Now Playing: Zombie Condos in Manhattan

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 |  Includes: AIG, AIG.PA, FMCC, FNMA, ICF, IYR, PNC, WFC, WFC.J
by: Jeffrey Bernstein


A buddy of mine from an old New York City real estate family recently returned from a trip to Florida. He's been quite bearish on all things real estate having sold much of his family's multi-family portfolio in New York City over the last few years. He has kept busy since, helping others do financing across the country and has had a ringside seat to the unfolding debacle.

He has been ahead of me most of the way through this in predicting massive commercial real estate losses and an eventual mass expunging of debt through the foreclosure and REO process. He called me today and said "have you heard about the Miami Falcons?" Now I'm a football fan, but not a fantasy aficionado. Surely I hadn't missed news about the Atlanta franchise relocating. "No" he said, it had nothing to do with football. "The Falcons are the only tenants in the penthouses of all the new empty luxury towers in north Miami Beach. They hang out on the roofs looking out at the nature preserve for rats to swoop down on."

NY Falcons

Well I've been doing my own Falcon routine here in New York, working on a catalog of zombie condos that could potentially make good rental buildings if purchased from the bank financiers at the right prices. The theory being that any condo project that has not sold out and closed on a substantial number of their units as of today is in grave danger of becoming a zombie. A zombie being a condo, where some of the units have actually closed, but the condo developer is likely to default on their construction loan: The bank is likely to come in and take over the building and rent up the unsold units, finally selling the building to an investor, who would run it as a rental until such time as value could be maximized by selling the rest of the units.

The problem with partially sold condo projects today is threefold: First, many folks who have not closed on new condo purchases are trying to get out of contracts; second, many units won't appraise at the contracted value (and therefore will not be eligible for mortgage financing or will have to be re-negotiated by the sponsor) and lastly, with Fannie Mae (FNM) and Freddie Mac (FRE) no longer allowing conventional mortgages in condominium buildings in which less than 70% of the units have been sold, most lenders for jumbo loans have taken the same tack, essentially killing any projects in this position.

I'm not finished with the project, but enough of the results are in to report back a couple of findings. To cut to the chase for those of you who don't want to geek out on the varied aspects of the data; there are not that many zombie condos lurking in Manhattan's future from the analysis I have done so far. However, those that do exist had high expectations for sell-out prices and significant amounts of leverage employed, such that however their situations are resolved....it's gonna leave a mark on someone's balance sheet.

Methodology

With that, first some background on my methodology. I went back and got all the condo filings for Manhattan for the period June 2007 to June 2008. My thinking being that in order to market a condo you had to make your condo filing, and only a developer who had gotten their construction loan and was somewhat into the process, would spend the money and go through the trouble of filing a condo plan.

At the outset of my work I spoke with an attorney from one of the biggest New York law firms about the condo filing process. She judiciously requested to go nameless, which I am sure her very large and active clients will appreciate her for. I was told that while a sponsor must file their condominium offering plan in order to begin signing contracts, this does not in any way suggest that ground has or will ever be broken. On the other hand, a significant amount of construction may have taken place before a filing is made. Once 15% of the units have been sold, the plan can be declared effective, but it doesn't have to be until 80% of the units are sold.

Early Results

So here are the early results: There were 182 residential condo filings made in Manhattan between June of 2007 and June of 2008 and recorded in the city's database system. These filings do not guarantee that the project was a new ground-up development as many were conversions from rental to condo, and many of the filings were not initial filings (the city's database is something of a blunt instrument and you can't really screen for initial filings). So while 182 sounds like a big number, not all of these were "brand new" projects. Additionally, the median number of units in these buildings was 16, and the average was 55. Notably, a few very large projects drag the average number up significantly.

Of the filings that were made over the period, price expectations were only included in 141 of them. This is likely because a good number of the filings were not the initial filings, but were supplemental filings. In some cases when prices were changed the expectations were included, in other cases where the filing was for other reasons, they were not. In any event, the mean price per square foot expected was $1,134, with the median at $1,200, suggesting some very low-priced projects were skewing the average down. Understand that these filings were from all over Manhattan from Harlem to downtown. It is still interesting to note that the $1,000 per square foot threshold is increasingly being breached to the downside even in more desirable neighborhoods in Manhattan, according to recent reports.

Targeting bank REOs

Now for my purposes - targeting potential bank REO - the acquirers will be looking to value these projects as rentals. There are two issues here. I previously discussed the dire consequences for valuations that this perspective implies in my piece Zombie Condos: Day of the Charge-Off . Suffice it to say, that values of rental properties are way lower than condo project values and generally way lower than construction costs (that's why very few people can afford to build rental buildings in New York City). Secondarily, an acquirer is really going to look for a project with enough scale to make managing the asset economical. So only buildings with 40 or more units are really worth looking at. (Give or take..... Don't anybody get mad-- of course smaller guys who are willing to roll up their sleeves and manage the properties personally can go much lower).

There were only 48 developments with this kind of scale. Of the 48 developments of scale, I narrowed the field further (actually Noah did the work for me here) by eliminating those where the New York City MLS system showed that more than 70% of the units had been closed. I also eliminated projects by the city's very largest developers, who I expect will not be forced to cough up their projects regardless of how underwater they currently appear. To be sure, some may choose to "give back the keys" anyway, but I'm not assuming that.

This process left 26 potential target properties. I was able to use the city's database to find out what the outstanding debt was on these properties. This requires a somewhat torturous odyssey through various mortgage filings. In my short experience looking through mortgage spreaders, blanket loans etc, etc., I believe that my data reflects the minimum debt on these properties and that in many cases the total debt may in fact be greater than what can be easily identified. Interestingly, the debt per square foot of residential space averaged $515, with a median level of $441, reflecting a few highly levered projects, dragging the overall average up.

Now I know of a few projects that are in progress, and are so far along that the structures will be finished, that did not fall into my screen of condo filings between June 2007 and June 2008. I am therefore going to bring my study of condo filings up to current day over the next few weeks. I will report if I find anything radically different. I am also going to study the zombies of Brooklyn, which I'll bet promises a lot more gore.

Conclusion:

From the work I have done so far, it appears that the financial institutions with the most exposure to New York’s Zombie condos, are 1) Bayerische Landesbank (~$530 million) 2) Wells Fargo (NYSE:WFC) (~$240 million), 3) PNC Financial Service (NYSE:PNC) (~$140MM), 4) AIG (NYSE:AIG) (~$100 million).

Disclosure: The author has no positions long or short in any of the financial institutions mentioned above, but owns mutual funds that may.