The Affordable Housing Crisis and a Capital Market Solution

The answer to the affordable middle-income housing crisis in New York City[1] and in other similar urban centers in the United States,[2] as well as, elsewhere in the world[3] is the creation of more middle-income housing. The capital markets can help solve the problem by financing the development of new middle income housing, as more fully discussed below.

On the other hand, the answer to low-income affordability is not more low-income housing; it is more income.[4] The distinction is cogent. The existing model for building low-income housing projects is structurally flawed. It just does not work financially because the rents that can be paid by low-income tenants are insufficient to cover all the expenditures required in order to properly operate, and otherwise carry the project. Hence, the financial problems facing NYCHA[5] low income housing projects in New York City.[6]

Instead of creating new low income projects that demonstrably do not work, we should be empowering households earning less income by providing them with the income needed to rent an apartment like others in the marketplace. There is a model for this kind of direct assistance; in the form of the Section 8 transferable rent voucher system.[7] Transferable or so called “sticky” vouchers awarded to a tenant enable the tenant to rent an apartment anywhere, so long as the rent charged does not exceed the prescribed market rent in the area. If the direct rent subsidy program is made compliant with capital markets requirements, as outlined below, then the solution to the affordable low income housing crisis can be dealt with as a part of the solution to the affordable housing crisis, generally, as discussed below.

Middle-income housing can be financed through the capital markets, without the kind of substantial public investment and guarantees required in order initially to create and then, over time, operate low-income housing projects.

Once upon a time[8] this could not readily be accomplished. There was a need for massive governmental intervention to enable the creation of affordable middle-income housing. This took the form of condemnation and slum clearance,[9] so called “buy-downs”[10] of purchase price, issuance of government bonds or other credit enhancements,[11] subsidies in the form of interest rate buy-downs,[12] real estate tax exemption and other relief.[13] As a result, over 100,000 affordable middle-income housing units were created[14] in New York under the so-called Mitchell-Lama program.

At the present time, though, the creation of needed affordable middle-income housing appears to be stalled.[15] This, at a time when other forms of housing continue to be produced, including luxury housing and some low-income housing. The reason sufficient quantities of affordable middle-income housing are not being produced is a complex matrix of interdependent factors. The solution is not obvious. Indeed, as one of Murphy’s laws states, the simple solution to a complex problem is usually wrong.

It is suggested that a dynamic approach is required. Whether it is issues of site selection, policy considerations, zoning, master planning, or other project specific concerns, a more nuanced approach can result not only in capital markets acceptance; but, also in genuine efficiencies.

With the advent of commercial mortgage backed securities (CMBS) and other forms of marketable securities, derived from what at its heart is a real estate mortgage loan structure, the capital markets have developed an institutional following that has embraced these financial products. What once required the issuance of government bonds or guaranties in order to be marketable can now be done without these wrappers and often at a lower overall cost.

The capital markets have been extraordinarily successful in providing financing for residential multi-family projects, at among the lowest interest rates in history.

A fundamental requirement for accessing the capital markets is conformity with its rules. The markets are extremely disciplined. If the requirements are met then a financing can be achieved on these favorable prevailing market terms and conditions. The penalty for non-conformity is usually denial of access. Although some exceptions are made, this often results in less favorable terms and conditions, including higher interest rates. This is understandable, because the efficiency of the marketplace is dependent, in no small measure, on delivering the conforming financial products that the broader institutional investor-side of the market requires.

To better understand what works (and what does not) is not just a study of history; although that is a good starting point. The marketplace is dynamic and has evolved over time. One requirement though has not changed and that is the need for predictability. This is a fundamental factor in determining whether a capital markets financing can be accomplished or not.

This article analyzes the problems and proposes a solution. As will be discussed below, a part of the solution suggested is to adapt existing public/private partnership structures and tools (including the very flexible financeable ground lease structure) that have proven to work in practice. This also includes the use of a public authority or public benefit corporation, which provides needed flexibility in terms of the effectuation of any such program. These proven structures and tools, if properly employed, can provide the means to access the capital markets, so as to facilitate the financing of new middle-income housing development.

It is suggested that an “Affordable Housing Authority” be created. This would not only provide an extremely flexible governmental vehicle, with appropriate staff, to focus on solving the problem, it would also provide a mandate and the powers necessary to accomplish the mission. Public benefit corporations and authorities, such as Battery Park City Authority and the 42nd Street Redevelopment Corp., with a precise focus and mandate, have been extraordinarily successful in accomplishing their missions. The results speak for themselves; a new, well functioning, mixed-income, mixed-use, city within a city, known a Battery Park City and a revitalized 42nd Street and Times Square.

While some form of real estate tax exemption is still a necessary component and the adjusted[16] cost of the land must be right, most of the other incentives noted above are no longer required. What that means in practice and how it can be accomplished are discussed below.

It is time to address the need for the creation of essential middle income and other affordable housing in New York City and other similar urban centers. Artificially preserving the existing affordable housing stock, as such, does not solve the problem. Indeed, it may exacerbate it. Consider the lengths families will go to in order to preserve the right to occupy an apartment that is rent regulated (including even from one generation to another).[17] People can and do hold on to bargain-rate apartments for years, even decades, depriving others of access to these rare prizes. Indeed, this kind of artificial rent regulation may be a root cause of the problem. Rather than artificially holding down rents to below market rates, we should build a new generation of housing for the middle class. We have financial models such as public-private-partnerships that have been proven to work. We have the land, as discussed below. Now we need only the political will to make it happen.

[1] The existence of the housing crisis is well documented in a number of governmental and non-governmental studies including those noted below. There are also many news articles reporting on the issue including those cited below. It would appear that the crisis has deepened in recent times. One indicator is the substantial rise in rents throughout New York City in the last few years despite the financial crisis of 2008 and the Great Recession that took hold during the same period. In this regard, the recent Harvard Study, noted below, describing how there has been a significant shift from home ownership to rental housing because of the spate of mortgage defaults and foreclosures during the relevant period, may help account in part for the acuity of the problem. See the excellent study commissioned by the Hon. Betsy Gotbaum, when she was the Public Advocate of New York City, entitled: “Affordable Housing in New York City-Definitions/ Options,” a publication of the Steven L. Newman Real Estate Institute, “Division of Applied Research & Public Planning” (October 2005), as well as studies by the City Council of the City of New York entitled “The Middle Class Squeeze-A report on the State of the City’s Middle Class” commissioned under the auspices of Christine C. Quinn, Speaker (February 2013); the Office of the State Comptroller, the Hon. H. Carl McCall, entitled: “No Room for Growth: Affordable Housing and Economic Development for the City of New York” (Report 8-2000); the Office of Comptroller of the City of New York, the Hon. William C. Thompson, Jr., entitled “Affordable No More: New York City’s Looming Crises in Mitchell-Lama and Limited Dividend Housing” (February 18, 2004) and the New School for Management and Urban Policy entitled: “Sustaining Affordable Housing in a Competitive Real Estate Market: A Case Study of Mitchell-Lama Rental Units,” (April 8, 2008). See also the recent study by the Joint Center for Housing Studies of Harvard University entitled: America’s Rental Housing-Evolving Markets and Needs (2013). Reference should also be made to the Study done by the Center for Urban Future entitled: “Reviving the City of Aspiration: A Study of the Challenges Facing New York City’s Middle Class” (February 2009). Relevant news articles include: “N.Y.C. so costly you need to earn six figures to make middle class” by Elizabeth Hays in the Daily News (February 6, 2009); “City faces middle- class exodus,” by Daniel Massey in Crain’s (February 5, 2009); “New York’s Funny Definition of ‘Moderate- and Middle-Income’ Housing,” by Stephen Smith in Forbes

(January 9, 2012); “In New York Having a Job or 2, Doesn’t Mean Having a Home,” by Mireya Navarro in The New York Times (September 18, 2013); “New York’s Affordable Housing Shortage,” an editorial in The New York Times (February 8, 2014); and “Affordable Housing Options for the Average NY’er,” by Lucy Cohen Blatter in AM New York (August 8, 2012).

[2]See “The Affordable Housing Shortage: Considering the Problem, Causes and Solutions” by Ron Feld- man of the Federal Reserve Bank of Minneapolis, Banking and Policy Working Paper 02-2 (August 2002). See also “America’s Emerging Housing Crises” by Joel Klein in Forbes (July 26,2013); “Why Middle Class Can’t Afford Rents” by Robert Hickey in CNN Opinion (April 23, 2014); and “In Many Cities, Rent is Rising Out of Reach of Middle Class” by Shaula Dewan in The New York Times (April 14, 2014).

[3] See “Four Ways to solve Britain’s housing crisis,” by the Editors of MSM Money UK (November 14, 2013); “Market failure and the London housing market” a study by the Greater London Authority (May 2003); and a study by the Reserve Bank of India entitled “Enabling Affordable Housing for All-Issues and Challenges” (April 1, 2012).

[4] See Harvard Institute of Economic Research Discussion Paper #1948 by Edward L. Glaeser of Harvard and Joseph Gromyko of Wharton (March 2002); and even more on point, “The Affordable Housing Shortage; Considering the Problem, Causes and Solutions,” by Ron Feldman in Banking and Policy Working Paper 02-2 (August 2002) of the Federal Reserve Bank of Minneapolis. A conclusion of that Paper is that a shortage of income is the root cause of the housing affordability crisis and that policymakers should recognize that government financing of new affordable housing units is unlikely to be cost effective response to the low household income problem.

[5] The New York City Housing Authority, which owns and operates housing projects in New York City, comprising more than 180,000 apartment units for occupancy by low-income households.

[6] See “New York’s Silent Infrastructure Challenge- Aging Public Buildings” by Adam Forman in City Limits (March 18, 2014), which notes that more than half of the NYCHA buildings are not in compliance with Local Law 11. The problems noted include leaky roofs, facades, ceiling collapses, holes in walls and even hazardous mold. Many are left vacant as a result of the serious deferred maintenance issues. See also “Re- skin Public Housing” by Fred Harris, the Executive Vice President of Development at NYCHA in the Forum for Urban Design (an estimated $17.8 billion project). He notes that there is a backlog of $6 Billion of required capital expenditures. Rent from NYCHA residents is reported to cover, at most, 50% of operating costs. He reports that the habitability of buildings is threatened if the capital expenditures are not made. The $6 Billion of so-called deferred capital maintenance was the subject of the Bloomberg plan to lease land with excess development rights in Manhattan NYCHA projects for luxury development. See “Funding of Plan for Public Housing” by Robbie Whelan and Josh Dawsey in The Wall Street Journal (August 20, 2013); and “City Announce New Goal for Public Housing Repairs, but with Big Caveat” by Mireya Navarro in The New York Times (March 11, 2013). See also “Good Place to Work Hard Place to Live” by Tom Waters and Victor Bach of the Community Service Society (April 2013).

[7] Code of Federal Regulations Title 24, Chapter 8, Parts 887–888. This is unlike project-based vouchers (under Parts 880–886, dealing with Housing Assistance Payments (HAP) Contracts for non-governmental and governmental projects) which tie benefits to a particular low-income project that, in effect, warehouses low-income households.

[8] For example, in the period between the passage of the Redevelopment Companies Act in 1942 and the passage of the 1960 Amendment to the so-called Mitchell-Lama Act of 1955, which set the initial buy-out period at 20 years; but, more on this below.

[9] Private Housing Finance Law (PHFL) Article V, Section 119. All references to PHFL are to the McKinney’s Consolidated Laws of New York (2002, as amended) Books 41–42.

[10] PHFL Article V, Section 116.

[11] PHFL, Article V, Section 111.

[12] Section 236 Interest Reduction Payment Program (which was terminated in 1973), under 24 CFR part 236 (12 USC 1715z-1; Section 236 of the National Housing Act).

[13] PHFL Article V, Section 125.

[14] See statistics reported on Rent Guidelines Board Web site, which notes that as of January 2006, there were 132 City sponsored Mitchell-Lama developments, comprising approximately 54,000 units. In addition there were approximately 100 State sponsored Mitchell-Lama developments, comprising approximately another 64,000 units. Although the so-called Mitchell-Lama Law (PHFL, Article II) was first enacted in 1955, it was not until the Amendments of 1959 (which permit- ted a buyout after a period of 15 years) and 1960 (which increased the period to 20 years) that construction of middle-income projects under the program began in earnest. This includes large-scale development projects such as Coop City in the Bronx, Starrett City in Brooklyn, Rochdale Village in Queens, as well as Waterside Towers, Rupert Towers, and numerous other large and small developments in Manhattan and the other Boroughs of New York City.

[15] See “Will Affordable Housing Plan Leave Middle Class New Yorkers Out in the Cold?” by Lindsay Arm- strong in Metrofocus at Thirteen.org (July 20,2012), which notes that a recent report from the Independent Budget Office suggests that the number of moderate and middle income units created under Mayor Bloomberg’s New Housing Marketplace plan was far behind the original goal. In this regard it is important to note that there is a genuine difference between creating new affordable housing and preserving existing housing as more fully discussed in this article. The author’s own anecdotal experience in the area of Mitchell-Lama and other middle-income regulated programs indicates that little middle-income housing has been created. And the efforts to preserve middle- income housing have only been marginally effective when compared to the exodus of units from rent- regulated status, whether under Mitchell-Lama, federal programs or rent control and stabilization. See also “Mayor Mike’s Legacy: What *Really* Happened To Affordable Housing In New York City by Choire Sicha in the AWL (August 19th, 2013), which describes how there was little housing created in New York City relative to prior periods, let alone affordable middle class housing. Preservation is not creation of needed new affordable housing in addition to the existing housing stock. The article also notes that formerly rent regulated units continue to diminish as well. It would appear that the City itself acknowledges many of these shortcomings, as outlined in the New York City Economic Development Corp. report on the need for the development of Hunters Point in Queens (NYCED.com). In that report the EDC notes that the last large-scale development effort to create middle income or workforce housing was through the Mitchell-Lama program in the 1970s. It goes on to say that most of the 27,000 new affordable housing units created since 2002 under Mayor Bloomberg’s New Housing Marketplace Plan focused on low-income households. Although it reports 21,000 Mitchell-Lama units were preserved, it goes on to say that 11,000 have left the program. It also notes that vacancy decontrol provisions covering rent- stabilized buildings have resulted in a further erosion of the middle class housing stock in New York City. The Hunters Point project plan includes 5,000 units of housing targeted at middle-income households, defined as earning incomes of between 80% and 165% of AMI.

[16] Zoning bonuses and rights to develop other higher end uses, such as retail, offices and luxury housing units, within the overall development project can, in effect, help reduce the cost of the land apportioned to the affordable middle income component of the project to a level that is financeable. However, it is suggested that more is needed, as discussed below.

[17] See “The Truly Affordable Apartment” by Rhonda Kaysen featured in The New York Times on January 31, 2014.

The UDC Precedent, Including Battery Park City Authority and the Need for an Affordable Housing Authority

The UDC[1] and its progeny[2] in the late 1970s and through and including the early 1990s accomplished a number of significant projects, without public investment or guaranties. It did this by exploiting the public/ private partnership model. It provided certain benefits to private sector developer partners, who were then able to source the funds needed to develop the project from the private sector, without government guaranties or direct investment.

The UDC had enormous powers. It could acquire real estate,[3] borrow money and issue bonds[4] and it was exempt from real estate and other taxes.[5] It could then sell or lease the real estate to others, so that they could develop the projects. It could do all this on negotiated terms and conditions, without having to publically bid out the projects.[6]

It had the right to override zoning.[7] While rarely exercised, this provided the UDC with the political leverage to work with local zoning agencies in New York State to accomplish its mission. This permitted sites to be used to best effect, including as to the scale, uses and bulk of the development. There was even a right to override local building codes in favor of the New York State Building Code;[8] however, this proved less useful in practice.[9]

At the present time, the capital markets no longer need a governmental guarantee or bond wrapper to permit access to the markets for real estate projects that otherwise stand on their own financially. Nor, strictly speaking, is the kind of subsided interest rate (as low as one percent) that used to be available under federal affordable housing programs[10] needed, per se.

Instead, what is needed is a discrete, definable, appropriate, predictable, priority and secure stream of NOI, derived from appropriately located real estate, along the lines outlined above. As discussed above, the middle-income model yields such a source of this income, provided that the other parameters are respected. It is the virtually inelastic demand for housing at the below market rent that animates this kind of financing model. However, as noted above, the stream of rents must not only be secure and predictable, it must be high enough to cover all the operating costs (including reasonable reserves for replacements), debt service and a reasonable return on equity, as noted above. Real estate tax exemption is presumed in this model, along the lines of existing programs. Imposing full taxes would be an operating budget buster that would require a dollar for dollar increase in the rents, which would substantially and negatively impact affordability. Hence, there is a need for real estate tax exemption and abatement.

The structuring of a functional public/ private development project is somewhat of an art; although, in terms of the financing model, it is more science than art. This is because the capital markets have evolved since the time of the creation of Sty Town, Parkchester, Battery Park City, and other large-scale public/private developments.

Battery Park City is a good example, although there are many others such as the Albany Hilton Hotel and the Grand Hyatt Hotel. In those deals, as well as others like them, the government negotiated for a piece of the upside, in order to recompense it for the tax abatement and exemption, forgiveness of back real estate taxes, UDAG grant sourced soft second mortgage, buy down of purchase price or other benefits, as the case may be, required in order to incentivize the creation of the particular project. This is the kind of flexible approach needed so that the nature and extent of the benefits granted could be adjusted to the particular circumstances. Similarly, this structure could be utilized to provide for repayment of all or a portion of those benefits granted, as appropriate. These kinds of tools can be properly utilized by an Affordable Housing Authority, as a part of the public/private partnership model, to achieve the mission, as outlined above. This is particularly so when effectuating a large scale development, in partnership with a number of different private developers and multiple and various tiers of financing sources, involving disparate parcels of land, various zoning and use requirements (including a mix of housing styles, from low to mid to high-rise, incomes and uses,) all in accordance with a master plan. This was the case in Battery Park City and other large-scale governmental sponsored developments. It is also appropriate for the kind of phased development of NYCHA and other City owned or controlled properties suggested above.

It is, therefore, proposed that a new Affordable Housing Authority be formed. It should have the kind of powers that the UDC has to deal with property. It is not suggested that the Authority have bonding power. Rather the concept is to negotiate public/ private partnerships for the development of a site that is to be devoted to the mixed income and mixed use community model noted above, as appropriately adapted to the particular site. The powers necessary to effectuate these purposes should include the following:[11]

1. The power to acquire property from the City or other governmental bodies for no consideration.
2. The power to transfer or lease the property, to one or more private developers, without public bidding and for a negotiated price or rent (under an up to 99 year lease) that can be a grant for little or no consideration.
3. The power to condemn land or other rights as needed to effectuate the purposes of the Authority.
4. The right to be exempt from real estate taxes.
5. The power to override local zoning and other building restrictions.

The City could transfer land it owns, directly or indirectly, to the Authority. This could include the NYCHA sites noted above, such vacant tracts as the 90 acres of land where the Brooklyn Army Terminal is located or the nine blocks remaining in the Seward Park Urban Renewal Zone. It could also include a variety of underutilized properties, such as the public library site in Brooklyn Heights (adjoining an existing Mitchell-Lama complex), which is already slated for redevelopment, or 40th Street midtown library branch, located on an underdeveloped site between 39th and 40th Street along Fifth Avenue. Much like the successful school building program, the existing library site could be redeveloped with new facilities that are incorporated into a new development project on the site.

It is proposed that the extremely successful approach of the Battery Park City model be employed. The vision was based in part on the model of Park Avenue, which projected a sense of security to those residing on the Avenue that was incomparable to other locales in the city and most especially governmental funded projects. Thus unlike the so-called projects following the Le Corbusier model of towers in the park, buildings were to be built to the property line, like on Park Avenue. Similarly, the buildings were to be built right next to each other to form solid block-fronts, with no places to hide. Lighting was also very important. Park Avenue is very well lit and there are few places in the shadows for predators to hide. Park Avenue itself is also wide and well lit to further enhance this feeling of security.

There were also to be a mix of incomes and uses. One of the first sets of residential buildings developed at Battery Park City was a complex of high-rise middle-income buildings. In addition, there were many luxurious units created in a variety of high, mid and low-rise buildings. There were also office buildings (commonly known as the World Financial Center), retail spaces, hotels, public spaces (including a museum, parks and the Esplanade) and even a marina. This model has proven to work in practice over more than 30 years.

By combining a variety of incomes (low, middle and high) and uses (residential, retail, office, hotel, entertainment and civic, as appropriate,), a new, integrated and harmonious neighborhood can be established. Flexibility is a part of the formula for success. The free market is dynamic and tastes and preferences change over time. We cannot legislate the future. Yes, there can and should be guiding principles; but, then the concept must be allowed to evolve and develop its own successful destiny.

It time to start again. This time there are ample financial resources available to do most of the work. As noted above the glue is allowing the land to be used at a price commensurate with the intended use. When that use is potentially changed after 20 years, the full price will have to be paid. But for the long-term, the problem can be solved and that is all we can reasonably ask be done.

The public/private model, developed in the depths of the fiscal crisis, with some alterations to adapt it to the modern needs of the capital market, can do the job. Let’s allow it to do so. An Affordable Housing Authority of the sort outlined above can help accomplish the mission.

[1] Now the Empire State Development Corp.

[2] Battery Park City Authority, 42nd Street Redevelopment Corp. and the Roosevelt Island Operating Corp. of New York State, among others

[3] New York Urban Development Corporation Act, Chapter 174 of the Laws of 1968 and printed in McKinneys Unconsolidated Laws, Section 6251, et. seq. (UDC Act). The right to acquire property including by way of condemnation is set forth in Section 6263 of the UDC Act. It could also acquire state land under Section 6263-a of the UDC Act and property from municipalities under Section 6264 of the Act.

[4] Sections 6267-6269 of the UDC Act.

[5] Sections 6256-69 of the UDC Act.

[6] Section 6272 of the UDC Act.

[7] Section 6266, Subdivision (3) of the UDC Act. See Opinion of the Corporation Counsel of the City of New York (No. 22-79). See also Floyd v. New York State Urban Development Corp., 33 N.Y.2d 1, 347 N.Y.S.2d 161, 300 N.E.2d 704 (1973).

[8] Section 6266, Subdivision (3) of the UDC Act.

[9] Lenders, in practice, required the issuance of a local certificate of occupancy. However, local building authorities balked at issuing the same if the building was not built in accordance with the local building code and with inspections by local authorities (not the State or UDC).

[10] The Section 236 HUD program that was used to foster development of Starrett City, for example.

[11] There is ample precedent for this under the UDC Act, as noted above.

Mitchell-Lama and Other Precedents

The Mitchell-Lama program on balance was an incredible success. It took blighted areas and transformed them. Now the neighborhoods that were once slums, or underdeveloped areas, including in urban renewal sites, are being marketed as luxury housing units. The residents were able to occupy good housing stock at affordable rents for decades. Some still do under the protection of rent stabilization. Some have even managed to transfer this beneficial occupancy to children and grandchildren. Others, through the magic of a condo or coop conversion, were even able to share in the tremendous increase in value. There is nothing inherently wrong with this kind of success. Stated another way, why challenge it; let’s rather embrace it as a methodology that can be adapted to create the next generation of affordable middle-income housing. Let’s not turn the clock back. The model has proven itself beyond what anyone could have envisioned at the time. In this regard, it should be noted that the law was amended to reduce the rent restriction period to 20 years, which allowed the program to flourish.[1] Until then it languished because a longer period of rent regulation did not find market acceptance. As discussed above, the concept of permanent affordability being bandied about is just not financeable.

Tax-free bonds may no longer be a necessary to induce developers to create affordable middle-income housing. Indeed, it would appear that given the availability of other lower cost alternatives for qualifying projects, the actual cost of financing using tax free bonds may sometimes be higher than the taxable CMBS or other mortgage financing alternative. We have come a long way since the 1950s when a government backed tax-free bond was a necessary component to financing of affordable middle-income housing. Today, it would appear that for projects of the sort under discussion in this article, neither government guarantees nor tax-free bonds are needed. The capital markets have evolved and embraced many of the concepts discussed in this article so as to enable the financing of residential middle income housing on a cost effective basis.

On the other hand, what is critical is that the cost of the land be at a level that promotes the creation of middle-income housing. Otherwise, why build for rents that are artificially below market as noted above. Moreover, it may not be economically feasible to build and charge the lower rents needed so that the units created would be affordable to middle-income occupants, for all the reasons noted above. While the income stream created at below market rates may be more predictable and secure than a market rate stream of rents, nevertheless, if it is insufficient to cover the expenditures needed to operate the property properly, service the debt financing and provide a reasonable return on equity, then it is just not financeable.

The hard and soft costs of construction cannot be materially reduced to a level that it would make a project of this sort economically feasible. Yes there can be some savings, but the key component is the availability of the land at the appropriate price. There are many precedents to deal with this threshold issue. Whether it was the 1942 Redevelopment Companies Act,[2] now embodied in Article V of the New York Private Housing Finance Law[3] or the Mitchell Lama Law, as amended, embodied in Article II of the PHFL, they each provide for condemnation. The Mitchell-Lama law also provides for a so-called buy-down of the purchase price[4] of the property. In common parlance, this means that the government may have to pay a higher price than is economically feasible to foster redevelopment of the property with middle-income housing. It subsidizes the development by selling the land to the developer of the middle income housing under the program for less than it paid or its worth. This was a hallmark of the incredibly successful Mitchell-Lama program that produced approximately 150,000 middle-income units. This was new construction of units that did not previously exist, not preservation of existing units or some other kind of rubric. This is the genuine article and it worked.

The Mitchell-Lama program offered land for little or no cost to private developers who committed to produce housing units for middle income occupancy at regulated rents designed to cover operating cost, including reserves for capital expenditures and depreciation, the cost of servicing the debt financing and a cumulative return on equity of six percent per annum. The program accomplished its mission.

In addition to reduction of the price of the land to an acceptable level, the tools used were government issued and backed bonds to cover 95% of the cost of the development and tax exemption and abatement for the period of rent regulation.

[1] As originally enacted (1956 N.Y. Laws 877), it was nearly impossible to exit the program. It required expiration of a 35-year period (not 20 years as is currently the case) and, in addition, the consent of the State or Municipal agency involved with the project. It’s no wonder that few projects were produced under this program. In 1959 (1959 N.Y. Laws 675) and then again in 1960 (1960 N.Y. Laws 669), the Mitchell-Lama law was amended to change the right to exit first to after a 15 year period and then to a 20 year period, as is currently the case. The requirement for governmental consent was also removed. The right to exit was now in the sole discretion of the owner after the expiration of the 20-year period. These changes allowed the program to flourish and the result was more than a 100,000 Mitchell-Lama housing units were created under the program. The Mitchell-Lama law, as amended, is now embodied in Article II of the New York Private Housing Finance Law. There are also other similar programs set forth in various Articles of the Private Housing Finance Law, including Article IV, Article V (which embodies the original Redevelopment Companies law, as amended, that enabled Sty-Town and Parkchester to be built) and Article XI (a newer provision upon which the West-Village Coop solution to continued affordability upon exiting the Mitchell-Lama program was based).

[2] NY Laws of 1942 Chapter 845, as amended by NY Laws of 1943, Chapter 234.

[3] PHFL Article II, Section 36-a and Article V, Section 119, respectively.

[4] PHFL Article II, Section 36-a.

The Need For Predictability—The AHA and Financeable Ground Lease can be Effective Tools to Accomplish the Mission

In 1976–1977, during the so-called fiscal crisis, there was such mistrust of New York City government that the Urban Development Corporation (UDC) was called in to play a role in two major[1] adaptive reuse projects, requiring tax exemption and abatement, in order to proceed. UDC was willing to participate in order to facilitate the development. It had the necessary powers to effectuate this kind of a redevelopment plan. It could acquire the real estate from the developer and lease it back. By UDC merely owning title to the property, it became real estate tax exempt. UDC also had the power to reduce the costs of construction because it could also exempt the development from the payment of sales and use taxes otherwise applicable to the reconstruction project. The actual tax relief granted could also be fine-tuned and similarly the government could ultimately be recompensed for playing this role, in a manner that was not easily accomplished in a purely statutory “as of right” tax relief framework. Thus for example, UDC did negotiate arrangements whereby it retained title to the property (in these cases for the ultimate benefit of the City) at the end of the term of the lease, unless the developer/net lessee exercised a purchase option under the lease and paid the price required under the lease. This could be market value or a formulaic price designed, for the most part to pay back the City for the real estate tax benefits extended to incentivize proceeding with the particular project. This was unlike other statutory real estate tax a relief program, like J-51 and 421a, where there was no requirement that title to the land be given to the government. Indeed, even under IDA financing structures, where the government does take title to the land, this was merely structural, in order to provide the tax relief offered under these programs. In the case of IDA financings, the purchase option price at the end of the financing and tax exemption period is nominal.

Using the UDC vehicle, we were able to adapt the model used in the redevelopment of the Commodore Hotel into the Grand Hyatt, to structure a financeable ground lease arrangement acceptable to the parties, including the developer and its financiers. The lease incorporated what amounted to the J-51, as of right, program of real estate tax abatement and exemption, into the rental and PILOT arrangements, under the lease. The market trusted UDC honoring a contractual commitment under a ground lease arrangement (that mimicked the J-51 real estate tax relief program) and, in effect, guaranteed the results intended by the program. Nothing really changed substantively; it was all about perception. Developers and their financiers were not willing to proceed under the City’s as of right J-51 program, directly, at the time. It took the security of a contractual arrangement embodied in the ground lease with a UDC subsidiary, for these two major developments to move forward, at the time.

Consider that the City could change the rules, as it did in fact, with respect to the J-51 program. It also could challenge someone’s right to access an as of right real estate tax relief program, as it in fact did in the case of Trump, under the 421a program.[2]

Predictability and certainty of execution is what the capital markets demand as a threshold condition to access. The City’s record in recent times has been good but that is not always the case. There are legislative efforts afoot intending to delay the right to exit under Mitchell Lama. There have also been a number of cases brought challenging the right to exit.[3] Other cases have been brought seeking to challenge the right to charge free-market rents upon exiting the program.[4]

This concern of the capital markets is not wholly unjustified. By way of background, there have been cases that support the proposition that a statute is not a contract and it can be changed.[5] Assurances by governmental officials do not necessarily bind the government.[6] Given these considerations, it is no wonder that the market rightly demands a financeable structure, with enforceable written agreements, along the lines outlined below, that have stood the test of time.

[1] The conversion of the St. George Hotel in Brooklyn and Two Hanover Square in Lower Manhattan.

[2] Trump-Equitable Fifth Ave. Co. v. Gliedman, 57 N.Y.2d 588, 457 N.Y.S.2d 466, 443 N.E.2d 940 (1982).

[3] See Tivoli Stock LLC v. New York City Dept. of Housing Preservation and Development, 50 A.D.3d 572, 856 N.Y.S.2d 608 (1st Dep’t 2008) dealing with a 50 year covenant to maintain the property as “moderately priced modern well-equipped housing,” which was enforced by the court to permit HPD effectively to bar the owner from exiting Mitchell-Lama and de-regulating the rents for the full 50 year period. See also Mendel v. Henry Phipps Plaza West, Inc., 6 N.Y.3d 783, 811 N.Y.S.2d 294, 844 N.E.2d 748 (2006) dealing with a provision of the Land Disposition Agreement (LDA) pursuant to which the owner acquired the land located in an Urban Renewal Zone, for the purpose of constructing the project. The Urban Renewal Plan promulgated for the site, as amended, provided for the acquisition of the site (through condemnation for most of the land within the project area) and disposition to the developer/owner for redevelopment as housing for occupancy by families of low and moderate income and certain other permitted uses. In this case, DHCR permitted the owner to withdraw from Mitchell-Lama. How- ever, certain tenants complained that the LDA required the project to remain in the Mitchell-Lama program for the full 40 years of the covenant noted above. The Court of Appeals held that the tenants lacked standing to bring the action because they were not third party beneficiaries of the LDA. They were therefore not entitled to enforce the 40 year covenant thereunder. Similarly, see Columbus Park Corp. v. Department of Housing Preservation and Development of City of New York, 80 N.Y.2d 19, 586 N.Y.S.2d 554, 598 N.E.2d 702 (1992).

[4] See Roberts v. Tishman Speyer Properties, L.P., 13 N.Y.3d 270, 890 N.Y.S.2d 388, 918 N.E.2d 900 (2009) dealing with a property benefitting from J-51 tax relief. In that case, he Court of Appeals held that the J-51 law required apartments in the complex to be rent regulated during the benefit period. Therefore, there was no luxury-decontrol (i.e. conversion to free- market rental status) permitted, which would otherwise have been applicable to a rent stabilized complex not benefitting form J-51. Similar arguments were advanced by tenants in Denza v. Independence Plaza Associates, LLC, 95 A.D.3d 153, 941 N.Y.S.2d 130 (1st Dep’t 2012), leave to appeal denied, 19 N.Y.3d 816, 955 N.Y.S.2d 554, 979 N.E.2d 815 (2012). However, the Appellate Division-First Department in that case held that the J-51 benefits were terminated by the owner upon withdrawal from the Mitchell-Lama program. Hence, the provision of the J-51 Law, upon which the Roberts decision had been based, requiring continued rent regulation during the J-51 benefit period, was not applicable in this case. Interestingly, in the Roberts case, the Court of Appeals held that the fact that DHCR agreed with the owner’s interpretation and even rendered an opinion in writing was not binding. It ruled that DHCR’s opinion was wrong as a matter of law and the law was clear and unambiguous in providing that luxury-decontrol did not apply to properties benefiting from J-51. It was the Court that determined what the law meant and not DHCR.

[5] Laws, rules and regulations can change. For example, if the zoning applicable to an area is changed, the owner of a development parcel in the area has no legal recourse against the government, unless certain prescribed criteria are satisfied. Thus, planning a project, preparing and filing building plans, financing it and even obtaining a building permit are usually not enough. Generally, the owner must have put a so-called shovel in the ground and actually begun construction of the project under the old zoning, in order to have an enforceable vested right that would transcend the new zoning change and allow the owner to proceed with the project under the old zoning. See Ellington Const. Corp. v. Zoning Bd. of Appeals of Incorporated Village of New Hempstead, 77 N.Y.2d 114, 564 N.Y.S.2d 1001, 566 N.E.2d 128 (1990), which requires the issuance of a valid building permit, substantial expenditures in reliance thereon and the completion of substantial construction. Imagine purchasing a property for development, financing it and completing the lengthy environmental review, building plan preparation and approval process (which can take upwards of two years for an as of right project) and even obtaining issuance of a building permit, only to have the zoning change in a way that makes the project no longer feasible.

[6] See supra note 60 and the discussion of the Robert’s case. See also Parkview Associates v. City of New York, 71 N.Y.2d 274, 525 N.Y.S.2d 176, 519 N.E.2d 1372 (1988) dealing with a valid permit to construct a high-rise building that exceeded permitted zoning. It appears that a mistake was made by both the City and the builder in interpreting the zoning applicable to the substantially completed project. Nevertheless, the Court held the City’s order to demolish the excess stories constructed at the top of the building was valid.

The Proposed Self-Financed Rent Voucher Program

Under this proposal, the ground rent payable with respect to the project would go into a separate fund administered by the AHA. It would be made available to prospective working tenants with low incomes wishing to rent in the new community to be created (or elsewhere if they so choose). Thus, they would be enabled to rent middle income units at the new complex (or elsewhere) like any other tenants.

Consider if the average low-income household targeted for this program earned 40% of AMI. At 30% of that amount, the rent that could be affordably paid by the household would be approximately $500 per month. This leaves a deficiency of $1,500 per month ($18,000 per year), based on the model set forth above. If a total of 120 low-income households were accommodated within this first phase development complex, then that would mean a total subsidy of less than approximately $2.2 million per annum. However, given that there would be 750,000 square feet of free market space paying ground rent of $24 per developable foot, this would yield a total of $18 million per annum, available for rent vouchers. To put this in prospective, the fund generated from just one complex, developed based on model outlined above, could conceivably subsidize a total of 1,000 similarly situated working low-income households. In this regard it should be noted, that at the present time, the NYCHA land under discussion not only earns no ground rent income at all, it suffers from enormous deficiencies, financially, physically and otherwise.

Another possibility is to sell the land underlying the financeable ground lease much like the author suggested with regard to completed projects such as Battery Park City. In this case the valuation of this kind of transaction would include three components, as follows:

1. The ground rental stream that is unsubordinated and extremely valuable once the development is complete and paying rent. This is because, once the development is completed, financed and rented out, it is unlikely that there will be a default in the payment of ground rent. There is an enormous amount of equity in the form of the investment by the leasehold mortgagee and developer, as well as the market value of the completed project;
2. The ground rental increase after the expiration of the 20 year affordability period, as to the affordable component, on a unit by unit basis, as they become free market;
3. The ultimate residual value upon exercise of a purchase option, the occurrence of rent reset or upon the expiration of the lease term.

It is believed that the sale of the land, or so-called ground lease, underlying this one new development, based on this model, could yield more than $400 million, upon completion. This could be used as the principal of a fund, which if properly invested, could yield even more money to subsidize rents under the self-funding low-income rent voucher proposal outlined in this article.

Remember too that this would be the first of at least 30 such projects[1] possible, on NYCHA underutilized land just in Manhattan, based on the concept of building additional housing on existing sites, using only the unused development rights appurtenant to those sites. However, if, as suggested, the existing projects were redeveloped as well, then many more such complexes could be built on NYCHA land.

Total redevelopment of these NYCHA sites is the recommended method of proceeding. This is because under this proposal, genuine integrated, mixed income and mixed use communities could be built, incorporating the valuable lessons learned from Battery Park City. This model can further be updated, based on experiences derived from the redevelopment of the Meat Market district, to create a lively streetscape presence and ambiance, with a variety of retail uses, on the ground floor. Let’s allow city planners, architects, engineers and other experts to create a master plan, based on all the accumulated experience over more than 50 years, since the Mitchell-Lama program was first initiated. As noted above, HUD has established a program designed for this very purpose. We have the financial tools needed to accomplish this kind of a plan, using the proven model outlined above.

[1] If only seek to utilize the 30 million plus of utilized development rights noted above or more if totally redevelop the sites from scratch.