Last month, Governor Kathy Hochul and Mayor Eric Adams, both first-term Democrats in New York, made a joint appearance in Manhattan to announce a 40-point revitalization plan for a “New” New York. In the wake of the Covid pandemic, the city has continued to struggle, with a 21.9 percent commercial office vacancy rate and a 60 percent ridership on MTA’s subway system compared to 2019 pre-pandemic levels. The economic-development plan, which focuses on midtown Manhattan, complements agendas already announced by Hochul, who wants to see 800,000 new homes built in the state over the next decade, and Adams, who wants to see 500,000 new homes built in New York City over the same period of time.
But these plans, as well as similar efforts proposed in other cities, could be in jeopardy because of one economic factor: rising interest rates. After years of more or less flat, and extremely low, interest rates, the Federal Reserve set out during 2022 on a different approach, purportedly to curb inflation. Between March 17 and December 14 of last year, the Fed raised interest rates seven times, taking the rate from an historically low 0.25%-0.50% at the beginning of the year to 4.25%-4.50% by year’s end. Rising interest rates will make the Hochul-Adams revitalization plan all that much more difficult to achieve.
The rising rates have already had a profound effect on various areas of the American economy. One noteworthy development could have far-reaching consequences. Just this week, Wells Fargo, previously the leading lender for mortgages in the country, announced it is “stepping back,” to quote CBNC, “from the housing market.” Once bullish on mortgages, the company will reduce its lending clientele, shut down its division that buys third-party loans, and “significantly” shrink its mortgage-servicing activities. The main reason for the retrenchment, according to the company’s chief officer for consumer lending, was the rate hikes implemented by the Fed.
Already, some mortgage holders with relatively new mortgages are underwater, and other owners, leery of the shifting economic playing field, are attempting to back out of deals into which they have already entered. Consider a company called EEI, a Brooklyn-based real estate concern registered in Delaware. According to an article in Forbes, last year “an entity called Java Capital LLC — an affiliate of a New York investment company called Emerald Empire Inc. (EEI) — entered into an agreement to purchase a multifamily residential housing property in St. Louis.” But when interest rates started to climb in 2022, causing the cost of a mortgage to spike, Java backed out of the deal before the closing date, despite having signed a purchase contract and putting up earnest money. Java argued the seller misled them by claiming the property had 429 units when four of the units were used for a gym, leasing office, and storage space. The case is pending in court, but, as Forbes points out, “Businesses need to abide by their contracts and the courts must uphold their terms, even if they may no longer be financially advantageous for one of the entities.”
That was not the only real estate deal on which EEI attempted to renege during 2022. On March 31, 2022, EEI purchased a multifamily residential property containing 412 apartment units on Kingsbridge Lane in St. Louis for $55 million, putting down a deposit of $550,000. A closing date was set for June 10. But when that date arrived, EEI not only refused to close the deal but also asked for the return of its deposit. This time, EEI argued the seller misrepresented the deal when, in all likelihood, it wanted out of the deal because rising interest rates altered the potential profitability of the property.
EEI is attempting to back out of yet another deal, for the purchase of 1194 Casa Brazilia Court in St. Louis for $44,280,000. After admitting the company was unable to close due to “financing issues,” it later argued there was a “material” breach in purchase agreement provisions. As with the other real estate deals, a court will likely uphold the purchase contract or force EEI to forfeit its deposit.
But the actions of this one company underscore the desperation some buyers are feeling now that interest rates have changed the rules of the game in a real estate business that had been comparably stable for years. And to make matters worse, it is unclear what future actions the Fed might take after it has clearly created turmoil in an otherwise orderly market. It is a reality everyone — from Governor Hochul and Mayor Adams and their plans for a “New New York” to the average American homeowner — will have to manage as interest rates may well continue to rise in the future.