Today is the day when the partnership led by Tishman Speyer and Black Rock turns the keys to Stuyvesant Town over to the people who lent them billions.

It's tempting to point fingers and laugh, because as I discussed in this month's magazine, this was a breathtakingly stupid deal.  As the commercial real estate bubble expanded, you saw a version of what had happened during the stock market bubble:  multiple inflation.  (Arguably, this is also kind of what happened in residential real estate). Much of the price increase in commercial real estate between 2000 and 2007 was due to rising rents.  But about half was just that buyers, suddenly and for no apparent reason, became willing to pay more for a given stream of projected rents.  Where previously, buyers might have wanted a price-to-rent ratio of ten or eleven to one, by the height of the bubble, they were willing to pay 14 or 15 times rents.

Collective insanity?  Or were they simply betting on asset price inflation--that some "greater fool" would be willing to buy their property from them at a higher price?  Hard to say.  But the net effect was a pretty impressive inflation in the commercial real estate market.  As in residential real estate, lenders participated too, loaning a higher percentage of the building's value, and demanding less amortization over the life of the loan.

Of course, in many cases, buyers convinced themselves that there was some reason that rents would go up even more dramatically in the future. Tishman Speyer, for example, believed that it could take many apartments out of New York's rent stabilization regime, bring them up to market rates, and make a small fortune.

But this involved some highly questionable assumptions.  First, you had to believe that it would be easy to decontrol apartments, which it almost never is, in New York, especially over the last few years.  Second, because there were a number of bidders on the property, Tishman and Black Rock paid top dollar for those projected cash flows, so there wasn't a lot of margin for error if things went wrong.  And they didn't just project that they'd be able to decontrol the apartments for a modest rent boost; they assumed a continuation of New York's sizzling real estate boom.

Oops on all three counts.  The buildings didn't upscale particularly well--the renovations have plastered the lobbies with marble, but the bones of the cheap-n-cheerful middle-income housing project are still visible beneath the facade, so the effect is faintly ridiculous rather than luxurious.  Decontrol was slower than expected.  The wide disparity between rents in the same building was known, and resented, which didn't improve matters.  And the feisty tenants association had a lawsuit challenging the decontrol process which had started under Met Life, on the grounds that Stuy-Town had taken the city's J-51 tax credit for rehabilitating rent controlled and stabilized buildings, which the tenants argued meant that they had to keep the apartments, well, rent controlled or stabilized.

As many of you now know, the tenants won last fall, meaning that thousands of apartments revered to their prior low rents.  That was the death blow.  But it merely hastened the end for a project that had previously been bleeding to death slowly.


The lawsuit was not exactly unforeseeable--New York has a special housing court to adjudicate its especially convoluted, irrational, and tenant-friendly housing law.  That court is where landlord dreams go to die.  But still, there are two good reasons not to give into the temptation to point and laugh. 

For one thing, Tishman Speyer is hardly the only firm to make such disastrous bets.  As a result, a lot of people think that over the next couple of years, we're going to see a big wave of defaults akin to the one still sweeping residential markets.  What the Stuy-town owners did was not a foreclosure--it was what would be known in residential real estate as a "deed in lieu of foreclosure" deal.  But while these avoid the ugly battles in bankruptcy court, they're otherwise much the same. 

To state the obvious, lenders have expertise in lending, not operating commercial real estate.  That means they usually want to sell--but so will a lot of other lenders, glutting the markets with commercial real estate.  Moreover, if they succeed in selling, that will give bank examiners a new, lower reference price for the collateral on loans held by other banks, which will cause further trouble.

The impairment of lender balance sheets is the other, bigger reason to worry.  The list of investors in the Stuy-Town partnership who will now see their investments wiped out includes grasping capitalist fools like CALPERS and the Church of England.  In the broader commercial real estate market, it's mostly banks one or more notches below "too big to fail territory".  The FDIC has the technical expertise to resolve them--but Sheila Bair has already had to force banks to "prepay" their FDIC contributions for three years in order to shore up the corporation's finances.  If the problems in commercial real estate deepen, the taxpayer will probably be the next place she turns for help.


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