What is “Predatory Equity”?

“From a tenant’s point of view, one major problem with ‘predatory equity’ is that if a real estate investor pays too much for a property – realizing post-purchase that the building’s rents will never be enough to pay back the mortgage debt assumed – the investor will start to cut costs by reducing maintenance of the property.” -City Limits Magazine

Image courtesy of Tenants and Neighbors

Where to begin to further explain this phenomena? Tenants and Neighbors, a grassroots tenants’ rights organization providing services to New York State, has an excellent explanation of predatory equity and, in fact, uses the issue of Urban American and 3333 Broadway as a case study.

How it works, in the words of Tenants and Neighbors:

  1. “Entrepreneur identifies a building as an “underperforming or “underutilized” asset. This means that the income that the building produces is significantly lower than it could be – because people with low and moderate incomes are living there instead of people with higher incomes, who could pay higher rent.
  2. Entrepreneur obtains “equity capital” by promising other investors a high rate of return – generally 20 percent a year. Investor then obtains “leverage” by borrowing more money – six to ten times more – from banks or other lenders.
  3. Entrepreneur buys the building and begins working to increase its income. Often the entrepreneur and the equity investors are willing to see income go down – or even to lose money – for a few years before it actually goes up.
  4. *In the case of a Mitchell-Lama buyout, this enables them to immediately suffer the loss of subsidies, along with huge interest payments on the borrowed money, while waiting for rental income to increase over a period of years as the original tenants move out and new tenants move in and begin paying higher rents.
  5. If the entrepreneur is a private equity group, it will sell the building to a new investor after three to five years – as soon it can show that the property’s income is going up enough to justify a significantly increased price. Other entrepreneurs may prefer to sell or to continue to own and operate the building. Either way, many or most of the original tenants must be replaced with higher-income people by this point, or the investment will be judged a failure.”

In brief, investors buying up buildings in run-down neighborhoods are banking on the next wave of gentrification to come through so that they can charge higher rents. However, in order to charge higher rents, they’ll need apartments to rent out — therefore, by decreasing maintenance services and harassing tenants, they can influence previous tenants to vacate.
Predatory equity investments are a serious cause concern for tenants and affordable housing advocates for two reasons:

  1. These investors must significantly increase the profitability of the assets they buy in order to reach their expected rates of return (or even just to avoid losses). When the asset is low- and middle-income housing, this can only be accomplished by raising rents significantly, so that the tenants in place are replaced by a new group of higher-income tenants.
  2. The speculative prices paid by these investors, and the high degree of leverage in their deals create the risk that income from the property will not be enough to support debt service, which can lead to inadequate maintenance, deteriorating conditions, and possibly foreclosure.

In short, speculative investments place both tenants and the buildings themselves at risk.”

Quotes on Urban American Management’s practices from various sources, which are also cited under “Urban American in the News” and “More Urban American In the News”:

Urban American is the poster child for predatory investing. This was one of the most insane deals of the real estate boom, and there’s no way they can pay their debt with the rent rolls from these buildings.” -Dina Levy, head of organizing at the Urban Homesteading Assistance Board.

“These days, Saunders and 4,000 other tenants at Schomburg and several other former Manhattan Mitchell-Lama developments are battling to keep their homes affordable. They are victims, they claim, of a “predatory investor,” one of many that swept through the city during the housing bubble.

Such investors gobbled up hundreds of rent-stabilized buildings with big money from Wall Street, then tried to force out old tenants and drive up rents.
Then the housing market crashed many owners can’t meet their heavy debt load.

Tenants say their landlord, New Jersey-based Urban American Management, is so deep in debt it’s trying to suck them dry.” –The New York Daily News

“‘They’re doing different things to get people out,’ said Mr. James Russell Outlaw, [a tenant of 3333 Broadway] who has not fully recovered from bypass surgery after a heart attack three years ago. ‘Scare tactics, I call them. People are scared to complain.'” –The New York Times

“The concern [of tenants under corporate landlords] is that the only way to squeeze the high returns demanded by private equity firms from rent-regulated units is to force existing tenants out and rent the units at market rates.” –The New York Daily News

‘With the rents they’re taking in, there’s no way Urban American can pay that almost $1 billion mortgage and continue to maintain the buildings,’, said Jackie Peters, secretary of the Metro North Riverview Tenant Coalition” –Crain’s New York

In the interviews linked, amongst others, Urban American’s representatives have asserted that their company remains viable, and that they’ve been pouring millions of dollars of investment money into restoring their buildings and turning them into better homes. The sources given, and the number of current open violations, say otherwise.

One Response to “What is “Predatory Equity”?”

Trackbacks/Pingbacks

  1. These are real – and illegal – problems. « Slumlord Millionaires - July 27, 2011

    […] What is “Predatory Equity”? […]

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