Yves here. This story is a variant on the case of Stuyvesant Town, where developers bought a large New York City apartment complex at insanely high prices, based on unrealistic assumptions about their ability to get rent stabilized* tenants to give up their apartments. They then tried illegal means, like harassing tenants, to get them to leave. That proved not to work so well either, so the investors declared bankruptcy. Moreover, any developer who needs to buy a series of separate in order to launch his project should be well aware of hold-out risk; there are plenty of examples in NYC of small building owners demanding and getting top dollar when they were the last to sell to a developer assembling a parcel. Here, the consequence of failing to understand clearly-written, well established rent regulations was merely costly, as opposed to fatal.
To put the matter more simply: wealthy investors love to talk about the sanctity of contracts until little guys assert their rights. Then the idea that they might have to fork over a lot of dough to get the other side to give up its right is presented as an offense against nature.
By Rumplestatskin, a professional economist with a background in property development, environmental economics research and economic regulation. Follow him on Twitter @rumplestatskin. Cross posted from MacroBusiness
At the risk of perpetuating the brilliant viral marketing campaign for Michael Gross’ new book, which is in fact the source of the story, I want to make a brief comment about it to counter some of the bizarre, emotional, and inconsistent reactions I have seen.
A short version of the story is that billionaire developers Arthur and William Zeckendorf paid $401million for the Mayflower Hotel adjacent Central Park, planning to turn the site into 202 super-luxury apartments.
The building was occupied by many long-term tenants under New York’s rent-control laws. This meant that tenants could only be evicted upon mutual agreement, which in turn led to the new owners offering attractive lump sum payments to tenants for them to leave the building. While most tenants accepted offers ranging from $650,000 to $1million, the final tenant held out for an astonishing $17million lump sum payment, in addition to the developers offering him another apartment to live in for the rest of his life for a peppercorn rent of $1 per month.
To me the most astounding part of the story has been the reaction by the press and social media, which has been of outrage over the injustices of rent control – that for some reason poor old Sukendik didn’t deserve the money.
There have also been cries of rent-control hindering development – that somehow rent-control is ‘inefficient’.
This absolutely wrong. Wrong, wrong wrong.
First, almost everyone has ignored the key fact that a developer buying the building knowing that rent-controlled tenants are occupying it should have expected these expenses and subtracted them from the purchase price. Thus, the tenants win at the expense of the previous building owner. The developer does not lose unless some unexpected legal loophole was exploited (which doesn’t appear to be the case) – it is merely that the economic rent was shared between the previous owner and the previous tenant.
It is therefore not any less efficient than in the absence of rent control. No one sees the previous building owner holding out for $401million as inefficient, yet it is exactly the same dynamic at play.
The second point routinely ignored is that rent-control describes a general set of rules about renting. That the NY set of rules allows this to happen doesn’t mean that another set of rent-control rules could be implemented that had mechanisms for relocation and prescribed methods for calculating compensation payments to tenants. After all, in the freehold world there are generally accepted methods for compensation for land owners upon compulsory acquisition by a government authority.
Third, if Sukenik owned his apartment in freehold he would have had the same power to hold out and extract this price from the developer. This happens routinely in Australia and elsewhere when strata-titles buildings are redeveloped. The last hold out seller extracts a massive payout. Yet we see nothing at all wrong with that because they have ‘the right’ to do it. Yet under a different set of laws, tenants could also have such rights, which they did in this case.
What really surprises me is that almost everyone who has written a reaction to the incident seems to fall on the side of the developer. If the developer had kicked out the tenant for $10,000 it wouldn’t be news, but it would have been equivalent to ‘Developer screws tenant of their rightful $17 million compensation’.
*For the uninitiated, rent stabilization means rent increases are set by the Rent Guidelines Board after input via tenant and landlord groups. The increases are meant to reflect increases in landlord’s costs and so roughly track inflation. And a critical bit if is you are current on your lease payments, the landlord has to offer the tenant a lease renewal, subject to some very limited exceptions.