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The New York Times      Link to NY Times Article
October 23, 2009

Court Deals Blow to Owners of Apartment Complex

The state’s highest court dealt a potentially crippling blow on Thursday to the owners of the sprawling Stuyvesant Town and Peter Cooper Village complexes in Manhattan when it ruled that they improperly began charging market rents on thousands of apartments.

The ruling by the Court of Appeals may leave the current owner, a partnership of Tishman Speyer Properties and BlackRock Realty, and the former owner, Metropolitan Life, liable for an estimated $200 million in rent overcharges and damages owed to tenants of about 4,000 apartments.

In a 4-to-2 decision, the court said the owners improperly raised rents beyond certain set levels at the complexes while receiving tax breaks from the city for major renovations.

The ruling could affect landlords of as many as 80,000 apartments across the city who may also have improperly raised rents and deregulated apartments while receiving special tax breaks.

But the immediate and most devastating impact was on the Tishman Speyer partnership, which was already facing extreme financial difficulties after paying a record $5.4 billion in 2006 for the properties near the East River. The owners are running out of cash to pay building loans, and analysts have said it is highly likely the partnership will default by December. If the owners are forced to reimburse tenants, analysts say it would only hasten the path to default.

Frank Innuarto, president of Realpoint, a credit rating agency, characterized the ruling as “the last shoe to drop” for Tishman Speyer and BlackRock. The partnership originally had $890 million in reserve funds that were established, in part, to pay the difference between rent revenues and the monthly debt payments on the property; Mr. Innuarto said there is only about $24 million left — only enough to cover the gap until December.

“The property has never been able to generate nearly enough cash to service its debt,” said Manus Clancy, a senior managing director at Trepp, another credit rating agency. “The interest reserve is dwindling, and now the property faces the prospect of taking a hit on its income.”

In its decision, the court acknowledged that the developers had predicted “dire circumstances for our ruling, for themselves and the New York City real estate industry generally.” But the court pointed out that numerous unresolved issues could reduce the amount of money the owners may have to repay, and said that “if the statute imposes unacceptable burdens, defendants’ remedy is to seek legislative relief.”

During the housing boom in 2006, the Tishman Speyer partnership, like other investors at the time, bought the complexes with aggressive plans to convert rent-regulated apartments to market-rate rents by weeding out tenants who it said did not qualify for rent regulation and by raising rents on vacant apartments after major renovations. The partners had planned to convert half the apartments by 2011, but the process has proven far more difficult and time consuming.

Shortly after the Tishman Speyer partnership took over, nine tenants of seven apartments in the complexes filed suit claiming that the landlord had improperly raised rents for thousands of market-rate tenants while collecting more than $24 million in tax breaks since 1992 under the city’s J-51 housing program. The program was intended to encourage landlords to rehabilitate their properties by providing tax breaks on the cost of various building improvements or renovations.

In March, the Appellate Division of the State Supreme Court ruled the landlords had indeed improperly raised rents and decontrolled apartments. That decision galvanized the real estate industry, which submitted briefs on behalf of the Tishman Speyer partnership.

They argued the court had misread the state law and had overturned “15 years of real estate industry practice that had been endorsed by two government agencies with primary responsibilities in this area.”

Alexander H. Schmidt, a lawyer who represented the original nine plaintiffs in the class-action case, said he hoped the current and former owners would quickly resolve the class members’ rent overcharge claims by “settling this case, and ending the litigation.”

Evan Horisk, a plaintiff in the case, was elated. He left Stuyvesant Town in 2007 after Tishman Speyer notified him that the rent for his two-bedroom market-rate apartment would jump 26 percent to $3,350, from $2,660 per month.

“When it comes to someone’s home — their most important place — we must prevent predatory corporations from shuffling their money around at our expense,” he said.

In a strongly worded dissent written by Judge Susan P. Read, the idea that the developers’ “losses ultimately will turn on legal issues and defenses yet to be resolved is cold comfort.”

“In the absence of meaningful legislative action, uncertainty will reign in an industry already rocked by the bursting of the great residential real estate bubble,” the dissent continued.

Tishman Speyer released a statement characterizing the decision as “an unfortunate outcome for New York.”

Mr. Innuarto, the credit rating analyst, said the ruling was likely to accelerate the process by which the lenders turn to a “special servicer” to oversee the property because of the imminent danger of default on about $4.4 billion in loans. Tishman Speyer Properties would lose only the $56 million it put into the deal, while its partners, investors and lenders would take a far bigger hit.

The ruling did not specify a remedy; developers fear they could have to pay treble damages and rent rebates dating back as many as four years, or to the point at which an apartment was deregulated.

There are about one million apartments with regulated rents in the city. Over the past two decades, landlords have lobbied successfully to loosen those restrictions. Under state law, landlords can deregulate an apartment when the rent for a vacant unit reaches $2,000 or more per month, or when the rent is above $2,000 and a tenant’s household income is above $175,000 for two consecutive years.

Once the apartment is deregulated, there are no restrictions on the landlord’s ability to raise the rent.

Landlords are also allowed to pass along a portion of the cost of major renovations to tenants. At Stuyvesant Town, for instance, the landlord routinely spent about $40,000 renovating vacant apartments and as a result was able to raise rents by $1,000 a month. The total rent would then exceed the $2,000 threshold and the landlord was permitted to charge market rates.

Joseph Strasburg, president of the Rent Stabilization Association, which represents 25,000 landlords and building managers, said it was clear the ruling has the “potential to force some buildings into bankruptcy or foreclosure if they’re required to roll back rents, but it would also have a direct impact on the city budget.”

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