Don't Be Fooled: 421A Tax Exemption
A: Let me be absolutely clear! The 421A Tax Exemption which is granted to developers by the city as an incentive to build and develop neighborhoods, is great for the developer's sales team as they ask top dollar for new units with temporarily low monthly expenses and a DUPE TO THE BUYER WHO INTENDS ON SELLING AFTER THE ABATEMENT EXPIRES! Originally published June 28th, 2006. Edited/Enhanced on April 25th, 2007.
I'm sure I will get a lot of harsh words for this post from either some colleagues or sales managers, or developers, but I can't help it! This is how I feel and think its important to at least play devil's advocate to anyone considering paying over $1,300 a square foot for a new development whose asking price can be this high because the monthly expenses are temporarily low due to the 421 Tax Exemption.
Don't get me wrong, new developments are a great product and perfect for those who can afford them. But for those seeking an investment play, its hard to rationalize the price per square foot + higher closing costs on some of these developments considering they will get more expensive to carry every two years for the next 10 or 15 years.
As I noted on a previous post, "What is a 421A Tax Exemptiont":
421 Tax Exemption - The Cooperative and Condominium Abatement Program provides partial tax relief for condo owners and co-op tenant-shareholders to reduce the disparity in property tax paid between residential Class 2 properties (i.e., condominiums and cooperatives) and Class 1 properties (i.e., one-, two-, and three-family homes), which are assessed at a lower percentage of market value.
The reason I think this temporary tax relief is a dupe for buyers who intend to sell their new home AFTER the abatement expires, is because in the world of real estate...
THE MONTHLY EXPENSES (MAINTENANCE + REAL ESTATE TAXES) OF A PARTICULAR PROPERTY ARE DIRECTLY CORRELATED WITH THE AFFORDABILITY OF THE APARTMENT AT RE-SALE. THEREFORE, A PROPERTY WITH HIGHER MONTHLY EXPENSES MUST LOWER THEIR ULTIMATE ASKING PRICE TO COMPENSATE FOR AFFORDABILITY OR ELSE IT WILL NEVER SELL. ON THE FLIP SIDE, A PROPERTY WITH VERY LOW MONTHLY EXPENSES CAN GET AWAY WITH A HIGHER ASKING PRICE ON THE OPEN MARKET.This is such an important factor for any prospective home-buyer to understand! If you are paying $1,300 a square foot for a 1,000 square foot Junior 4 apartment in a new development, with monthly maintenance of $875 and real estate taxes of $115 (due to the 421A tax relief), what happens after the abatement expires and the actual assessed real estate taxes kick in? That $115 in monthly costs to you will now shoot up to about $600-$700 or so, perhaps even more, making the property less affordable? When you go to resell, your the one without a chair when the music stops!
Now lets apply this to real life and specifically look at a new development that was granted a 421A Tax Abatement, to get a better idea of what I am saying. On a recent visit to The Ariel West sales office, my client was considering purchasing a new apartment that was benefiting from a 421A tax abatement for 10 years. Here are the details of one of the property's we were looking into:
245 West 99th Street - Ariel West Apt. 21A
Size: 2,526 SFT
# Beds: 4
# Baths: 3.5
RE Taxes w/ 421A: $201
Price Per Sq. Ft.: $1,386
Marketed By: Corcoran Sales Center
Now, the number that is important for sake of this discussion is the monthly real estate tax of $201 for this apartment. The way abatements/exemptions adjust is that every 2 years the monthly real estate tax rises 20% until maturity. At least that is what I originally thought. When I decided to put the sales agent on the spot and asked him what the assessed tax value of this apartment would be AFTER maturity of the abatement, we were shocked to find out the formula isn't as simple as a 20% adjustment every 2 years until maturity!
In fact, once the 421A tax exemption expires in 10 years the annual tax costs of this apartment would be approximately $31,000, or $2,583 a month! You should have seen the sales agent's face when I told my client of my concerns right then and there.
I ask you:
HOW MUCH CAN MY CLIENT REALLY SELL THIS APARTMENT FOR IF THE MONTHLY'S JUMP FROM $2,492 A MONTH TO $4,875 A MONTH IN 10 YEARS?From a seller's standpoint I would have to inform my client to lower their asking price to compensate for the now much higher, monthly expenses of this apartment. Sure you can try to ask $4.5M, but that doesn't mean you'll get it! In the end, my client decided to pass on this deal as they were hoping to keep their monthly expenses closer to the $3,500/Month mark. Smart move if you ask me; but then again the people buying these very expensive new developments usually have the luxury of not worrying about money.
Most people don't have this luxury!
Here is how the tax abatement gradually expires:
EVERY 2 YEARS, 20% OF THE ABATED TAX TOTAL IS ADDED TO YOUR MONTHLY REAL ESTATE TAX PAYMENTS UNTIL MATURITY.
For example, if you just moved into your new development property and your real estate taxes start at $100/month, and mature at $800/month, then there is $700 of abated taxes. In 2 years, 20% of $700 (or $140) will be added to your monthly expenses bringing it up to $240/month. In another 2 years, 20% of $560 ($700 - $140 = $560 left) will be added to your monthly payments, and so on until maturity.
UrbanDigs Says: The 20% every 2 years hype is usually misunderstood. Instead, ask the developer's sales team to tell you what the actual taxes will be upon expiration of the 421A tax abatement BEFORE you buy so that you are fully informed of what you are getting into! I know for a fact that every new development is different and some neighborhoods will not experience what I discussed here (such as 70 Washington in DUMBO, Brooklyn), so make sure to go out of your way to educate yourself on this very important factor before you sign that contract and put your deposit down!
Quick Tip: No rocket science here. Look to sell your new condo when there is still 5-6 years left of the tax abatement so that you are not left without a chair when the music stops. By unloading when the monthly expenses have not yet reached their peak, you will be able to get a higher asking price before the monthly expenses top out and restrict affordability.