Ep 13: Apartment Flipping

Attorney General Eric Schneiderman calls Steven Croman the Bernie Madoff of landlords. And according to the New York Times, Croman’s business strategy is wrecking New York’s housing policy.

To see why Croman, suddenly, has become so interesting, let’s look first at the economics of housing.

New York City is a very expensive place where poor and middle-income families are being pushed out by gentrification. To push back and to keep many New Yorkers from being pushed out, progressives have rallied around rent controls.

So…this is the way rent controls or price caps, work.

Whenever the quantity demanded—of anything—exceeds the quantity supplied, price rises. To protect tenant consumers, then, price caps may be enacted. However, at the capped price, buyers want more than suppliers are motivated to provide. Consequently, rationing emerges as a response to scarcity, and often takes the form of waiting lists. If you want an apartment but can’t afford the market price, then be prepared to be wait-listed.

Economic conservatives argue, rent controls are bad ideas, then, because they distort market forces and incent landlords to reduce the number of units they offer. Therefore, they call for ending price caps and for telling poor families, if you can’t afford to stay and play, then it may be time to move on.

Liberals don’t deny market-distorting impacts, but advocate for economic controls as the lesser of evils to protect marginalized families and to preserve economic diversity.

Now, back to Steven Croman. He bought up 140 New York apartment buildings. Then, allegedly, his employees forced out tenants in rent-controlled units, and re-rented to nonsubsidized tenants at higher rates. So, to the extent those units now rent for more—not in one year only, but in all future years—then someone like Croman may be able—through flipping—to improve their net worth, dramatically. Definitely, it is a take-the-money-and-run-strategy!

Suppose some hypothetical landlord—like Croman—flips a tenant occupied building, purchased for say—$10 million, with annual cash flow from tenant rent payments of one-half million. Now, to show the power of flipping, assume—all other things equal, as economists say—cash flow from tenants can be jacked up—overnight—by $100,000.

Well, hypothetically, the building flipper just made a paper windfall of about $ 2 million. But if it is a leveraged purchase, financed with a loan of say—20 percent down, then the flipper just doubled their money!

And the disclaimer? Well, the capital asset valuation strategy used for illustration…assumes a useful building life of about five decades and a prevailing interest rate of about 4 percent.

Our conclusion? Well, probably you guessed it. With regard to public policy, flipping strategies may motivate economic players to take the money and run, rather than to stay put and to offer consumers vital services over the longer haul. Indeed, it turns suppliers away from selling products, instead, toward becoming leveraged, serial sellers of businesses, instead. Of course, this is how short-term thinking looks.

From Boulder, Colorado, this is Jim Sawyer for Capitalism in Crisis.