A House Regulated Cannot Stand
If you want to see the devastating effects of regulation, look no further than the New York City housing market. As a former director in a municipal housing agency, I often wondered why property owners would come into my office ready to sign over their deeds. As a current property owner and developer, the reason is now all too clear. Battling all of the regulations imposed upon me, I often wonder, Who owns this property anyway?
In the Big Apple, there are several agencies having direct jurisdiction over the housing market and several other agencies whose actions impinge upon housing. These agencies employ several thousand employees whose only job is to "get the landlord." Even those programs that seem landlord oriented — rehabilitation financing, for example — are really tenant-oriented programs designed to keep rents low and to exert more bureaucratic control over the market.
In NYC, all housing-related matters have been extracted from the NYS Supreme Court and placed under the jurisdiction of Housing Court. This was done so that more favorable tenant-oriented decisions could be rendered. It is interesting to note that many Housing Court judges are my former coworkers from the Housing Department. The administration of Housing Court justice is not exactly blind. Let us just say that in housing matters, Lady Liberty leans heavily in one direction.
The Historical Setting
During the 1960s and '70s, the city's housing stock was devastated. Once-viable neighborhoods succumbed to the ills of decay, crime, and abandonment. As a graduate student at Columbia in the early '80s, I can relate to you the shock of traveling from mid-town Manhattan via Broadway to the campus in Morningside Heights. It was astonishing to believe that I was traveling through the financial capital of the world.
Neighborhoods such as Bedford Stuyvesant, Harlem, and Brownsville became worldwide examples of urban decay. While doing a market study of East New York, I was dumbfounded to see that virtually every other house was abandoned. Neighborhoods that I often visited as a child were now desolate and oppressive.
To counter the perception of blight, the agency once devised a plan to board up windows in abandoned buildings using plywood painted with flower pots and curtains. The idea was to hide this devastated housing from out-of-town commuters traveling to Manhattan via the Cross Bronx Expressway!
Abandonment grew to such an extent that vacancy rates in lower-income neighborhoods hovered around 2%. Decent families virtually could not find a place in which to live. Finding a decent apartment required an "old-boy network" and the ability to pay key money. I witnessed all of this happening from a key vantage point — my office at the municipal agency that was responsible for preserving and developing housing!
Neighborhoods have life cycles and, as they change, they provide housing opportunities for those lower on the income scale — if the market in these neighborhoods is left to operate freely. This economic concept is referred to as filtration. As high-income people vacate a unit to occupy newer, more luxurious housing, the vacated unit becomes available to those of less economic means. It is a win-win situation for all.
The problem begins when the City requires that landlords maintain the same level of services even though the lower rent received can no longer support it. As landlords cut back on those nonessential services, the City regulators step up their compliance efforts and begin bombarding the building with violations. Tenants then file for a rent reduction due to a reduction in services. Some tenants see the opportunity to withhold rent. The downward spiral in rent collection begins.
Eventually rents are so reduced and uncollectable that basic services can no longer be provided. More violations pile up. The property owner can no longer support the building and it is sold and resold until it winds up in the hands of a speculator who milks the building as best he can before walking away.
This is a common scenario, which I have witnessed hundreds of times during my 15-year employment with the City of New York. In fact, abandonment was so great that at one point I supervised the management of over 7,000 units in a City receivership- type program. This does not include the thousands of units that the City directly owned through tax foreclosure.
Magnify the above scenario thousands of times and you get a full picture of the urban blight that confronted New Yorkers. Decent tenants would no longer remain in these neighborhoods and the vacant buildings became a heaven for junkies and for all kinds of antisocial behavior.
This is the result of intervention usually pushed by interest groups determined to supplant the landlord. I once appraised a building whose tenants posted a large sign at the building entrance stating, " Buyers Beware. This is a City Managed Building." The idea was to discourage all potential free-market ownership. For many years the tactic worked.
A One-Sided Burden
The New York City Housing-Maintenance Code places the burden of repair solely on the landlord. If a tenant creates a hazardous condition, the owner must repair — no matter what the cost is. Some tenants became very adept at creating violation-inducing conditions.
I once inspected a building that had just been rehabilitated using City money. Some tenants were withholding their rents, and the owner was having difficulty repaying the loan. The reason these tenants were withholding rent was that some tiles in the bathroom had become unglued!
As the legions of Code Enforcement inspectors add on violations, the fines begin to pile up. Eventually, the case is referred to the Litigation Bureau, where City attorneys institute legal action. The landlord is fined and forced into a compliance agreement. If he fails to make repairs, he is held in contempt and subject to imprisonment. The inability to collect rent is no defense. Nevertheless, the Court never asks who caused the violation. Tenants are never fined or required to correct any violation that they created.
Fines can be steep. The penalty for hot water 1 degree below the legal limit is $250 per day until the violation is corrected. In the meantime, tenants can withhold rent. The landlord is always at a disadvantage because he must hire an attorney while tenants can use the "impartial" attorneys in the housing agency to press their case.
After so many violations are piled on a building that the landlord is unable to correct them, the City employs one of its most confiscatory tactics — an Article 7A Proceeding. Article 7A of the NYS Real Property Law authorizes the City to petition the Housing Court for the appointment of an administrator to manage the building in lieu of the owner. Once the administrator is appointed, the owner cannot enter his building without permission and cannot collect rent. Of course, he must still pay his property taxes!
Although the administrator is charged with the removal of housing-code violations, it is interesting to note that this is seldom accomplished. Additionally, once a building is in the 7A Program, Code-Enforcement inspectors are not authorized to issue additional violations unless specifically requested by their supervisors. If only the property owner had this luxury!
The payment of property taxes is last on the administrator's list of things to do. As a result, taxes continue to pile on and eventually the property is subject to in rem proceedings and becomes City owned. After the building is rehabilitated by the City at the taxpayer's expense, it is sold to community residents for $250 per unit. The property owner, however, receives no compensation for the loss of his building, and the taxpayer continues to subsidize the property.
The 7A administrator is given a host of special privileges that are never accorded a private owner. He is not subject to City-sponsored litigation. He is not fined, and he is not imprisoned for his failure to provide building upkeep.
Tenants seldom bring action against an administrator. If they do, a representative of the housing agency appears in court to support the administrator. In fact, a 7A Administrator bears no personal liability while he is acting in his capacity as administrator.
It becomes evident, then, that government intervention in the housing market leads to further and further intervention. As each tactic fails to cure the problem, more has to be done. Eventually, all value is stripped from the property and the City becomes the owner. In the end, the intervention has achieved very little because the property continues to degenerate and tenant living conditions do not improve.
The Inequity of Rent Control
As a real-estate investor, price ceilings do not bother me as much as the forms of regulation described above. I calculate building value according to the discounted cash flow available. However, rent control does create a serious problem of equity — something that politicians and bureaucrats are constantly clamoring about.
You can find numerous examples of someone living in a rent-controlled apartment, usually acquired through the right of succession, paying substantially less rent than someone living in a decontrolled or rent-stabilized apartment of the same type in the same building. Property owners need to charge more for the decontrolled unit to make up for the loss they are taking on the rent-controlled unit. So once again, government's efforts to foster equality generate inequality.
I am not arguing in favor of rent control. In the past, price ceilings have had a devastating effect on the NYC real-estate market. However, since they affect a smaller percentage of units than do the other forms of regulation, they are no longer as devastating to the market in general. Every multiple dwelling in the city is subject to housing-code violations, rent reductions, Housing-Court action, and possible City extortion through an Article 7A proceeding.
The Essence of Government Regulation
Why does government continue to interfere in the housing market when the results of that intervention are so devastating? The answer is simple: local interest groups organize and pressure City Hall for action.
In NYC there are dozens of community groups that devote a substantial portion of their time to housing matters. Most of these groups are subsidized by taxpayer dollars. Even the now-infamous ACORN operated in the city, agitating tenants to organize against building owners guilty of even the slightest infraction — real or imagined.
Most of these housing pressure groups are left-leaning and believe that housing is a fundamental right of all — rent paying or not. I have often discussed building issues with community group representatives who spoke in terms of the "struggle." They were often surprised to find out that I was a supporter of free-market capitalism.
Pressure from these community groups distorted the actions of most local politicians. These politicians were often allied with these local groups and beholden to them for votes. Municipal bureaucrats were often allied with these groups to gain favor with the local politician. The result of this was the intervention in the market and the disastrous consequences that followed.
The Rebirth of the Central Cities
New York City has gone through a spectacular rebirth during the past 20 years. Neighborhoods like Harlem, Williamsburg, and areas of the Bronx are much sought-after these days. However, this rebirth is the result of macroeconomic trends set in motion by the Reagan revolution of the '80s and carried on by Clinton and Bush — not of the failed regulatory attempts of government.
As the investment climate in the United States improved in the '80s, jobs were created and investment capital came into being. Much of this capital found its way to the real-estate market. Once-shunned neighborhoods were again the focus of investors and developers. People from all over the world came to NYC seeking jobs and investment opportunities. They also occupied the housing units rehabilitated by private developers.
In addition, with the election of Rudy Giuliani as NYC Mayor, many of the regulatory activates of his predecessors were scaled back. The 7A unit was disbanded, and buildings were no longer taken in rem. Instead, tax liens were sold to private entities.
This gave landlords a greater opportunity to reclaim their properties through negotiations with the servicer. The entire inventory of City-owned housing was put on the market and returned to the private sector. Confidence in the city was restored through these, and other, private sector initiatives.
Mayor Bloomberg for the most part continued the free-market policies of his predecessor. Even with the current real-estate meltdown, New York City is in better shape than most big cities in the United States.
So for those clamoring for increased government regulation, I have only one piece of advice: take a look at the disastrous consequences of government intervention in the housing market. The results are bound to change your mind about the effectiveness of government action.