold on and holders of debt not to have to recognize losses, but at the same time it is essentially preventing the resolution of these issues that exist and aren’t going away,” said Scott Singer, an executive vice president at Singer & Bassuk.

Helps: Developer bailouts

Most agree that nobody wins if construction grinds to a halt in New York.

As of early last month, the city’s Department of Buildings counted 456 stalled construction sites citywide. If none of these projects restart, the city could end up dotted with empty towers and water-filled construction pits.

As a way to avoid this fate, the city has launched or tapped into several government-funded “bailout” programs to resuscitate at least a portion of these dead projects. On balance, many say these programs could provide an important cash infusion.

One such program is the Housing Asset Renewal Program, or HARP, an admittedly modest $20 million fund spearheaded by City Council Speaker Christine Quinn that would turn unfinished or unsold apartment buildings into middle-income housing.

So far, 30 developers have applied for the funding, according to a city spokeswoman.

Meanwhile, the city selected the stalled City Point project in Downtown Brooklyn and a retail center for the Arverne by the Sea development in Far Rockaway to receive a combined $36 million in tax-exempt bonds financed by federal stimulus cash.

The program, Recover NYC, has $90 million in bonds left for projects with a commercial component that are critical to the success of “distressed” areas. It is currently reviewing 41 applications for additional funding.

While these stimulus programs have been panned by critics as an example of taxpayers footing the bill for speculative development, supporters argue that stalled projects have broad negative implications for both the overall economy and the surrounding communities.

“[City Point] could be a very important lynchpin project in Downtown Brooklyn,” said Jay Neveloff, a partner at the firm Kramer Levin. “City Point has enough scale and vision that it might change a neighborhood, and that is exactly an example of how this money should be spent.”

Neveloff consulted with several clients about the new bond program, but said restrictions kept them from completing the application.

Mayor Michael Bloomberg also announced in August that $60 million of $85 million in federal stimulus money earmarked for affordable housing would be spent to build 739 apartments in East New York, Brooklyn, and in East Harlem. Some of those projects will be on construction sites stalled by the recession.

Hurts: TALF expansion

A federal program that has succeeded in easing the flow of credit nationally for consumer-oriented loans has had little impact on the commercial real estate market in New York City or nationwide.

In response to the frozen credit markets, the Federal Reserve opened up the Term Asset-Backed Securities Loan Facility to commercial real estate financing.

While expansion of TALF was announced with great hope, just one loan in the country has been announced for the program, slated to expire in June 2010.

That first loan, which still needs to officially be accepted into the program, was in the amount of $400 million and issued by Goldman Sachs to shopping center owner Developers Diversified Realty, a single borrower based in Ohio. Developers Diversified has no properties in New York City.

“As far as we are concerned, it is not happening in Manhattan to any degree,” said Eastern Consolidated’s Hauspurg.

The extension was designed to provide financing to investors to purchase securities backed by commercial real estate loans, but the program’s restrictions have proven overbearing.

In addition to the Goldman loan, another deal that was rumored to be in the works in July was from Vornado Realty Trust, but no details have emerged since then.

Hauspurg said the program’s apparent failure in Manhattan could be helpful for the industry.

“It is better to get through the pain and the hangover,” he said. “Let the prices adjust and go forward.”

Toby Cobb, managing director at Deutsche Bank and former cohead of its real estate group in the United States, said the risks associated with pooling commercial real estate loans and packaging them under the TALF conditions were still too high for many potential originators.

One problem is that there is a limited class of borrower who has leverage low enough to make using TALF possible, but that same borrower can generally turn directly to the unsecured credit markets for cheaper funding, he explained.

And the program will do nothing for the highly leveraged borrowers with 70 or 80 percent loan-to-value ratios, he said, because it requires loan-to-value ratios closer to 50 percent.

In fact, with so little activity from the program, it may be aggravating the lending situation further. “They are creating more problems than they are solving by having a TALF that doesn’t work,” Cobb said.

Helps: Diversify operations

Suddenly, real estate companies have become jacks-of-all-trades. With the real estate market slogging along, residential and commercial brokerages have diversified their portfolios to include rentals, commercial property and distressed sales.

Eastern Consolidated,, Jones Lang LaSalle, Colliers ABR, Cushman & Wakefield, Halstead Property, Prudential Douglas Elliman and CB Richard Ellis, in addition to others, all now have teams handling distressed assets.

Eastern Consolidated’s Hauspurg said his firm began forming its distressed asset team in 2005, when it could smell the bust coming.

“[Nondistressed] property sales have been off nationwide 70 to 80 percent, which has been extremely painful for people in this business,” he said, adding that Eastern Consolidated’s small distressed asset team now accounts for half of the firm’s sales activity.

Meanwhile, as residential firms and offices shuttered in the last year, brokerages began doing everything in their power to diversify and capture a portion of the remaining market. The shift is helping many firms financially weather the down market.

“You really have to do more than one thing in real estate because times change,” Marc Lewis, president of Century 21 NY Metro, told The Real Deal this summer, after his firm founded a new commercial division. That move follows in the footsteps of two other residential firms that have reached into commercial, Bond New York and Mark David Real Estate.

While some experts predict that the ill-fated commercial market has only begun to crack, Lewis is betting he can get a piece of the commercial and retail pie.

Chris Salizzoni, executive vice president of the division, said that the team has closed 13 deals representing the owner and 15 deals representing the tenant since launching.

Other brokerages are going back into rentals, which most agree is a savvy move since two-thirds of New Yorkers rent, and more failed condo projects are expected to turn rental as the fallout continues.

Elliman recently launched a rental listings site, which now has 2,731 listings in Manhattan, and opened its first rentals-only office since the early 1990s.

Lewis recently said his firm also expanded its rental division by adding 75 agents.

“We realized there was a downturn in sales and we needed to generate income rather than wait for the market to come back,” he said.

Additional reporting by Adam Pincus