The Real Deal: “Multi-billion dollar private-equity fund targets local appraisers in lawsuits”

Yesterday, the Real Deal published an article reporting that Lone Star, a Texas-based Private Equity group, is suing local New York appraisers. We are familiar with Lone Star as a lender on a number of large, Predatory Equity portfolios we have been tracking for many years. Now, Lone Star is arguing that during the housing boom, appraisers acted “fraudulently and negligently” when valuing properties, and as a result Lone Star mis-lent.

As we have previously asserted on this blog, we believe that banks have a pivotal role to play in breaking the cycle of Predatory Equity. Despite how we may sometimes feel, banks do not arbitrarily set a price for their distressed assets, nor do they arbitrarily decide how much they are willing to lend on a property.  As we understand it, third party building appraisers are hired by banks to determine the real value of a particular asset, and lending levels are supposed to reflect this value. It’s interesting that a major Predatory Equity lender is suing real estate appraisers for property evaluations during the housing boom. Though we are not appraisal experts, we certainly have a few thoughts.

  • According to at least one bank we work with, appraisers are not taking building conditions into account when determining value of a property. This is a huge problem.  How can buildings be bought and sold for the right price if the repair needs – potentially millions of dollars — are ignored?  To us, it’s a no-brainer that the cost to stabilize a distressed property must be taken out of the total value when determining the cost of acquisition. Otherwise, the building is doomed for shoddy repairs and another round of neglect.

Another aspect of this article which is particularly strange is that Lone Star is the group driving these cases. We haven’t seen specific examples, but would likely agree with them that pre-2008 home values were highly inflated.  However, it’s odd for us to uncritically side ourselves with a Predatory Equity company, so we have some follow-up thoughts:

  • The article quotes Matthew Parrott, an independent attorney. He says “the cases appear to be a way for Lone Star to generate revenue from distressed loans.”  We don’t fully understand how this works. Has Lone Star determined that they paid too much for a distressed asset, and are now trying to sue other parties to recoup their losses?
  • Banks hire independent appraisers but those appraisers do not hold a guns to banks’ heads commanding them to lend at a particular level. We believe that the lenders’ eagerness to maximize profit encouraged them to believe the perhaps-inflated appraisals. Lone Star still made the loan. It seems that Lone Star is attempting to place blame for their own mistakes on other parties.

The question of appraisal seems to be linked to how much faith one puts in the free market: do you believe that the value of an asset is what someone will pay for it? Or is the value linked to the actual income potential (in NYC: regulated rents) and conditions (cost of repair)? We certainly believe that it is the latter.  Any bank making loans should hire appraisers that know building details like rent roll, and have been inside of apartments,  and have checked out the boiler, the roof, and other systems.

We leave you with one last question: what would it take to reform the way that appraisers value buildings? We intend to continue to thinking about this issue, and flush out potential answers to that question. Stay tuned!


The Return of Predatory Equity

We are not social scientists or academics, but researching trends in affordable housing is a major part of our job. By maintaining (to the best of our ability) an updated list of multifamily buildings in foreclosure, we are able to target our outreach most effectively, and in some cases, more skilled researchers have digested it and drawn exciting conclusions. It is this somewhat tedious but incredibly important practice of data collection that alerted us to Predatory Equity in 2007 and that now is unveiling a second round of speculation in 2012.

As we have noted here and elsewhere, the way that multifamily buildings are bought and sold in New York City has fundamentally changed since 2008. Rather than purchase a deed to a distressed building, potential property owners purchase delinquent mortgage notes from foreclosing banks. Presumably the note-buyer finishes the foreclosure and takes title to the building at auction, at which point some bring in long-term financing. Because of this, there are almost no multi-family REO properties despite the very high number of foreclosures in this category.

We have tried to track who is buying mortgage notes, and some of that information was released last week in The Real Deal: “Private Equity Firms Snap Up Debt on Small NYC Rentals.” In the past year, the number of private equity firms re-entering the NYC distressed housing market – by way of buying mortgages – has soared. The Real Deal notes some examples:

In February, Stabilis Capital, headquartered in the General Motors building in Midtown, bought the note on six, six-unit buildings in Queens, including 1894 Cornelia Street. Last fall, Madison Realty Capital bought the debt on 12 buildings with a total of 237 units, such as 974 St. Nicholas Avenue in Washington Heights; and in December, Onex Real Estate Partners bought the debt on five buildings with a total of 131 units, including 100 Audobon Avenue in Washington Heights. 

In addition, last June Waterfall Asset Management through its Waterfall Victoria Master Fund, bought the notes on two Bronx properties with a total of 15 units, including 852 East 213 Street and 674 St Anns Avenue; and Richard Maidman’s Townhouse Management between March 2011 and January 2012 bought the notes on five properties — including 735 Bryant Avenue in the Bronx — with a total of 133 units, the survey from UHAB shows. (These totals are preliminary, and the funds may have acquired additional mortgages, UHAB said.)

Many of the deals noted in the article are less than a year old, so it is too early to tell what specifically will happen to the highly distressed housing stock. We are suspicious, though, by what seems like a reoccurring (and regrettable) trend that characterized the pre-2008 housing market. Furthermore, it is not too early to tell what the intentions of private equity investment firms are: private equity investors get into such a business because they are interested in making money. In this high-risk game, investors expect such a large rate of return that in order for these deals to be profitable, the housing involved has to significantly increase in (monetary) value.

While some say that the housing market can only improve, it is important to bear in mind that these investors are purchasing regulated housing. You can increase revenue in two ways: by increasing income or by reducing spending. In regulated housing, it is impossible to significantly increase income (rents) without displacing regulated tenants. (The fierceness and sophistication of New York City renters assures this is no small task.) This leaves reducing spending – severely cutting maintenance and operating on already physically distressed properties. Put simply, we do not understand how private equity plans to make money on rent-regulated housing without acting against the interest of low-to-moderate-income tenants.

We are not professional researchers; we are advocates and activists. Our data is preliminary and by no means comprehensive, and we have an admitted tendency to distrust anyone whose primary interest in owning affordable housing is profit. (“Housing for people, not for profit.”) However, it is safe to say that we’re gearing up for another fight, and it is sure to be a doozy.

The Real Deal: “Bluestone sells former Ocelot Bronx portfolio for $17.6M”

The real estate investment firm the Bluestone Group, which denied for months it would unload a six-building portfolio of once severely distressed Bronx properties, sold the package for $17.6 million, a source close to the deal said.

The sale closed yesterday as part of a bankruptcy case filed by the former ownership company BXP 1, controlled by investor Susumu Endo. The buyer was Anthony Gazivoda, owner of Gazivoda Realty, a prominent landlord in the Bronx Albanian community, an employee at Gazivoda said. Gazivoda himself was not immediately available for comment.

Bluestone, led by principals Eli Tabak, Ari Bromberg and Marc Mendelsohn, purchased the defaulted notes on the six properties, with a face value of $13.15 million, for about $10 million in June 2010, according to city property records.

Tabak, speaking for Bluestone, declined to comment on the sale.

Bluestone, formed in 2006, has been an active player in the distressed real estate market, especially through note purchases.

The Bronx units were in terrible condition in 2010, with Crain’s reporting in July last year that there were 2,936 housing code violations on the buildings’ 260 units, or 11.3 violations per unit. Yesterday there were 334 housing code violations, or 1.3 per unit, the city’s Department of Housing Preservation and Development website shows.

Read more at The Real Deal.