Reaching for the Sun: Is It Possible to Own Too Much Real Estate?

By Al Barbarino 11/13 7:00am

 

When the credit crisis hit and the real estate market all but collapsed, news of disgraced developers became commonplace, their tales more often than not layered with intrigue.

Take Kent Swig, who, after being divorced by his wife, filed an affidavit in May responding to a lawsuit filed by his ex-father-in-law, industry luminary Harry Macklowe, arguing that Mr. Macklowe embarked on a “vendetta” aimed at “starving” him of every last penny.

But as the downfalls of real estate tycoons like Mr. Macklowe, Shaya Boymelgreen, Bruce Eichner and Larry Gluck stack up like so many new developments across Manhattan’s skyline, analysts and the city’s landlords themselves have begun to wonder aloud if there’s a limit to how much real estate can be accumulated.

“A developer’s function is to develop property, and sometimes they develop and develop until they can’t develop anymore,” said appraiser Jonathan Miller of Miller Samuel Inc., a real estate appraisal and consulting firm based in New York City. “Where people fell short was that the market was more powerful than them … the market is brutal, and it has no compassion.”

With President Obama elected to four more years in the White House, a juggernaut exists in the looming Bush tax-cut deadline. Nobody knows for sure whether the cuts will expire, but as it stands, if Congress does nothing, capital gains taxes will increase from 15 percent to as much as 28.8 percent, including surcharges, tax experts said.

Depending on which side of the aisle you’re on—Republican or Democrat—the expiration is expected to either hurt or stimulate the economy. Some believe that in order to erase the massive national debt ($16,260,682,814,332.77 at press time), the country has no other option but to increase taxes. Opponents of the hikes believe that if the wealthiest taxpayers have less money, they’ll spend less on consumer goods, restaurants and, perhaps, real estate.

Either way, brokers are scrambling to push deals before the end of the year, to some degree playing off fears of the tax deadline—and some people are making decisions as though the expiration is a certainty.

“Since the summer, we’ve seen unusually heavy volume of high-end property owners who are transferring properties” as the tax deadline approaches, Mr. Miller said, adding that this leads to an “artificial compression of the market.”

One broker wrote in an email that was sent out to a group of clients and later obtained by The Commercial Observer that “Since the low capital gains taxes are expiring soon, I would say that it’s in your clients’ best interest to reach an agreement before 2012 … I would think it’s in your best interest also to close in 2012.”

The good news is that the shrewdest of investors—and perhaps the luckiest—will rise to the occasion, navigating the real estate terrain with intelligence and vision, which most likely means running business as usual and paying little attention to the tax deadline.

“The traditional developers and real estate families hang on for generations—no one-term presidency or Congress is going to affect them,” said the real estate attorney Adam Leitman Bailey. But, he added, there are those who treat investments “like ATM machines and who are not making the most intelligent investments … that is a different world.”

Some say capital gains taxes will likely stay the same, meaning that these transactions may be happening for the wrong reasons.

“Obama said the tax cliff will not happen and that he is going to reach some sort of a compromise with Republicans in Congress,” said Kenneth Weissenberg, who advises real estate clients as the head of EisnerAmper’s real estate department. “I think there’s an increase in taxes for households earning over $250,000, but capital gains taxes stay at 15 percent.”

But any reason seems like a good reason for some real estate professionals to continue buying. At least a few New York City-based real estate tycoons have made Forbes’s “Richest People in America” list. An obsession with joining those ranks drives the industry elite—and not-so-elite—but more often than not, the result is more like a nosedive than an ascent toward greatness.

Just last month, a federal grand jury charged 87-year-old Seattle real estate tycoon Michael Mastro and his wife with bankruptcy fraud and money laundering. And runaway costs are allegedly pulling prominent real estate figures like Joe Moinian and Brian Fallon, president of Manhattan House, underwater, brokers said.

“By the time that a lot of these deals are foreclosed or modified, it will be after January 1, and these people will have an even higher tax burden than before,” Mr. Bailey said, referring to property owners who find themselves on the edge of bankruptcy. “But it’s like beating a dead horse, because they just won’t have any money left by then.”

Some will scoop up properties for the wrong reasons, taking out loans that they cannot pay off—the main culprit in the downfall of many of the city’s once-lauded moguls.

“Owning too much of the wrong real estate may be a bad thing, but I doubt owning too much of the right real estate is a bad thing, irrespective of the expiration of the Bush tax cuts,” said Guy Arad, a real estate attorney at Bailey’s firm.

Instead of scrambling to sell off properties, at least one other option exists for those frightened by any imminent tax increase, in the form of 1031 exchanges, which allow people to replace real estate assets and be spared the taxes. In the simplest form, a seller and buyer simply transfer their properties to each other. Tax experts recently told The Commercial Observer that a giant uptick in these transactions is on the horizon.

The wealthiest of developers seem to “have nine lives,” with a knack for bouncing back amid the most unlikely of conditions, because they often have access to capital that “mere mortals don’t” in terms of leveraging other peoples’ money, Mr. Miller said.

“Macklowe is one of those people who has used up many lives, but he has many more to go—and more power to him,” Mr. Miller added. “Leveraging is intoxicating, because you can move so far with it, but it also can cut you down very quickly.”

That could lead to a future in therapy, said Dr. Nando Pelusi, a New York City-based psychologist who studies corporate greed and has worked with real estate professionals who have been overcome by their own outsize desire to accumulate property.

“During most of human history there were conditions of scarcity, so our buttons are always switched on for acquisition,” said Dr. Pelusi, who was unable to name his real estate patients due to confidentiality reasons. “We think we want something. When we get it we want something else. We have a Porsche—then we want a Ferrari.”

“There is something bittersweet about the American Dream,” he added. “It does propel innovation, but that innovation comes with few winners and many losers.”