Commuters arriving in Brooklyn via the Manhattan Bridge are greeted with a shiny vision of New York City's future that never came to be: condo buildings with names like the Oro, the Toren, and Forté, towering monuments to real-estate developers' credit-bubble hubris. Two-bedroom apartments in the Oro were priced at nearly $1 million apiece; today, just 90 of 303 units have been sold. The Forté would have gone into foreclosure had its developer not voluntarily relinquished the building to the bank, losing investor Goldman Sachs its $13 million stake. Property records declare 37 of its 108 units purchased, and the high-rise itself feels even lonelier -- as night falls, just a few windows in its upper reaches are illuminated.
On the opposite sidewalk of Flatbush Avenue one drizzly fall evening, more than a hundred demonstrators, members of the Right to the City Coalition, drew attention to another possibility: A city starved for affordable housing could find it in the glassy confines of failed luxury dreams. They had converged from hardscrabble neighborhoods on the frontiers of gentrification, where jackhammers had provided the soundtrack for Mayor Michael Bloomberg's second term.
At the height of the national mortgage boom, New York City was deluged with cash -- fees for packaging, rating, and selling securities. Wall Street bonuses alone totaled nearly $24 billion in 2006, and finance employed almost 200,000 people at its peak. That money had a ripple effect out from Lower Manhattan, bringing formerly fringe working-class neighborhoods -- Bushwick, Crown Heights, East Harlem -- into the limelight as desirable new frontiers. Developers raced to catch the wave, armed with funds not just from the local banks that usually back speculative construction but from some of the biggest names on Wall Street. New York City made the Scarface mistake: It got high on its own supply.
Developers' speculative fever far outstripped any real demand for the real estate they were building or acquiring. The Right to the City Coalition surveyed downtown Brooklyn, Bushwick, Harlem, the Lower East Side, the West Village/Chelsea, and the South Bronx and counted more than 600 incomplete or largely empty condominium buildings, some with units priced at more than many longtime residents of these communities could hope to earn in a lifetime. In Bushwick, Brooklyn, where over one-quarter of households fall below the poverty line, apartments in one 15-unit building have been on sale for more than a year at over $500,000 each. Only one has found a buyer. In Chinatown, where the median household income is $36,538, all 13 apartments in one condo were on offer for an average $1.3 million. In Harlem, a new building with pads priced at $1.47 million sat vacant.
But this is only one half of New York's post-gentrification cautionary tale. A few blocks from the demonstration stands a former mint factory, a casualty of a second and even more pernicious wave of high-stakes real-estate speculation that targeted buildings where tenants already live. It was subsidized housing for artists until a private-equity firm bought the 42-unit building for $6.6 million and went to court to force residents' eviction. Those who held out faced faltering maintenance and security, then open threats of lawsuits. Once the tenants were cleared, the owner flipped the former factory and an adjoining lot to a condo developer for nearly $20 million, with the help of a $9.8 million investment from American International Group (AIG). In 2008, the Brooklyn apartments went on sale for a high of $1,100 a square foot. A year later, it is a derelict site of torn tarps, rusting scaffolding, and boarded-up windows.
An estimated 100,000 occupied apartments in New York City are in financial distress and heading toward foreclosure. Loosened rent regulations, the expiration of state and federal rent subsidies, and the credit bubble have purged the region of hundreds of thousands of formerly affordable rental apartments. The shadow doesn't just hang over New York: Across the country more than 1 million apartment dwellers are at risk of foreclosure, service and maintenance cutbacks, or both.
"We could be facing a multifamily foreclosure crisis just as the single-family crisis is easing," warned William Apgar, senior adviser to Housing and Urban Development Secretary Shaun Donovan, at a July House Financial Services Committee hearing. "This could have significant, negative impacts on the economy as well as the families living in these multifamily properties, who will likely experience worsening housing conditions." HUD, Treasury, and the Federal Housing Finance Agency, the overseer of Fannie Mae and Freddie Mac, have formed a working group to weigh a response.
"These were risky bets at the top of the market," says John Tyus, a member of Families United for Racial and Economic Equality who helped survey downtown Brooklyn's see-through condos, including the Forté and Oro. "Meanwhile we've got 39,000 people living in homeless shelters. It doesn't make sense. The boom is over." New York must now figure out what to do with the detritus of its mistakes.
The idea of turning failed condos into affordable homes has ignited New Yorkers' imaginations, and not just at the radical margins. Ardent supporters include property owners who bought pricey real-estate in the boom, only to find themselves living next door to inactive construction sites. Last June, with elections on the horizon, City Council Speaker Christine Quinn laid out a vision for turning empty condos into living quarters for the middle class. Vacant new buildings, she said, "now represent our best asset in the fight for affordable housing."
The council committed $10 million and asked Bloomberg to do the same. In July his administration agreed, funding a test of what it dubbed the Housing Asset Renewal Program. In exchange for making half of the apartments affordable, developers of struggling condos receive payments of $50,000 for each of them, $75,000 if they become rentals.
Bloomberg was eager to distract New Yorkers from the ugly truth. His administration rezoned dozens of areas, often to promote high-end residential development where industry once stood. It declined to press the state legislature to restore shredded rent regulations. True, Bloomberg launched a campaign in his first term to create or preserve 165,000 units of affordable housing and agreed to expand affordable housing tax and zoning incentives. But New York is losing far more than it's building to deregulation and gentrification. According to the Community Service Society, every year nearly 60,000 apartments become too expensive for the poorest two-fifths of city residents to afford. The new Housing Asset Renewal Program won't change that trend, because it's aimed at households making up to $126,000 a year. Advocates like Right to the City want to see more housing for those earning less than half of the median household income in the New York area ($70,900 for a family of four), even if that means yielding fewer apartments.
As Bloomberg enters a third term backed by a humblingly thin majority of voters, the effort to convert luxury condos to affordable housing has a symbolic power. In the Bloomberg years, the city has seen its economy bifurcate into extremes -- on one end, high-paying professional employment, largely tied to the financial-services industry and, on the other, low-paying work in retail, health care, and other service sectors. New York is the most unequal city in the country.
Under the Housing Asset Renewal Program, a high-end apartment in a reasonably desirable location costs the same to subsidize -- marble countertops and all -- as the cheap brick boxes affordable-housing developers usually build. "That's like a heist!" says Kirk Goodrich of Maverick Developers, who has been trying to persuade condo builders to participate. The promise is great, but the reality is more somber. One might expect developers -- and the lenders they owe -- to be hungry to cut deals. Yet few have even sniffed at the city's bait. They don't want to lose the money they've put in, nor do they want to walk away and let someone else scoop up a bargain. So they dip into reserve funds, stall for time, and pray the market will recover.
That's a risky gamble. A projected $2 trillion in commercial mortgages will expire by 2013, and Deutsche Bank estimates that 70 percent of them will not qualify for refinancing. Analysts predict commercial real estate will be a second calamity to follow the home-mortgage bust, thanks in large part to failed new condos and takeover misadventures.
This fall, federal regulators pressed banks to recognize losses on these loans -- a healthy step toward bringing sky-high real-estate prices back to earth. But the guidelines also allow lenders to lengthen the timeline on short-term mortgages, even if property values have plummeted below the size of the debt, as long as payments keep coming in. That insulates already-ravaged banks from further losses but keeps the price bubble inflated -- a form of "extend and pretend" that only delays the inevitable.
New Yorkers are demanding a reality check. "Government could accomplish a wholesale transformation," says Hakeem Jeffries, a state Assembly member whose central Brooklyn district includes 66 condo projects, most in varying stages of trouble. "The underlying deals are based on fantasy. We have to restructure these loans." Jeffries has sponsored legislation that lets the state Housing Finance Agency insure long-term refinancings of developers' mortgages in exchange for affordable housing. But it will take more than modest incentives to stabilize neighborhoods. Federal regulators must coax banks to stop holding out for a return of the Gilded Age.
With so many lenders at the brink of insolvency, the Treasury Department and the Federal Deposit Insurance Corporation (FDIC) appear to be in no rush to cause them further pain. "We need to convince lenders that it's in their interest to preemptively recapitalize condos and restructure the loans, rather than rely on traditional bankruptcy and foreclosure," says New York State Housing Finance Agency CEO Priscilla Almodovar. "We need a carrot-and-stick approach. Unfortunately none of us -- the state, city, not-for-profits -- has an effective stick yet."
"Rent now," advertises the banner, six stories high and visible from Harlem's 125th Street. The owner, Urban American Management, bought this and four other apartment complexes in 2007, renaming them after jazz greats. This one, on Lexington Avenue, is called The Miles, commemorated by a trumpeter's jaunty silhouette on the lobby wall. Urban American paid nearly $1 billion for more than 4,000 apartments -- $232,000 for each, triple their price two years earlier. Not bad for bare-bones high-rises erected in the 1970s under a state subsidy program. Deutsche Bank lent the company $918 million and then sold the debt to Fannie Mae. The city's pension funds have a $150 million stake.
With the help of the Wall Street mortgage-backed-securities machine, private-equity firms acquired portfolios of modest buildings like The Miles and aspired to turn them into much more expensive quarters. As with the Brooklyn condos, high-end occupants never showed up. An increasing number of apartments in The Miles, with skyline views and $1,600-a-month price tags, are vacant. Most of the remaining tenants are old-timers who rely on federal rent aid. The windows, original to the building, bring in energy-sucking drafts, but Urban American won't replace them. A former community room now serves as storage for appliances, and the hall outside smells of urine. Tenants buy their own bathroom fixtures at Home Depot because the standard-issues don't work. A fire last year killed an autistic teen. "The issue is not that they're incompetent slumlords," says Benjamin Dulchin, executive director of the Association for Neighborhood and Housing Development. "These are the most sophisticated managers in New York City real estate, and it's their sophistication that makes them dangerous."
Even as conditions deteriorate, many private-equity firms have failed to meet their revenue targets. The Riverton, a 1,228-unit complex in Harlem, has already gone into foreclosure. Its owner, Stellar Management, which runs more than 24,000 apartments across the country, had been counting on turning over more than half of occupied apartments to market-rate tenants -- and tripling their rents in the process. It got through only 10 percent before going into foreclosure.
"People want decent neighbors and affordable homes to live in," says The Miles' tenant association vice president Bridgette Scott, a Head Start teacher. "Where are they supposed to go -- down South? New Jersey? The Bronx? They're fixing that up, too!"
"Fixing up" should be a welcome development, but it's actually a rebuke to holdovers like Scott, since only newcomers get to live in renovated apartments. The landlords' plans were no secret: Their prospectuses to mortgage-securities investors, available from the Securities and Exchange Commission, promised annual returns of up to 20 percent and spelled out expectations that a significant portion of rent-regulated tenants would somehow disappear. They didn't. Now, an estimated 10 percent of all the regulated real estate in New York City is wedged in a no-win situation. Tenants protected by rent regulations are entitled to remain, but they face the prospect of deteriorating conditions as creditors press to cut their losses.
New York remains haunted by the experience of the 1970s, when property owners abandoned tens of thousands of buildings and brought entire neighborhoods down with them. Years of rebuilding forged a pragmatic cadre of advocates who are terrified at what they see coming. One of them is Harold Shultz, a former city housing official now with the Citizens Housing and Planning Council. "For those of us who lived through the '70s and saw how quickly a building can deteriorate once you stop making an investment in it -- and what one bad building can do to an otherwise OK neighborhood -- we don't want to see any of that happen again," he says.
In parts of the Bronx, those days are already back. Fannie Mae has taken charge of 14 buildings held by one landlord, the Ocelot Capital Group, with more than 3,000 code violations between them. "This is the crappiest housing I've ever seen," says Dina Levy, an organizer with the Urban Homesteading Assistance Board who has been working with tenants in the buildings. She describes the conditions as "Third World." In one apartment, a mother and her three children use a bucket and hose as a toilet. Constant leaks cause ceilings to buckle and mold to spread.
This isn't just a New York City problem. In San Francisco, one landlord, The Lembi Group went on a buying spree of more than 7,000 apartments, paying twice as much as tenants' rent payments could reasonably cover. Many of Lembi's holdings have since gone back to lenders in lieu of foreclosure. Nearby in East Palo Alto, an investor purchased some 1,800 rent-regulated apartments and abandoned them two years later after a court blocked rent hikes, leaving lender Wells Fargo in charge. The story is the same on the fringes of Memphis, Atlanta, Austin, Charleston, and other Sun Belt cities. Nearly half of all loans packaged into commercial mortgage-backed securities are heading toward default, and one-quarter of those are on rental buildings.
As with single-family-home foreclosures, this quagmire is unlikely to resolve itself. Last March, Sen. Chuck Schumer and Reps. Charles Rangel and Nydia Velázquez of New York wrote to Treasury Secretary Timothy Geithner and HUD Secretary (and former New York City Housing Commissioner) Shaun Donovan, pleading for intervention. Soon after, Schumer's office hosted a meeting with HUD and Treasury. Levy and Shultz attended, as did Emily Youssouf, a former mortgage-securities banker and city housing finance chief who has been hired by the Rockefeller Foundation and Partnership for New York City to figure out how to rescue apartment buildings from default and decay.
Youssouf offered Treasury a detailed proposal for saving such buildings, and part of her plan found its way into federal banking regulators' new rules: Lenders can rework troubled mortgages into a "good" piece supported by current income and a "bad" remainder, and take losses only on the bad. In effect, they reincarnate the old bloated debt into a slimmed down and more manageable size. That avoids foreclosure and simultaneously reduces crushing debt-payment obligations that would otherwise force landlords to make a devil's choice between rent hikes and service cuts.
But the new regulation skipped a pivotal element of Youssouf's plan -- the part that prods lenders and owners to undo the damage caused by their speculation. Youssouf wants Treasury to buy these revamped mortgages on the condition that the owner commit to running the properties as affordable housing for the long term.
So far Treasury is not persuaded. The proposal faces the same conflict that has enfeebled the Making Home Affordable mortgage-modification program: With federal banking regulators obsessed with keeping institutions' balance sheets healthy, other vital objectives -- helping homeowners, stabilizing communities -- lose out. After repeated trips to Washington, Levy is exasperated. "There's no political will to force the banks to do anything," she says. In this case, the politics are even less favorable, since greedy landlords make for an unattractive bailout target. "There needs to be some kind of federal pressure and incentive through federal facilities -- banks need to be feeling the pressure to cram down," observes Dulchin of the Association for Neighborhood and Housing Development. "But there's a contradiction between Treasury getting banks to shore up the books and preserving the public good of affordable housing."
Treasury Department spokesperson Meg Reilly says, "The commercial real-estate market is something we're watching closely, but it's premature to discuss solutions."
In the meantime, federal agencies are getting drawn into the mire. Fannie Mae is a massive backer of debt on apartment buildings, holding or guaranteeing $302 billion, and a major holder of commercial mortgage-backed securities. The prospect of a market-wide catastrophe in multifamily housing risks pushing Fannie even deeper into taxpayers' pockets.
Ideally the government-run, mission-driven Fannie Mae would be at the forefront of a solution. Instead, under orders to collect every dollar it can, it has become part of the problem. Buildings it has taken over, like the Ocelot slums in the Bronx, have become both private tragedy and public embarrassment. Marc Landis, the court-appointed manager of three of them, has taken Fannie Mae to court charging that it has refused to pay for repair work. He's demanding a cash infusion to "safeguard the lives, health, and safety of the tenants" as well as Fannie Mae's own property. Under relentless pressure from advocates and Sen. Schumer, Fannie has agreed to transfer its stake to a respected affordable-housing developer at a significant discount. But what happens to the rest of Fannie Mae's troubled holdings?
The same question falls on the FDIC. When it takes over failed banks, the collateral on their loans comes into government hands. For Chicago's Corus Bank, that includes more than 100 condo developments nationally, most of them failed. The FDIC auctioned the Corus portfolio to an investment consortium, which maximizes returns to the FDIC -- and minimizes the chance that the projects will end up affordable.
With federal agencies reluctant to reverse the damage of out-of-control gentrification, the burden falls on cities. They do have options. They can take over blighted real estate for nonpayment of taxes or failure to do proper maintenance, and transfer it to responsible caretakers. They can use zoning laws to guarantee that affordable housing is part of all new development.
In New York, Bloomberg is unlikely to concede that his coddling of luxury developers has only deepened the city's perpetual housing crisis. Nor has his administration rid housing-subsidy programs of their fatal flaw: They eventually expire. Most of the affordable housing New York City has been building under Bloomberg won't be affordable anymore by 2030. Even the condos the city hopes to turn into middle-income residences will eventually revert to top-shelf prices.
The credit crisis gives the administration a chance to restart. Other cities are finding means to stretch out affordable-housing commitments for as long as possible. In San Francisco, any project that gets a loan from the city has to sell its land to the city in exchange and then lease it back. Local officials came up with the idea because they were sick of pouring billions of public dollars into affordable housing only to see developers reap huge windfalls down the road. "If we don't do something for permanent affordability now, we're doomed to replace the units we've lost," says Olson Lee, who masterminded San Francisco's land-lease program. "We learned from our experiences. We asked: What can we do differently?"