The Stuy Town Decision and Economic Rule-Breaking
Tom Acitelli Nov. 4, 2009, 12:32 p.m.
Two weeks ago, New York’s highest court ruled that residential apartment units in buildings receiving J-51 tax benefits could not be removed from rent regulation via High-Rent Vacancy Decontrol or High-Rent High-Income Decontrol. This landmark case pitted several tenants against the owners of the Stuyvesant Town–Peter Cooper Village apartment complexes. This decision is impactful mainly because it gives no weight whatsoever to the Department of Housing and Community Renewal’s (DHCR) policies and also ignores the manner in which the Department of Housing Preservation and Development (HPD) has overseen the J-51 program.
DHCR is vested with “a broad mandate to promulgate regulation in furtherance of the rent control and rent stabilization laws” and is the entity from which multifamily property owners in New York rely for guidance on how to interpret and implement the regulations. Since 1993, DHCR has issued guidance indicating that apartment units could be decontrolled in buildings receiving J-51 benefits, provided the units did not become regulated simply because of the benefits. Over the past 16 years, investors and lenders have made business decisions involving billions of dollars based upon DHCR’s guidance. These decisions not only included purchases, sales and refinancings of apartment properties, but day-to-day management decisions by operators of these buildings.
In addition to relying on DHCR’s guidance, property owners were comforted by the manner in which HPD actually administered the J-51 program. After all, HPD was responsible for oversight of the program and had direct involvement with the Peter Cooper Village complex. In 2003, HPD reduced the J-51 benefit that 350 First Avenue received in proportion to the number of luxury-decontrolled units in the building (a standard operating procedure), consistent with DHCR’s interpretation and regulation.
Since the decision, there has been a tremendous amount written about the potential impact, containing much speculation about how it will affect tenants, owners of these buildings and the investors who want to buy them. Unfortunately, speculation is all there is, as the decision, other than affirming the Appellate Division’s findings, was relatively vague and leaves much, if not all, of the details up to the lower court to decide. Even the decision issued by the court indicates that the impact of its decision will “depend, among other things, on issues yet to be decided, including retroactivity, class certification, the statute of limitations, and other defenses that may be applicable to particular tenants.”
There is no doubt that specifics will only be derived after dozens, if not hundreds, of lawsuits and years upon years upon years of litigation.
THERE ARE MANY QUESTIONS to be answered and issues to be addressed, the most important of which deals with the retroactivity of the decision. This single issue is very complex. Will the decision apply only prospectively? Will the units that have been decontrolled become regulated at the present rent level, or will the rents revert back to a prior level? If retroactive, how far back will the rent reduction go? Back to the March 2009 appellate court decision? Four years before that (the statute of limitations on overcharge complaints)? Four years before the date the lawsuit was initially filed? Back to the year the unit came out of regulation, even if that was 10 years ago? Will treble damages be applicable? How are these units to be registered with DHCR moving forward? Would the registrations have to be retroactively amended?
The myriad questions don’t end there. What will the damages be and who will receive compensation, if any? Free-market tenants willingly agreed to pay their present rents and, presumably, have the financial ability to pay rent at that level. Should they get a windfall benefit for simply being in the right place at the right time? What about the tenants who were displaced? How does the decision apply to co-ops and condos that utilized J-51 abatements?
The City of New York could be on the hook for millions. Since the city proportionately reduced the J-51 tax abatement by the percentage of the deregulated apartments, if those apartments are now rent stabilized, does the city owe money to the owner? If there is any retroactive reduction in rent, wouldn’t annual RPIE forms have to be refiled, which would retroactively reduce real estate tax assessments, resulting in the city owing real estate tax refunds to building owners?
The decision clearly leaves “the rules” up in the air, as there are literally dozens of permutations of each of these issues that need to be answered to effectively determine the ruling’s impact.
MORE IMPORTANTLY, FROM A macro perspective, this decision highlights a troubling trend that we have witnessed very vividly in the United States recently. This trend is a complete abandonment of economic rules by our politicians and by our courts.
During this recession, we have observed a massive and unprecedented shift in economic power from the private sector to our government. Since September of 2008, we have witnessed the most abysmal economic leadership in America since the 1970s.
Our government has replaced the precepts of economics with government mandate. These policies began under President Bush and Treasury Secretary Paulson, and have continued under President Obama and Treasury Secretary Geithner. The U.S. Treasury and the Federal Reserve have abandoned long-standing rules of economic behavior. The U.S. has transitioned from relying on legislated policy to ad hoc decision making. Predictability and transparency disappeared in a matter of weeks. This lack of clarity about the rules created uncertainty, and this uncertainty caused investors and consumers to move to the sidelines.
During every recession, people cry out for government help. The true danger in a recession is that the government will help in an inappropriate and ineffective way. Our leaders have decided that they, rather than bankruptcy courts, should decide which firms are insolvent and which ones aren’t, who gets bailed out and who doesn’t. Hasty decisions were made that ignored the fact that the rules and processes used by bankruptcy courts have evolved to a high level of sophistication and predictability in making the insolvency/illiquidity determination.
Critically important decisions have been made within a matter of hours or days with limited and poor information. Using the TARP program as an example, which was the largest peacetime spending initiative in history, we see an unthinkable set of circumstances. The TARP was conceived and approved within a six-day period with no hearings, no cost-benefit analysis, no idea how the money was to be used, no accountability for the spending and no limitation on the Treasury’s use of the funds. The result was that the politically blessed got billions of dollars.
These entities were typically in highly politically sensitive industries like housing, finance and the automakers. For example, Congress held hearings for two weeks regarding the fate of the Big Three in Michigan. The result was that they recommended no bailouts for the auto industry. Twelve hours later, the Treasury agreed to bail them out.
These unbelievable actions were based upon no discernible rules and have exacerbated the effects of the recession, resulting in hundreds of billions of dollars of wasted taxpayer money, the destruction of trillions of dollars in wealth and the loss of more than seven million jobs (and counting).
In the U.S. economy, winners and losers should be determined based upon who can satisfy customers, control costs and adjust to changing market conditions. Prosperous economic systems require certainty, require transparency; and people must win or lose based upon their economic ability, not on their political ability.
“Too big to fail” is a theory that has never been proven. It is also disastrous policy. If we direct scarce capital, particularly in times when credit is scarce, to the big and incompetent, we assure that there will be insufficient capital available to fund the growth of the small and competent, and, without growth capital for the small and competent, future growth will be anemic. This is the real systemic risk.
WE HAVE SEEN UNTHINKABLE breakdowns in our economic rules, where bankruptcy court decisions place subordinate unsecured creditors ahead of senior secured creditors. We have seen pension obligations remain completely intact while a big automaker is in bankruptcy, which will cost, unnecessarily, U.S. taxpayers an estimated $40 billion over the next decade.
Our system has degraded into one of raw self-interest, using political influence to redistribute income in one’s favor. During this recession, the politically powerful housing and finance sectors, and more recently the powerful American automakers and their unionized employees, have become the center of the storm and have received significant government support. In contrast, the recessions of the early ’90s and early 2000s were centered on the politically weak. These were real estate developers and the technology sectors, respectively, neither of which received any government bailouts.
If we could revert to a system of clear and consistent policies—i.e., “rules”—our economy will come out of its malaise much sooner and stronger than most people think.
The Court of Appeals decision will have one certain impact on the market. Further abandonment of established rules and policies as a result of the decision has created uncertainty. The uncertainty not only revolves around the J-51 issue. A Pandora’s box of issues has been opened, as the DHCR’s implementation of rent regulation will be questioned. A DHCR opinion letter no longer has value. This is the real risk of the recent decision.
The uncertainty created by this decision adds significant risk to investing in multifamily properties in New York City. The risk premium that investors require can only go up in this circumstance. This means that investors will require additional yield, which will exert downward pressure on values. What is left to see is to what extent value will be affected.
Robert Knakal is the chairman and founding partner of Massey Knakal Realty Services, and has brokered the sale of more than 1,000 properties in his career.