What SCOTUS’s case means for NY multifamily investors
U.S. Supreme Court decisions & Signature Bank Loans
The story
Industry groups Community Housing Improvement Program (CHIP) and the Rent Stabilization Association (RSA) mounted a legal challenge to rent stabilization, and on Monday (10/2/2023), they were denied by the Supreme Court of the United States (SCOTUS). Today, I will provide historical context for this news, and explain how this outcome is connected to other important developments in NYC real estate.
SCOTUS announced that it would not hear or review the CHIP/RSA challenge to New York’s Rent Stabilization Law (RSL). The argument driving CHIP and RSA’s combined legal challenge was that rent stabilization was in breach of the 5th amendment and constituted an unlawful taking of property. The attorneys representing the landlords also highlighted some of the problems that landlords who have rent stabilized properties experience and tied that into the housing crunch in NYC. The court did not weigh in on the merits of the legal suit. It declined to investigate it. This decision is significant because it is estimated that there are between 900,000 and 1,000,000 rent regulated apartments in NYC. If the median household size in NYC is between 2-3 individuals, that means this decision affects 2-3 million NY residents. Introduce housing scarcity and high rental costs and that makes SCOTUS’s decision that much more meaningful.
The context
Prior to this decision, CHIP/RSA attorneys had tried to voice their legal challenge in the second circuit court. Below are some excerpts from one of my prior newsletters that cover that challenge and its ultimate defeat back in February of 2023:
Judge Barrington Parker said the taking claim didn’t hold up. His reasoning took a very tenant-friendly view. His exact words were:
“It is well settled that limitations on the termination of a tenancy do not effect a taking so long as there is a possible route to an eviction,” page 21 of Judge Parker’s opinion.
In other words, if there is still a path, no matter how muddy, long, or arduous– if there exists a way to remove tenants and regain possession of a property, the landlord is still in control, and nothing has been taken from him or her. Restricting when eviction can be used by the owner does not serve to erode an owner’s right to exclude, according to Parker. Parker cited Supreme Court precedent law that corroborated his view.
“This Court has consistently affirmed that States have broad power to regulate housing conditions in general and the landlord-tenant relationship in particular without paying compensation for all economic injuries that such regulation entails,” page 22 of the opinion.
In other words, Parker is saying that the landlord needs to roll with the punches and accept legislation when it is passed. The judge also took it upon himself to remind stakeholders of the court’s role in settling disputes:
“The case law is exceptionally clear that legislatures enjoy broad authority to regulate land-use, without running afoul of the Fifth Amendment’s bar on physical takings,” page 24 of the opinion.
Back when I wrote about CHIP’s legal defeat in February, landlords appeared hopeful and optimistic. That has not changed. Alongside this challenge to the RSL, there are two other suits that take issue with the law. According to legal experts, the CHIP/RSA challenge is broad. It tried to say that the entire concept of rent stabilization was unconstitutional (something about a facial challenge). The case received much attention because of this. Columnists opined that, were the challenge to pass, maybe rent control would be abolished or significantly altered – maybe even at a federal level. One could conceive that this may have also endangered the legal footing of Good Cause Eviction.
The two other suits argue that some aspect of the way the law is applied is unconstitutional. This is a much narrower scope, and to reference Judge Parker from the second circuit, it would not challenge the State’s authority to regulate housing. Rather, it would ask for a slight modification specifically in the way NY authorities apply the law. This is harder to understand and less interesting, so less covered by news outlets. SCOTUS has not yet responded to these cases, which leaves the door open for them to hear these cases. These cases are 74 Pinehurst LLC v. New York and 335-7 LLC v. City of New York, NY.
The implication
Let’s zoom out. Besides waiting on SCOTUS’s decision on these two other rent stabilization challenges, we want to see if Hochul will sign the two multifamily bills that lie at her desk, and we are watching to see at what price the Signature Bank loans trade hands. These three outcomes are interrelated, and owners of multifamily should be paying attention.
Let’s consider what would have happened if the Supreme Court had agreed to review CHIP’s rent stabilization challenge. This would have put tenant advocates in a bind because of the current court’s conservative majority and what that means for property rights. It also would have increased the paper value of the rent stabilized loans in Signature Bank’s book. Having a non-zero chance that rent stabilization across those ~1 million apartments would be reversed or tweaked in some way is a big deal. Newmark brokers Adam Spies and Doug Harmon in charge of the loan sales would be pitching the value add that SCOTUS offers to potential suitors, and some speculative buyers would perhaps price in some upside at the prospect of having looser rent controls. Signature Bank loans would go up in value if SCOTUS had agreed to take this case.
Recall that the Signature Bank sale will act as a litmus test for the value of rent stabilized buildings in NYC and all the loans that are underwritten on top of them. Whatever the strike price of the loan portfolio sale is in relation to the original loan value will dictate how much local and national banks alike write down their loan portfolio values. Signature’s multifamily portfolio was initially valued at ~$15.6Bn, according to Maverick Real Estate Partners. Let’s say that a buyer was willing to take ownership of the loans for a discount of roughly a third of the original value. This is realistic because some rent stabilized buildings today trade at 30% discounts compared to pre-2019 valuations. That means a buyer purchases the portfolio for two thirds of the original value at a price of $10.4Bn. Since Signature Bank was at one time the most active lender by volume of multifamily loans, according to Maverick Real Estate Partners, let’s say it accounted for a quarter of total multifamily loan volume in NYC (this is directionally correct). That means the remaining three quarters of loans used to finance NYC multifamily also need to get discounted. In other words, that’s an estimated $45Bn in loan value that also needs a 33% discount. This would lower the value of those non-Signature Bank loans down to $30Bn. 2019’s HSTPA and the ensuing bank collapses could together yield loan write downs of ~$20Bn ($5Bn on Signature Loans + $15Bn on all other MF loans).
But wait, what if the Supreme Court had agreed to take on the rent stabilization case. The $20Bn loss in loan value spread across banks can maybe be mitigated if the Signature sale goes better than expected. There may be some loan purchasers who are willing to take chances and pay more. Maybe the Signature portfolio gets bought at $12Bn instead of the initial $10.4Bn. That’s a slimmer discount to par (closer to 20%). If that reduction in discount is applied to all NYC bank loans, then that’s approximately $6.5Bn of value added back to the total multifamily loan pool. This is hypothetical because SCOTUS shot down the initial case, but the two other cases were scheduled for conference on Friday (10/6/2023). Whether SCOTUS agrees to review the remaining cases could add billions of dollars to the value of Signature Bank’s loan portfolio.
Sources: NYT, City Limits, The Real Deal, Romain’s Newsletter