Regulatory Arbitrage, Rent-Seeking and the Deal of the Year

by on April 21, 2016 at 7:28 am in Economics, Uncategorized | Permalink

united-charities-building-287-park-avenue-south-777x959The NYTimes ran a full page ad yesterday congratulating NY real estate broker Mark Weiss for winning the Real Estate Board of New York’s Most Ingenious Deal of the Year Award. I was curious, so I did some research and found some information about one of Weiss’s most succesful deals.

A Chinese developer bought 287 Park Avenue South, a nine-story building built in 1893, in order to convert it to a mix of condos and retail. But a problem arose:

The 1893 landmarked building straddled two zoning districts, which left one half of the property overbuilt….trying to expand the building at 287 Park Avenue South would be like struggling in quicksand: additional FAR purchased would essentially be sucked up bringing the overbuilt part of the property into compliance.

That’s what prompted listing broker Geoffrey Newman and his Newmark Grubb Knight Frank colleague Mark Weiss to MacGyver a solution that earned the brokers a nomination for the Real Estate Board of New York’s “Ingenious Deal” award.

Here’s what they did:

By removing several floors from the interior part of the building that was overdeveloped, Newman realized, a buyer could bring the entire building into compliance, freeing the way to add bonus square footage from inclusionary housing certificates the NGKF team identified in the area.

“The idea was, that by removing 4,000 square feet we were able to add 27,000 square feet onto the building,” he told The Real Deal. “That was really the basis of what differentiated our approach to other ways of selling the building.”

The idea was indeed ingenious but you will also note that all of the ingenuity was devoted to evade the zoning and the price of evasion was high. In order to work around the zoning law, 4,000 square feet of very valuable New York real estate had to be destroyed. (Not to mention all the hours of ingenuity and legal effort that was used up devising and implementing the deal).

When thinking about why it’s so expensive to build in many American cities just remember that the deal of the year is when you build 31,000 square feet of space and only have to destroy 4,000 square feet of space to do it.

1 Steve Sailer April 21, 2016 at 7:43 am

That reminds me of the construction of the office building on Ventura Blvd. in the San Fernando Valley that’s now home to the Hallmark Channel. The zoning rules clearly stated that the maximum height in this area on the edge of the Hollywood Hills was three stories, but the developer built a six story building on Ventura by measuring from the side street well up on the hillside.

There’s a reason why real estate developers make the big bucks.

Here’s Scott Alexander of SlateStarCodex.com reviewing the 1988 book “Trump: The Art of the Deal.” Section III is relevant.

http://slatestarcodex.com/2016/03/19/book-review-the-art-of-the-deal/

2 Dmitri Helios April 21, 2016 at 10:21 am

“There’s a reason why real estate developers make the big bucks.”

Just curious, how much do your real estate developer cousins in SF make in an average year?

3 marcos April 25, 2016 at 1:45 pm

Didn’t the developers of Rincon Towers pocket $250m in profit off even paying into he SOMA stabilization fund?

4 mulp April 21, 2016 at 1:09 pm

Are you arguing that the 3 story zoning limit prohibited building more than zero stories on the high end of the property?

Or are you arguing that the zoning requires the floors be pitched at a 30-45 degree angle?

5 Hazel Meade April 21, 2016 at 1:30 pm

Now think what would happen if that guy made an enemy on the city council.
Destroy three floors of building or face escalating fines and bankruptcy either way.

6 Jan April 21, 2016 at 1:51 pm

I don’t have personal experience, so take it with a grain of salt, but I tend to think these things work much more through carrots and favors, rather than sticks and threats.

7 BenK April 21, 2016 at 8:07 am

‘That reminds me’ – I think we could have an entire category of anecdotes based on this story.

On one hand, I admire the poet who, working within artificial, even silly, constraints, finds a clever expression.
This feels, somehow, different than someone who is working against the constraints of nature (or society) –
including architects, mechanical engineers, and so on.

On the other hand, I resent when the progress of medicine and science seems to rest almost entirely on
overcoming some bizarre regulatory hurdle having to do with federal funding, continuing resolutions, and the like.

8 Eddie April 22, 2016 at 9:59 am

It is different.

1) A poet chooses to work within a contraints or not, and then chooses which constraints. A real estate developer has those limits imposed.

2) A poem, being art, is not meant to be functional; the limits are part of making the expression more beautiful, even if they impede clear communication. A building is function-first.

9 charlie April 21, 2016 at 8:48 am

Alex should be focusing his firepower, such as it is, on IZ.

Here is the complete quote:

“By removing several floors from the interior part of the building that was overdeveloped, Newman realized, a buyer could bring the entire building into compliance, freeing the way to add bonus square footage from inclusionary housing certificates the NGKF team identified in the area.”

10 Duh April 21, 2016 at 9:12 am

The complete quote is what Alex quoted.

11 rayward April 21, 2016 at 9:27 am

Current code compliance often means something much more significant than current zoning compliance, such as building codes (fire, safety, access, etc.). Old buildings are usually grandfathered, unless there’s a substantial change to the building. For some buildings (such as medical facilities), however, a change in ownership alone can trigger current code compliance. As for the lawyer who provided the legal opinion on 287 Park Avenue, I hope he shared in the broker’s commission – he may need it.

12 A Definite Beta Guy April 21, 2016 at 9:51 am

Doesn’t sound like this is code compliance. Not building code. The actual problem is the FAR. If you have a plot of land, you are only allowed to build so many square feet on it. Apparently NYC allows builders to build additional FAR. Not bad. The problem is that any additional FAR purchased goes right into putting the building into compliance, first.

13 callan April 21, 2016 at 9:56 am

That the “…building straddled two zoning districts” would be very strong justification for a formal waiver to the conflicting legal code requirements, in a rational world.

Of course, this is New York City with a notoriously byzantine city government. If Trump was the developer he would know which strings to pull in city government to get the desired code waivers.

14 A Definite Beta Guy April 21, 2016 at 5:58 pm

Why waiver? If the city sticks to its guns, then the city gets money.

15 Alex from Germany April 22, 2016 at 1:52 am

Funny that you’d mention Trump. This sort of “deal making” by circumventing zoning restrictions is what made Trump his fortunes (aside from his inheritence).

16 Lord April 21, 2016 at 9:41 am

Remember though, nearly all urban development requires destruction first, so this is more typical than not, though usually for functional and structural issues.

17 Roy LC April 21, 2016 at 9:57 am

How did a building from 1897 end up in two zoning districts? I have some actual experience with planning but this is a new one for me. How many NYC buildings are like this?

18 Anonymous April 21, 2016 at 10:00 am

Skirting regulations truly is where the money is nowadays. Think of Uber, Airbnb, this guy… So much value to be added to the economy and fortunes to be made by clever people who can just come up with new ingenious ways to avoid the slimy tentacles of bureaucracy.

I predict that the next multi-billionaire entrepreneur will be the person who comes up with a way to allow people to travel using airlines without all the security theater. Perhaps by starting an airline company and hiring each passenger as a security guard for the duration of the flight?

19 Urso April 21, 2016 at 10:57 am

Interesting thought. Even online commerce, in general, got a major boost from the fact that they “skirted” sales tax laws for many years. Maybe a real competitive advantage of the online economy; that for a good decade+ the rules simply weren’t designed to cover it.

20 Sam P April 21, 2016 at 2:10 pm

This “exception” existed for decades before; mail order “skirted” sales taxes the same way. I remember buying RAM from MacConnection years before they had a website. They did the “special deal with shippers” thing before Amazon.com existed.

21 BC April 21, 2016 at 11:49 am

Private sector solutions to public sector problems.

22 RustySynapses April 21, 2016 at 11:54 am

While I agree with your overall point, your second paragraph forgets (unless it’s just a joke) (1) that the risk from hijacked planes isn’t just to the passengers (see, e.g., 9/11), so it’s a lot more likely Congress would step in, and (2) large jets, anyway, have to take off from airports – so until there’s something different than large jets to fly lots of people around, it’s hard to get around moving masses of people through the security at airports (as opposed to small numbers of people boarding private jets, even at big airports – which already have solved this issue for the rich). Plus, for all of the complaining (and for the reality that we’re fighting the last war – no one could hijack a plane with a box cutter today) – security via TSA Pre is really not that bad.

23 asdf April 21, 2016 at 2:25 pm

While Uber certainly skirted regulations, I never saw that as the reason for its popularity. Being able to hail a cab from your phone is way more convenient then using the old taxi service. It’s just a better product, and would win whether there were Taxi Medallions or not.

We know this because there was already a service, gypsy cabs, that skirted the regulations, but without the new tech fundamentally changing the product it wasn’t too popular.

24 GW April 21, 2016 at 10:17 am

Sure, there are elements of any zoning plan that are, or appear to be, arbitrary, particularly when a property is at or over boundaries, or sits in an area in which the existing residents or owners wield political influence. But a knee-jerk condemnation of zoning, as found here, is rarely completely justified. For example, in Manhattan, the existing water supplies and sewage lines define some strict limits on the size of all projects that cannot simply be altered without the investment of decades of work and tens of billions of dollars, representing a scale or more of magnitude greater than any single project. In such cases, zoning is less a means of restricting development than an efficient way of bundling such long-term infrastructure planning with short term construction projects. For example, from this point of view, an earlier, both more ambitious AND demanding zoning plan may have created the political and commercial environment required for the long-delayed NYC Water Tunnel Nr. 3 to have been completed at a reasonable point in time.

25 A Definite Beta Guy April 21, 2016 at 10:37 am

I would agree with this. Municipal infrastructure takes a massive amount of work to overhaul. Even in my suburban subdivision, we’re talking multiple months to rip out the road, the parkway, the old sewer lines, any internet or phone cables running through the area, etc. And then replacing it all. And then repaving the street.

Chicago Deep Tunnel has been underway since the 70s. It’s not expected to be fully complete until the 2020s. That’s a 50-60 year project to augment the city’s sewer system.

I think the criticism is also misplaced. Urban planners reference the “missing middle.” The problem isn’t necessarily building skyscrapers downtown. It’s building efficient multi-family homes at the 3 or 4 story level. Someone, maybe Steve, mentioned a complaint of a San Fran resident when a single family home was converted into a duplex. THAT’S the killer Nimbyism right there.

26 Bob from Ohio April 21, 2016 at 11:06 am

Your touching faith in the rationality of city officials is quite naive.

“existing water supplies and sewage lines define some strict limits on the size of all projects”

If true, then the permit process could openly accommodate this, not arbitrary zoning lines as a sub rosa method.

27 Noumenon72 April 21, 2016 at 11:16 am

For example, buildings could include a level or two of parking garage without using any extra sewage, but a height limit prevents that.

28 Nicholas May 11, 2016 at 11:08 pm

Doesn’t the water cycling through the sprinkler system loop back into sewage?

29 Ray Lopez April 21, 2016 at 10:42 am

Contrary to AlexT’s suggestion, this could be the “deal of the year” because it was so exceptional, and rare.

30 brad April 21, 2016 at 12:48 pm

I would have thought the deal of the year would have been the Rivington House deal.

Village Care, an AIDS non-profit, was sold the building by the city in 1992 for a very low price. However the property came with a deed restriction that forbid any other use than residential health care. The demand for AIDS nursing home beds having diminished Village Care attempted to get the deed restriction lifted to no avail. So it sold the building to Allure Group, a nursing home operator, for $28M. Mysteriously sometime between February 15, 2015 (when the sale went through) and May 11, 2015 the city changed its mind and agreed to release the deed restriction for $16.15M. Allure group promptly turned around and sold the building to condo developer Slate Acquisition for a cool $116M, $71.85M in profit in almost exactly one year.

The award should have been awarded to the Allure Owners — Joel Landau, Marvin Rubin and Solomon Rubin (Hassids in case you were wondering).

31 JWatts April 21, 2016 at 4:29 pm

“The award should have been awarded to the Allure Owners — Joel Landau, Marvin Rubin and Solomon Rubin (Hassids in case you were wondering).”

And to the local planning commission of course. Oh never mind, I’m sure they got their percentage off the top.

32 Hazel Meade April 21, 2016 at 1:22 pm

The idea was indeed ingenious but you will also note that all of the ingenuity was devoted to evade the zoning and the price of evasion was high. In order to work around the zoning law, 4,000 square feet of very valuable New York real estate had to be destroyed. (Not to mention all the hours of ingenuity and legal effort that was used up devising and implementing the deal).

But think of how many people were employed as a result. All that red tape creates jobs. Good, decent, middle-class jobs, with benefits, for hard working Americans. Which can’t be outsourced to China.

33 Cooper April 21, 2016 at 1:47 pm

That reminds of the Onion video about whether or not America should stop dumping its money into the giant hole.

http://www.theonion.com/video/in-the-know-should-the-government-stop-dumping-mon-14289

34 spencer April 21, 2016 at 1:59 pm

I agree with Lord, virtually all urban building requires some floor floor space being destroyed.

About the only vacant land in Manhattan is parking lots and that probably exist because someone is banking the land for future development.

35 prior_test2 April 21, 2016 at 3:05 pm

‘4,000 square feet of very valuable New York real estate had to be destroyed’

Prof. Tabarrok will likely be thrilled to discover there is an entire industry branch devoted to demolishing thousands of square feet of real estate – and it’s historical footprint can be seen all around GMU’s Arlington Campus. And if he writes about it in typically breathlessly fashion, we can all enjoy another mockery worthy contribution to this web site.

36 J April 22, 2016 at 10:12 am

In Tel Aviv, a city not yet a hundred years old, thousands of buildings have been declared “historical”, to be preserved forever. They must be repaired/rebuilt using the same materials as the original. When it comes to water and sewage systems, the results are pathetic. The place is being renewed with fake “antique” buildings (from the nineteen thirties). Real estate in Tel Aviv is more expensive than in New York or Hong Kong.

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