By Stuart Saft, Partner & Real Estate Practice Group Leader, Holland & Knight LLP
There are presently two pieces of proposed legislation in Albany (S7825 introduced by Senator Liz Krueger and A5031A, introduced by Assembly Member Linda Rosenthal) (the “Bills”) that alters the terms of ground leases of land on which cooperative buildings were subsequently formed by sponsors. If either of these Bills are enacted, it would destabilize the real estate industry including properties that are neither co-ops nor ground leased; would only benefit the shareholders in perhaps fifty buildings in New York City who knew what they were purchasing,; and would result in an erosion of property rights.
The beneficiaries of the Bills are shareholders of co-ops who purchase in buildings built on ground leased land, and were warned in the offering plans that the reason the prices they paid were significantly below market was due to the limited term of a ground lease or the fact that the ground rent could increase significantly on renewal. A ground lease is not a New York invention, but rather a structure that has been used in the United States since we were colonies and came from England where it has been used for more than five centuries. The purpose of a ground lease is to enable the owner of the land and their descendants to retain their land, but permit the land to be developed by a tenant. Many ground leases are 99 years long. In fact, they were not just used by wealthy landowners, but even institutions, including Columbia University, which was once located at Rockefeller Center until the area began to gentrify, and Columbia moved to Morningside Heights and ground leased the land to a developer, which enabled Rockefeller Center to be built. About 30 years ago, when its expenses got too high, Columbia sold the land for several billion dollars, which went into its endowment.
The pending Bills would require the landlords of co-ops built on ground leased land to provide renewal terms regardless of the provisions of the ground lease, at a rent increase of 3%, less any real estate taxes the co-op is required to pay, maintenance and repair costs to the property, and other expenses determined by the co-op, which could mean that the land owner might not receive any rent increase. If the increase is not high enough to cover the expenses, the excess expenses would be carried forward to be applied toward future rent increases. Moreover, the co-op would have a right to place a mortgage on the property and the co-op would have a right of first refusal if the land owner ever wanted to sell the property. The right of first refusal would make the property unsaleable and the cap on rent increases would reduce the value of the property as a result of inflation.
You might be thinking that it serves the landlord right for forming a ground leased co-op, but you would be wrong because I have not found a single instance where the original land owner formed the co-op. The original land owner entered into a commercial transaction with an investor, who became the tenant and built a building or converted the building and either sold the property to the sponsor or became the sponsor. There is not a single instance where the land owner was also the sponsor.
Other than the unconstitutionality of the legislation and its unfairness by changing the terms of a contract, there also remains the fact that the Legislation ignored the fact that New York Division of Housing and Community Renewal (DHCR) has had Regulations dealing with deconverted co-ops for over thirty years.
The Bills also ignore the genesis of DHCR’s Regulations and the impact the Bills might have on the economy. I can report on how this came about because I was actively involved in stopping an attempt by Freddie Mac to deconvert co-ops and turn them into free market rentals. In the early 1990s I worked closely with the New York City and New York State officials to stop the collapse of moderate income co-ops caused by sponsors who defaulted on paying maintenance on their unsold shares. In fact, on June 30, 1993, Andy Kellman and I were sent to Virginia to meet with Freddie Mac by Clare Shulman, the Queens Borough President, to stop Freddie Mac from foreclosing on mortgages it had on New York City co-ops and further destabilize the market. Shulman even held congressional hearings in Queens Borough Hall to stop the banks from foreclosing, including a hearing chaired by then Congressman Chuck Schumer.
Having failed to stop Freddie Mac from foreclosing and attempting to rent the apartments to obtain fair market rent rather than regulated rent, National Cooperative Bank’s (“NCB”) President Charles Snyder and I worked with DHCR to produce the deconversion regulations. Freddie Mac then sued DHCR in the Eastern District Court of New York taking the position that DHCR did not have jurisdiction over Freddie Mac because it was quasi federal agency. I submitted Amicus Briefs in the Eastern District, the Second Circuit, and the New York Court of Appeals supporting the authority of DHCR to set the deconversion rents. The New York Court of Appeals confirmed DHCR’s authority to issue the deconversion regulations, the Second Circuit affirmed the District Court’s ruling and the United States Supreme Court did not grant certiorari to Freddie Mac, so there was no longer an incentive for the banks to foreclose defaulting co-op’s mortgages.
Chuck Snyder and I decided upon this approach because we were concerned about saving the co-op movement in New York. If the DHCR did not have the authority, then Freddie Mac and every other lender would be able to foreclose on co-ops and, considering all the co-ops with financial troubles at the time because of sponsor defaults, it would have been the end of co-ops in New York. Conversely, if DHCR ruled that the rent would go back to the co-op’s pre-conversion rent, then all the co-ops that were in trouble could have purposely defaulted and no bank would be able to make another mortgage on a co-ops because the banks needed appraisals to be able to make the loans. We needed to have flexibility built into the system to keep either side from killing co-ops. It worked because DHCR agreed with what we did and for thirty years there have been virtually no deconversions.
As a result of our working together to solve the problem, Chuck invited me onto the NCB Board where I served for 12 years making certain that New York’s co-ops had access to financing. I ultimately served two terms as Board Chair and reciprocated when I was able to keep the federal government from closing the bank during the Great Recession.
The reason the above is so important today, is because the Legislature is about to fall into a trap of its own making. If either of these Bills is enacted, the unintended consequence is that lenders may stop making loans in New York for fear that the Legislature will decide that lenders should not be able to foreclose mortgages and decide that a signed contract or mortgage is meaningless, and take away the ability of the bank to obtain its collateral. Although I knew it before, from my years as a banker, my experience at NCB reinforced my understanding of the critically important role banks play in co-ops, and these Bills will force the banks out of the New York market. This is not about the shareholders in perhaps 50 buildings, but the ability of the banking system to function, not just for co-op loans.
Think about the fact that there has been no bigger supporter of co-ops in New York than I; having been chair of the largest co-op self-help organization for 36 years, giving dozens of lectures and writing dozens of articles. These Bills may be a nice gift to a couple of dozen co-ops filled with owners who were told that this was a bad investment but proceeded anyway because the price for the apartments was low. If the Bills are enacted, these shareholders will get a huge windfall at the expense of the rest of the housing industry.
Finally, why have there not been endless stories about co-op ground leases being terminated and the apartments deconverted into rentals? Basically because there have not been any deconversions primarily because the owners of the land do not want to be landlords of rent stabilized buildings. In every situation in which a ground lease was coming to an end, as a lawyer I was able to either negotiate for the co-op to buy the land or to extend the lease at an accepted ground rent. The experience of other lawyers was the same. The system has worked for decades without the involvement of the Legislature. There is no reason for them to get involved now.
