Your Air Rights Aren't All Yours: Lenders' New Nickel-and-Dime Squeeze Play

"We were stunned," recalls Jason Wagenheim, then-president of the seven-member board. Air rights are a corporate asset, and thus require a lender's approval — a former formality that, as the overall market climate has changed in the last five years, has now become another profit-making opportunity.

In Spring 2007, a developer offered Wagenheim's Park Slope co-op $1 million for 13,500 of the building's 37,500 square feet of unused air rights, for a building next door (see above). "We approved the architecture and engineering plans, and were all set to pop a cork" when they learned that lender JPMorgan Chase needed to approve it. And now Chase was essentially saying: If you go ahead with this deal, we'll call your mortgage.

The bank's stance stunned the board. Air rights are a form of collateral, but the original 20-year mortgage was itself for only $1.1 million (scheduled for payoff in 2018) and the whole building is "probably worth" $5-$8 million, Wagenheim says. After some discussion, the bank said the co-op could go ahead with the air-rights sale — if the co-op placed the million dollars in a Chase escrow account until 2018!

The board rejected that — "What would be the point?" says Wagenheim (right, with family) — and after a year of more negotiation, Chase would allow the co-op to sell its air rights only if the co-op paid off its loan right away, plus a prepayment penalty of $141,000 (discounted from $250,000). The co-op took out a new underlying mortgage for $500,000 and paid off the Chase loan, minus $6,600 in closing costs. After $30,000 in closing costs on the new loan, the co-op's profit is about $820,000 — nearly $200,000 less than originally envisioned.

"We paid a penalty because Chase acted in a manner that we thought was unreasonable," adds Jeffrey Reich, a partner at Wolf Haldenstein Adler Freeman & Herz, the attorney who represented the co-op.

Some would disagree. "Prepayment penalties are almost always based on some form of yield maintenance," explains Patrick Niland, president of mortgage broker First Funding and a Habitatmag.com blogger. "That is, the interest rate on the loan is the yield to the lender or investor. The lender is counting on six percent interest from now till ten years from now. If you prepay in year six, you [must then] give them the value of the remaining four years of interest. In essence, you're maintaining the yield of the investor. You're making them whole under the contract."

From the bank's point of view, selling such commodities as air rights is getting rid of loan-securing collateral — even when, as in this case, the building was worth several times the amount of the loan even without the air rights.

Regardless, "We have to know about air rights in advance," says Mindy Goldstein, a senior vice president at NCB, a major lender to cooperatives. It's the same, she says, "If they want to lease air rights to an antenna company or put up billboards or sign a new commercial lease…. Anything that affects income needs our approval" from a lender's investor-consent department.

How Wall Street Works

But why would a lender turn down or place roadblocks before a moneymaking opportunity? "Sometimes, a bank may not have as large a portfolio [in this area] as we do and may not be as flexible," says Matthew Wehland, the senior vice president at NCB’s investor compliance and credit review department. Other times, notes Reich, the lender may simply want to "get out of the business of making loans to cooperatives."

More significantly, Niland believes, "The effect of the subprime mess rippled through the marketplace…." As he describes it, "Wall Street takes every kind of debt — credit cards, home mortgages, and so on — and packages it; they buy these debts and put them all together in a big basket and then they issue a bond to the investing public, which is secured by the payments of the interest on the principal of whatever the assets are in that basket. If the assets are junky, then payments don't come on a regular basis," hurting the bond-payers' cash-flow.

That increases the "risk premium spread" of the loan, and lessens lenders' ability to refinance their own debt at an affordable rate. As a result, many lenders are more likely to turn down a deal or else call a loan, taking the short-term money over the long-term uncertainty.

Wehland suggests that if you think your co-op might sell air rights in the future to have air rights placed under a separate tax lot. "That way, the building would be in one parcel and the air rights in another. Then the loan is only secured by the real estate portion and there is less difficulty in selling off the air rights."

Adapted from Habitat July / August 2008. For the complete article and more, join our Archive >>