Fear of Defaults After a Flurry of Apartment Sales

by Terry Pristin

Until a few years ago, places like Upper Manhattan and the Bronx held little allure for investors in residential property. But as the New York real estate market heated up, major real estate companies began competing vigorously for rent-regulated buildings in these neighborhoods in the belief that they could manage them more professionally and, hence, more profitably.

The recent disclosure that the owners of Riverton Houses, a 1,228-unit apartment complex in Harlem, might default on their loan has shocked the real estate industry. And it has raised fears about other apartment building deals from the not-so-distant past, when the frenzy in the market was reaching its peak.

Those include Stuyvesant Town and Peter Cooper Village, a complex of 110 rent-regulated buildings along the East River that Tishman Speyer Properties and BlackRock Realty, bought in November 2006 for $5.4 billion. But while Riverton has apparently burned through its debt service reserve fund, Stuyvesant Town’s should last for several years, according to Realpoint, a research company in Horsham, Pa.

Still, Riverton’s problems “will put more eyeballs on Stuyvesant Town,” said Manus Clancy, a managing director at Trepp, a research company in New York.

But there were many other transactions that received far less attention than Stuyvesant Town. Many of those deals involved major players like Apollo Real Estate Advisors, one of the developers of the Time Warner Center at Columbus Circle.

In March 2006, for example, Apollo and its partners paid $175 million for Delano Village, a seven-building apartment complex in Harlem that was built in the 1950s as middle-income housing by the Axelrod family, which held onto it for nearly five decades.

The new owners told their lenders they would vastly increase the rental income, even though all of the 1,802 apartments were subject to New York’s strict rent-stabilization program. And the banks went along. By the end of 2006, the complex, now known as Savoy Park, was appraised for $420 million, according to documents filed with the Securities and Exchange Commission.

Savoy Park, which is bounded by 139th and 142nd Streets and Fifth Avenue and Malcolm X Boulevard, was refinanced a few months before the credit markets stalled last summer. Credit Suisse pooled the main or senior $210 million loan with other mortgages and sold it to Wall Street investors as a commercial mortgage-backed security. The owners secured four additional loans, bringing the total debt on the property to $367.5 million, with a loan-to-value ratio of 88 percent, according to Realpoint.

There is no evidence that the owners are having trouble covering their debt service of nearly $2 million a month, though none of the units at Savoy Park have been removed yet from rent stabilization. The landlords have a more generous reserve fund than Riverton had to cover the shortfall on their senior debt — $30 million, compared with $19 million.

But Frank Innaurato, a managing director at Realpoint, said he believed the chances that the Savoy Park loan would eventually run into trouble is “moderate to high.”

“Could this go south?” he asked. “Sure it could.”

The Savoy Park sale occurred at a time when lenders were vying feverishly to make loans and when borrowers in apartment building deals were making robust projections of rent growth, despite the rent-stabilization program.

At Savoy Park, for example, the building’s annual net cash flow was only $4.3 million at the end of last year, yet the loans were underwritten for an ultimate cash flow of $19.1, million, according to Realpoint. Executives at Apollo and its main partner, Vantage Properties, declined to comment.

But Harold M. Shultz, a senior fellow at the Citizens Housing and Planning Council, a research and policy organization based in New York, said once operating costs and total debt service were taken into account, average rents at Savoy Park would have to exceed $1,900 a month for the owners just to break even. “How they were ever going to make this work, I don’t know,” he said. One broker who encouraged his clients to aggressively pursue apartment building deals said the market was so hot from late 2005 until early 2007 that buyers could get financing for more than the value of the property while also paying themselves fees for managing and renovating the buildings.

Most investors, like most lenders, thought that values would keep escalating, said the broker, who did not want his name published in order to protect his business relationships. But, he added, underwriting standards were very casual. “Back then, you could write down anything, and people would believe you,” he said.

A real estate professional who is familiar with the Savoy Park deal but was not authorized to speak about it publicly said the new owners had projected an annual “natural attrition” of 10 percent as tenants relocated for business or personal reasons. But fewer than 6 percent of rent-regulated apartments in New York are vacated each year, according to city figures.

Vacant apartments leave the rent-stabilization program only when the rent exceeds $2,000 a month. For an occupied apartment to be removed from the program, the rent must reach $2,000 and the household income has to be at least $175,000 for two consecutive years.

An aggressive owner can accelerate the process initially by weeding out tenants who are not legally entitled to live in the apartments because, say, their primary residence is elsewhere, said Peter Hauspurg, the chief executive of Eastern Consolidated, a brokerage company in New York. “In the first year of ownership, you’ll get 10 percent back,” Mr. Hauspurg said. “After that, turnover is about 3 to 5 percent a year.”

Frank J. Anelante Jr.. the chief executive of Lemle & Wolff, which owns and manages 7,000 apartments in Upper Manhattan and the Bronx, said turnover in his units was closer to 2 percent. “I have been in this business since 1977,” Mr. Anelante said, “and I have never seen these huge turnover numbers that a lot of these properties seem to have used.”

Yet last year, when Apollo and Vantage bought eight apartment buildings in Washington Heights with a total of 455 units, they said they planned to empty as many as 30 percent of the apartments within a year and 10 percent a year thereafter, according to S.E.C. documents.

Private equity investors have bought 66,000 subsidized and rent-stabilized units in New York in recent years, mainly in Manhattan and the Bronx, said Gregory Lobo Jost, the deputy director of the University Neighborhood Housing Program, a group in the Bronx that seeks to create and preserve low-cost housing. “The prices have gone through the roof, while the profitability has remained flat,” he said.

Even before Riverton’s woes became public, tenants’ groups were closely monitoring the business dealings of Laurence Gluck, the chairman of Stellar Management, which bought the complex with Rockpoint Group, a real estate fund.

Since 2004, Mr. Gluck has bought 16 apartment buildings that were initially part of the income-restricted housing program known as Mitchell-Lama, and has tried but failed to deregulate those that were subject to rent stabilization, said Amy Chan, an organizer for Tenants and Neighbors, an advocacy group in New York. Mr. Gluck declined to be interviewed.

For Riverton, Stellar told its lenders that 53 percent of the apartments would be deregulated by 2011, with monthly rents for one-bedroom apartments rising to $2,012 a month, from an average of $868. But even when rent stabilization is lifted, market-rate rents above $2,000 a month are not always easy to achieve in Harlem or the Bronx, Mr. Shultz said.

“As the financiers got farther and farther away from New York, everything looked like Manhattan below 96th Street to them,” Mr. Shultz said. “They all got caught up in the bubble mentality.”