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Confronting the Condo Glut

by Allison Lirish Dean, Feb 23, 2009
 
Photo adapted from Brownstoner
The Oro Condos in downtown brooklyn

When the Oro Condominiums building in Downtown Brooklyn was still under construction in 2007, the Brooklyn Paper branded it as a "deluxe singles bar in the sky." Now, though, the glitter has apparently faded. On a recent winter night, only a smattering of light emanated from the otherwise eerily dark (though now completed) 40-story luxury tower on 306 Gold Street, not far from the Manhattan Bridge. A hip-looking young woman entering the building, who identified herself as an owner of one of the 300 homes but who preferred to remain anonymous, said the building "feels empty."

A similar picture is emerging across much of the city. In recent years, ordinary New Yorkers saw new condo construction transform their neighborhoods. This is especially true in hotspots like Downtown Brooklyn, Williamsburg and Long Island City, where large rezonings by the Bloomberg administration have spurred the rise of sleek luxury residential towers seemingly overnight.

But as New York City's economy rapidly worsens, people wonder how many of these new condo apartments will languish vacant. Precise numbers are difficult to come by, but government leaders and housing industry experts agree: The condo market is in serious distress.

It is not just the vacant units that are worrisome. In many neighborhoods, half-built projects sit stalled and land cleared for development shows no signs of activity, creating a nuisance for residents who now must live indefinitely with deserted construction sites.

All of this is expected to have a dramatic impact on New York City. But how bad is it, and how might policymakers, housing advocates, developers and financial institutions respond?

The Current Picture

Photo adapted from Brownstoner
The Avalon (left) and the Toren (right), in downtown Brooklyn

It was not long ago that the condo boom seemed unstoppable, with visions of "botoxing Brooklyn" -- as Faith Hope Consolo, chair of the Retail Leasing and Sales Division at Prudential Douglas Elliman Real Estate, put it -- threatening, or promising, depending on your outlook, to transform the borough's character on a grand scale.

Now, banners hanging from unfinished projects with names evocative of a sleek modernism like "Edge" and "Toren," touting a roof deck, fitness center and library, have, amid talk of a second Great Depression, acquired a surreal air.

New condo development tapered off in the summer of 2007 when the credit crunch began, according to Jonathan Miller, president and chief executive officer of Miller Samuel, a residential appraisal and consulting firm. Initially, this was good news for existing projects because it meant less competition. As time went on, though, the crunch affected buyers, which in turn has lowered sales.

"In general activity is down significantly in terms of number of sales, which is primarily from the credit problem and related to the recession," said Miller.

Bill Staniford, chief executive officer of Property Shark, a firm that provides real estate information, echoes Miller. "Right now we have a glut of supply and no demand." Staniford added that it's not just credit problems that are to blame, but also the downturn in the city's local economy, which relies heavily on the financial industry.

"I have a feeling the financial sector is not going to come storming back to NYC – a lot of those jobs are gone for good," he said. This is potentially devastating for a housing market that boomed in tandem with Wall Street profits. "The bonuses were really the drivers," noted Staniford, "because the bonuses were the down payment."

Tens of thousands of individuals who once got those big bonuses are now out of work and are struggling to keep their existing homes, let alone buy new, more expensive ones. Their parents may help pay the mortgage for now, Staniford said, but eventually these people may decide to leave the city. In that event, their homes will go onto the market, further adding to the glut.

"These people are of means, and they may be running through their savings right now and therefore you won't know they are in distress yet," Staniford added. "I've got a lot of friends in the finance industry – you lose your job and when reality sets in you say I've got to go back to North Carolina or Virginia or wherever I came from."

A Bottom In Sight?

Experts say the worst effects of the economic crisis on the condo market are still taking shape. Staniford projects another 15 to 20 percent drop in value before the end of 2009. "I keep looking at it and I don't see how it stops. I don't think we have seen the complete repercussions of this," he said.

The outer boroughs face particular challenges, according to Miller, because new development there was fueled by the high prices in Manhattan. The notion was that developers would be able to successfully market homes in Downtown Brooklyn or Williamsburg to buyers who wanted a luxury residence but who couldn't afford Manhattan prices. Now, declining prices in Manhattan have undercut that. Many buyers simply no longer need to look to Brooklyn or Queens.

For his part, Staniford worries about the ripple effects of an economy in distress. An increase in crime, for instance, would diminish the quality of life in the city – a recipe for "a perfect storm of negativity for the real estate industry."

"If you have a city that takes a 33 percent cut in revenue from the financial sector, if you keep walking down that path, it just keeps getting scarier and scarier. No one really imagined what is happening now," he said.

Reality Check

Not surprisingly, developers resist painting such a gloomy picture.

Don Capoccia, developer of Toren Condos at Flatbush and Myrtle avenues in Downtown Brooklyn, which is on schedule for completion this spring, says the biggest challenge now is to get prospective owners to sign a contract. "Buyers are spending a lot more time deliberating and comparing and contrasting properties," he said.

While he admits that things have slowed down significantly in the past several months, Capoccia said he has closed two contracts since the beginning of the year at his asking price and without making concessions. He also played down the concern that falling prices in Manhattan are an issue. "Toren has been averaging $750 to $775 per square foot, which is still a great deal even if Manhattan's prices do drop," he said.

But Miller of Miller Samuel says that $750 to $775 per square foot, while still below the rate for a comparable place in Manhattan, does not reflect the market corrections that have taken place since September, when there was a 20 percent drop in values after AIG and Lehman Brothers collapsed.

According to Miller, in September, prices in Manhattan fell from roughly $1,500 or $1,600 a square foot to $1,200 or $1,300. "Apply the same proportional drop – at least half of what it was for Manhattan – to developments (in Brooklyn) priced in the mid $700s (per square foot) and you're talking in the $600s," Miller said. "Brooklyn developers who have not adjusted their prices are receiving little contract activity."

Still, Capoccia insists, his apartments will sell. Citing the quality of the finishes in the condos, he said, "Toren looks a lot different than anything that's coming up right now."

Some experts question, however, whether luxury amenities alone will lure enough affluent buyers to keep these developments financially afloat. In the boom days, Miller said, "If you had the pet spa or the on-site sommelier, that meant something to people," but, he said, it's hard to imagine that dialogue today. "It's the age of austerity now. People are looking for shelter as opposed to lifestyle."

Staniford is matter-of-fact: "Say you have to move to New York City – are you really going to be thinking, 'I need that new fangled pool or gym' or whatever? No you're going to be looking for the best deal you can find."

Holes In the Ground

As bad as things may be for developers with finished apartments to sell, the situation can be even more calamitous for those whose projects have yet to get off the ground.

Developer John Catsimatidis, who is also a potential mayoral candidate, owns a vacant parcel of land on Myrtle Avenue in Downtown Brooklyn, which previously featured a modest retail strip, including an Associated Supermarket that served hundreds of public housing residents across the street. These businesses were torn down in 2006 to make way for a project that was originally supposed to include 1.4 million square feet of new development, of which 250,000 square feet was to be commercial space. The remainder of the project was slated for residents, including 200 affordable units and 600 luxury condos in a 38-story tower and a smaller building.

But nothing has been built yet, and now, with the economic crisis, Catsimatidis, a billionaire, has had to scale down his plans considerably. "We were supposed to build a $500 million dollar project with four to five large buildings and one smaller one," he said, "but banks don't have it. So right now, we're just building the smaller one."

But even for this severely scaled-back version, which will contain 100 market-rate residential units, the financing wasn't easy. Securing a construction loan meant putting up additional cash guarantees, something Catsimatidis says other developers are not willing -- or cannot afford -- to do.

"Banks are saying they want developers to take equal risk now," he said. "We have taken on more risk than we would normally take so that we can get this built."

Catsimatidis has been under fire from residents, advocacy groups and the local Councilmember Letitia James for tearing down amenities such as a supermarket, leaving a hole in the ground and abandoning the idea of affordable housing on the site. Catsimatidis claims that he has had difficulty obtaining bonds that would enable him to build the affordable component. He also indicated that he is seeking alternative options for the land that remains undeveloped, saying he is in conversations with institutions such as Pratt and Brooklyn Law School about building dormitory space.

"The financing is the same as any other project," he said. "But if you have the signature of an institution like NYU, that goes as additional collateral on credit and it's easier to finance."

Policy Mistakes?

Img from Rev. Santino
Condo construction in Long Island City

While developers are paying the price for the luxury-building binge, they had help in creating it. Many appraisers over-assessed the value of condo properties due to pressure from brokers and owners, which contributed to overdevelopment, according to Staniford. The city is at least partially responsible in the view of Councilmember James, who represents parts of Downtown Brooklyn where new condo construction has proliferated.

"In fairness to the developers, it was a bull market, and real estate was the hottest thing in town. No one anticipated that the economy would crash and that all these toxic mortgages would explode," she said.

James believes that Mayor Michael Bloomberg should take responsibility for the condo crisis. "His policies have been tilted toward the benefit of developers, and not enough towards working class residents. He was basically giving away the house for the purpose of generating revenue from the sale of these high-end luxury condos, not recognizing that it was disrupting stable communities and causing the displacement of long-term residents," she said.

James cited the mayor's zoning policies, which she said should have been designed to produce more affordable housing and jobs citywide. Under Bloomberg, the city has pushed through a historic number of large rezonings that have increased the value of land and fueled speculation. In many cases, such as Downtown Brooklyn, the original intention behind these zoning measures was to promote office space, but instead neighborhoods received an overabundance of luxury housing because of the boom market. The city did not have any policies in place to prevent such an imbalance.

In downtown Brooklyn at least, this new housing was beyond the reach of many longtime residents. At the same time, James said, the rising costs forced out manufacturers who had provided industrial jobs for residents who lack college educations. Such arguments have been echoed in other parts of the city from Williamsburg to Long Island City to the Lower East Side.

City officials have contended that changing obsolete zoning has been key to unlocking the potential of underutilized land and to stimulating the creation of new housing, jobs, public space and other amenities. Attributing the city's loss of industrial jobs to larger economic changes, they argue that rezoning measures combined with investment in public infrastructure has drawn private investment and resulted in economic growth, including an increase in affordable housing construction.

Lost Revenues

Whatever its role in creating the current problem, the city is feeling its effects. The administration has already started bracing for the revenue consequences of a dramatic slowdown in residential property sales and has proposed budget cuts and increases in taxes to close the resulting deficit.

"We're already seeing property transfer taxes and mortgage reporting taxes plummet," said City Councilmember David Yassky, whose district includes the condo-dense neighborhoods of Downtown Brooklyn and Williamsburg. "The city will definitely lose out."

Revenue from these two types of taxes depends exclusively on property sales. (Renters are not required to pay taxes for leasing space.) In the current climate, developers are being forced to convert units that were once for sale into rentals in order to pay their loans. This translates into revenues that, rather than just being delayed due to a slow sales pace, are permanently lost.

According to the mayor's Financial Plan Summary released in January, real property transfer and mortgage reporting taxes combined declined by 57 percent from December 2007 to December 2008. The Office of Management and Budget projects these revenues will fall by hundreds of millions more dollars in 2010 before stabilizing and moving up in 2011.

While the OMB calculates these revenues as a relatively small percentage of the total budget – only 4.2 percent for fiscal year 2009 – they still represent hundreds of millions of dollars the city won't see. This percentage is expected to shrink to 3.2 percent for 2010, with the gap being filled by increases in property and sales taxes.

From Crisis to Opportunity

With general agreement on the existence of the problem, if not its magnitude, government officials, real estate experts and housing advocates are currently debating solutions.

One small step forward occurred on Feb. 12, when City Council Speaker Christine Quinn, in her annual State of the City address, put forth a proposal that would help convert thousands of vacant condo units to affordable housing.

"Capitalizing on New York's recent development boom," she stated, "the Affordable Housing Recovery Program will work to make unsold condominiums affordable to middle income New Yorkers to buy or rent."

According to Andrew Doba, a council spokesperson, the initiative is the result of efforts by a special housing task force created by the speaker a year ago that brought together developers, affordable housing advocates and other stakeholders.

At this stage, the program is still just an idea with few specifics. Before it can move forward, the City Council and the mayor will have to hammer out possibly controversial policy questions and craft a plan acceptable to both. For instance, while Doba emphasized that the goal is to stabilize communities, it is unclear whether the program would include rental units or only those for purchase. According to Doba, the Bloomberg administration has signaled that they like outlines of the proposal so far, which is designed to use capital funding that has already been budgeted.

If the Affordable Housing Recovery Program is implemented, individual developers would have the option to negotiate with the city to make apartments available to middle-income residents, who would qualify based on income. The amount of the subsidy would be determined on a case-by-case basis and would depend on a number of factors, including the original asking price of the units, the debt structure of the project, and whether or not the development is in foreclosure, to name a few.

No one has yet specified even a range of how much money developers might be awarded, but Doba states that it is not intended to bring them windfall profits. But should the city take resources that could go to other programs and use them to fix this problem that developers at least partly brought on themselves?

Brad Lander of the Pratt Center for Community Development, who also participated in the speaker's task force and is a candidate for City Council, supports the idea, as long as the per-unit cost does not exceed the amount designated for other homes in the city's affordable housing program. This, he said, would safeguard the city from over-subsidizing developers and ensure there is more affordable housing in the long run.

"You're talking about developers who speculated in a boom marketplace, who had unrealistic expectations that included no affordable units and who were taking advantage of the 421-a tax break [for housing development]. I do not think we should bail out failed speculators," he said

Lander acknowledged that a lot of discussion needs to take place before the speaker's program can move forward. "It's an idea more than a fleshed-out program," he said, predicting that the implementation process, which will involve looking at buildings one by one, is bound to get messy. "If you're building a totally new development and are interested in taking advantage of one of the city's programs, it's a lot easier because it works the same for everyone," he said.

But will developers come to the table? Yassky believes they will. "You will see the city working with developers to get buildings filled at affordable rates," He said.

This could turn into something of a waiting game, however, as officials calculate the precise conditions needed to justify intervention. "There are some big issues here," said Yassky, "and I think that Housing Preservation and Development and the mayor will want some sense of where the market has ended up." Housing Preservation and Development is still waiting on its new commissioner, Rafael Cestero, who is scheduled to take over in March.

Not everyone feels the city should intervene. "Whenever the city has become involved in the property ownership business in the past, it has been a failure," said City Councilmember Peter Vallone, whose district includes Astoria, where there has been significant new condo development. "People need to relax. This is very cyclical and the economy will soon recover."

Staniford agrees government involvement will only make a bad situation worse, adding that until the market reaches the bottom, gridlock will persist. "What I'm most concerned about is that the pricing becomes accessible for the market again," he explained. "We are still priced too high, and until prices get down lower transactions won't occur."

Beyond Damage Control?

The speaker's press release announcing the recovery program stated, "New Yorkers who were once nearly priced out of their communities will now have a chance to buy or rent one of the new homes that were built in their own backyards."

To affordable housing advocates focused on the effects of gentrification and displacement, this statement surely reflects a certain backward logic. Still, many support the basic spirit of the program. Ismene Speliotis of New York Acorn's Housing Here and Now initiative participated in the city's housing task force. She views the current crisis not only as an opportunity to increase levels of affordable housing, but also to adjust policies that were skewed in the first place, which will promote more equitable approaches to development over the long-term.

Speliotis says the Affordable Housing Recovery Program is a good idea, but the city should not have subsidized these developments to begin with. "Acorn had done a study when these buildings were being built -- Sweetheart Development -- and was completely outraged because developers were getting an automatic 10-year tax abatement, " she said. Affordable housing advocates have long objected to what they view as an extraordinary level of public subsidy for market-rate housing that would have been built anyway and criticize the city for not extracting greater public benefit in exchange for such subsidies. The rules on the subsidies have been tightened somewhat, but for years they went to anyone who built housing -- regardless of how expensive it might be.

Putting together a program that does not reward developers for having built vacant housing poses difficult challenges, Speliotis acknowledged. "You've got legal, financial, and then kind of just the psychological hurdles, the perception of the market and what is going to happen," she said. "But in our view, if developers convert some of these empty units to affordable housing, people lose less money. They make less profit, but still, one could define that as an opportunity."

Amid all their disagreements, though, experts do seem to agree on the resilience of New York City's real estate market. For Miller, it's just a question of time. "People are anxious to get things back to where they were, but unappreciative of how long it's going to take," he said. "Time is a four-letter word right now."

Staniford concurs, albeit from a slightly different angle. The real question, he said, will be what's going to replace all the financial sector jobs. But he remains certain something will: "There is no doubt in my mind that New York City will come back again. The place is just way too unique. There is great energy here."

Allison Lirish Dean is a journalist, urban planner and filmmaker. She lives in Brooklyn.


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