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This guest commentary was written by Christopher Whalen. It was originally posted on The Institutional Risk AnalystThis piece does not necessarily reflect the opinion of Hedgeye.

Is New York City Coming Back? - 11 11 2021 7 35 40 AM

This past weekend, The Institutional Risk Analyst enjoyed a tour of Lyndhurst Mansion in Tarrytown, NY, the gateway to the Hudson Valley.

Lyndhurst is best known as the home of the notorious financier and railroad magnet Jay Gould, but in fact he was the third owner of the Gothic castle. Constructed between 1838 and 1842, the original house was built upon farmland as a haven from the filth and contagion of New York City.

In the 1800s, the enemy of urban residents was cholera, yellow fever and small pox, vile sources of pestilence that pushed the death rate to almost 5% in some years or roughly twice the death rate of the Spanish flu in 1918-1922.

When the NYC Board of Health was established in 1866, disease was still killing 3% of the population annually. The death rate in New York at the end of the Civil War was twice that of London or even Philadelphia.

Is New York City Coming Back? - FIGURE 2 Pestilence History

Source: Columbia University

The death rates seen in New York City the mid-1800s are far higher than the worst of COVID, which the New York Times estimates to be below 35,000 people out of 8.4 million NYC residents in 2019.

An estimated 500,000 people have left the city since the start of 2020, a vast increase in the net outflow that existed pre-COVID and continues today. COVID only made the problems facing New York City accelerate.

The difference between the 1800s and today, of course, is that the leaders of New York City in the years prior to the Civil War never even considered a lockdown or the other measures taken in 2020 to fight epidemics. Indeed, such was the commercial focus of New York that the fact of limited space and frequent epidemics did not cause any reaction from the political class other than charity.

It was not until the early 1900s that the deplorable health conditions in American cities, combined with high levels of price inflation, began to become a progressive political issue. In fact, it wasn't until the 26th President of the United States, Republican Theodore Roosevelt, that social insurance, including health insurance, was even considered.

Today New York City has contended not only with COVID but with an outbreak of political antagonism toward the business and financial elites that has accelerated the migration of business and investment out of cities like New York, Chicago and San Francisco.

In the 1800s, these legacy cities could depend upon a growing and vibrant business community to buffer the economic shocks caused by epidemics, recessions and wars. In 2022, however, the same technology that allowed businesses to operate remotely during 2020 has now enabled them to leave the legacy cities forever.

Last November, before the Democrats took control of the Senate, we asked whether NYC faced financial default (“Will Senate Republicans Force New York into Default?”). Billions of dollars in subsidies later, NYC is still functioning, but without a commercial heart. Yes, some brave souls have ventured back to Manhattan in search of deals on the most expensive residential real estate in America, yet the commercial heart of the Big Apple has been cut out by progressive lunacy in the streets and in City Hall. Business, whether large employers or landlords, are now the stated enemy of most New York politicians.

Back in 2019, we spoke to Dale Hemmerdinger, the former Chairman of the Metropolitan Transportation Authority and the head of a large commercial real estate manager and developer (“The Interview: Hemmerdinger on the End of Hope for NY Multifamily Housing”).

Since that interview, the fortunes of residential housing in the New York suburbs have improved, but the dire situation facing multifamily housing in NYC has deteriorated further. Hemmerdinger told The IRA two years ago:

“Our new projects are in markets like Charlotte, NC, and Austin, TX. We have more coming down the pike. In these markets, we are welcomed for bringing capital and financial know-how to growing communities. We are considered friends and often partner with local developers. In New York, by comparison, we are the enemy. The Democrats in Albany couldn’t go after the big private equity funds, so instead they attacked the local developers and small business owners, the very people who invest in New York and make it livable. These are very self-destructive policies.”

Under socialist Mayor Bill DeBlasio, hostility toward the business community in New York only intensified as the cost of living in NYC has reached absurd levels. Even with the decrease in residential and commercial rental costs due to COVID, New Yorkers spend far more for food, housing and other necessities than residents in the more affluent suburbs.

New York is a very expensive city, with layers of taxes, regulation, graft and corruption that add to living cost. This cost differential begs the question as to whether you can ever make NYC affordable for people of average income without massive subsidies.

Even before COVID, NYC was coping with the increasingly irrational behavior of New York politicians, who are admittedly mostly liberal Democrats of varying flavors. Voter registrations in NYC run 7:1 blue vs. red, so expecting rational behavior when it comes to public spending is a dream that has been dead since the departure of former Mayor Michael Bloomberg. A Wall Street mogul, Bloomberg was gracious enough to pretend to be a Republican during his successful tenure as mayor.

Under the disastrous Democrat Bill DeBlasio, NYC has spent every dollar of revenue coming in the door and then some.

The city spends about $100 billion annually, leaving an accumulated deficit of almost $200 billion funded with debt, and net liabilities for other post-employment benefits of $117 billion.

As of the end of the fiscal year at June 30, 2021, NYC had revenues of $99 billion, including $32 billion in real estate taxes, $28 billion in state and federal aid, $15 billion in personal income taxes, $8 billion in other income taxes and $7.6 billion in sales and use taxes.

Most of these line items depend upon the business community, first and foremost, to make ends meet.

The bigger deficit created by DeBlasio was the loss of public confidence in the police and other governmental institutions when his office embraced rioters in the streets during COVID. Much of mid-town Manhattan was closed and boarded up when DeBlasio refused to support the police and instead sided with looters and criminals who took full advantage of the chaos in New York City just a year ago. Similar scenes were seen in Chicago, Portland and other cities.

The public confidence in New York’s security situation, which was built up over decades by Ed Dinkins, Rudi Giuliani and Michael Bloomberg, was flushed down the toilet in a matter of hours by Bill DeBlasio.

Is New York City Coming Back? - b0226b 2839404019cb480f8292a7db9914f7dc mv2

The financial and social damage done to New York City by Mayor DeBlasio and his fellow Democrats is incalculable at this point in time and ongoing. The good news in FY 2021, however, was that the fact of the city being largely closed pushed down spending significantly.

Governmental expenses fell by $5 billion as spending for public safety and schools declined. The arrival of billions more in federal subsidies c/o the Biden Administration also helped to float the city on a sea of liquidity through the end of FY 2021. But health expenses and payments to city hospitals rose by $2 billion due to COVID.

As NYC reopens, however, there are dramatic credit events ongoing that are going to result in lower revenues for the city going forward.

We have already alluded to the dire situation facing owners of multifamily real estate even before COVID. After a year of rent moratoria imposed by the Biden Administration and, incredibly, the Centers for Disease Control, many landlords are facing bankruptcy. Unlike single-family residential real estate, the resolution of insolvency for commercial properties including rental apartments is a largely institutional affair that occurs behind closed doors.

As in the 1970s, we expect to see a rising number of multifamily properties sliding into bankruptcy and abandonment when owners realize that they cannot recover their operating costs.

Keep in mind that these rental properties are no longer financeable with banks because of 1) the 2019 rent control law passed by Albany and 2) national COVID rent moratoria that have greatly reduced the value of these properties.

Take an example. A bank that started 2020 with a 50% mortgage loan on an apartment building in NYC today is looking at a troubled-loan that is probably closer to 75 or 100% of the property value. This commercial loan will likely be placed into a troubled-debt restructuring (TDR) by state and federal bank regulators, meaning that the property cannot be refinanced.

The bank will ask the property owner to add cash to bring the loan back to a 50% loan-to-value or LTV, but the property “owner” is unlikely to throw good money after bad. The owner will hand the city the keys and walk away, meaning that the property will deteriorate.

The chart below from the most recent IRA Bank Book for Q3 2021 shows the loss severity on $500 billion in bank owned multifamily loans and $2.4 trillion in residential mortgages.

Note that the loss severities on 1-4 family mortgage loans, HELOCs, residential construction loans are currently negative, thus the trend in multifamily loans is notable and disturbing. Strangely, nobody in the financial media seems to care about this emerging story.

<chart5>

Source: FDIC/WGA LLC

More problematic for New York City, however, is the situation with respect to commercial office properties.

If you take a ride up to one of the top floors of a midtown Manhattan tower at dusk and look around, what you see are empty buildings. Commercial leases, like mortgage loans on multifamily properties, are long term assets that are generally of seven or even ten years’ duration. But as leases run off, the tenants are frequently letting the space go.

At best, the tenants will downsize into smaller office space that is more conveniently located. At worst, the tenant will leave NYC entirely. The landlord will drop the rent on the property and look for new tenants.

Over time, as commercial landlords face attrition in their tenant base, especially from larger tenants, the value of these commercial properties will also decline.

The mortgages on the under-utilized commercial buildings in Manhattan will see LTVs rise above 50%, meaning that bank lenders and bond investors, and regulators, will request a cash infusion from the building owner to bring the loan back above water.

Even if the owner is willing to advance more cash and continue paying the mortgage, the next step will be to seek tax abatement from New York City because of the drop in the value of the property. And remember, property taxes are the single largest revenue line item in the New York City annual budget.

During COVID, we were amused by the confident statements from the likes of JPMorgan (JPM) and Goldman Sachs (GS) about reopening their offices in Manhattan, this even as they quietly moved senior executives out of the city to new suburban locations.

Recall too that New York City’s new Mayor, Eric Adams, is a younger, perhaps smarter version of Bill DeBlasio. Adams is a political opportunist with no particular competence as a manager and even less of a political base.

Just as Democrats in Congress have begun to attack investors who want to renovate blighted urban multifamily properties, Adams will be forced to demonize the business community to survive politically in New York City.

BTW, Adam’s thinks that crypto trading should be taught in NYC schools. He has zero credibility with the city’s already distressed businesses and, even as a former cop, with the New York City Police and Fire Departments.

Over the next several years, as the economic cost of the COVID lockdown becomes full visible in the business community and commercial real estate market, New York City may face its second financial crisis in half a century. Stay tuned.

ABOUT CHRISTOPHER WHALEN 

Christopher Whalen is the author of the book Ford Men and chairman of Whalen Global Advisors. Over the past three decades, he has worked for financial firms including Bear, Stearns & Co., Prudential Securities, Tangent Capital Partners and Carrington. Currently, he serves as the editor of The Institutional Risk Analyst.