NY Rental Property As Good As T-Bills?

Posted by jeff

Mon Jun 16th, 2008 09:38 AM

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Way back last summer my friend Mike Stoler wrote an article in his column in the New York Sun about how some investors were viewing the New York residential rental market. The piece was entitled Investors Compare Manhattan Buildings With T-Bills. Being a skeptic like me, I was certain at the time....as I am today, that Mike raised an eyebrow when Israeli real estate mogul Ofer Yardeni said "We truly believe that owning apartment buildings in Manhattan is as secure as owning treasuries with upside in value creation." Now Yardeni is as smart as they come. He buys under-managed buildings that are of high quality and in desirable locations, and his fund doesn't employ high degrees of leverage. He has been an avowed bull and buyer through this downturn and I am sure he will make out fine. It's just that comparison he made..."as good as T-Bills"...it's the kind of thing people say at market tops. Maybe it was that Yardeni realized that the full faith and credit of Uncle Sam wasn't going to be quite as highly valued in the future or that T-Bills were going to become a loser of an investment. Today they offer negative real (adjusted for inflation) returns. But all kidding aside, many of the investors in Manhattan and New York City rental buildings are neither as smart as Yardeni nor as conservative in how they finance deals, and a confluence of events are making life tougher for leveraged rental landlords around the city who have any of the 1.2 million rent controlled or rent stabilized apartments in their buildings. Rent regulated buildings have been a magnet for investors the last couple of years; you see clever real estate investors in New York realized a long-time ago that the market is distorted by the lack of buildable airspace and the existence of rent control regulations. With regard to the latter, they figured out that there was embedded value in all rent controlled buildings that was not expressed in the current net operating income generation of the buildings. Over time, attrition combined with several aspects of rent control regulation would allow rents on rent controlled or stabilized units to rise from synthetically depressed levels to market levels. Owners of rent regulated buildings were in a position to capture this upside, with very little risk due to the high occupancy of New York residential buildings. You see, as one would suspect, the holders of rent controlled or rent stabilized apartments try to hang on to them as long as possible and not get thrown out for missed rent payments or any other reason. So in a rent controlled/stabilized apartment, you essentially have a tenant base that tries very hard not to get thrown out for non-payment, coupled with very high occupancy, but natural attrition (death and major life changes) that would translate to a certain number of people leaving every year and certain regulatory thresholds that de-regulate your apartment base over time. It's all good.

The only problem is that these types of investments include a perverse incentive to try to expedite this natural attrition rate, thereby raising your return on investment, This incentive is heightened if the landlord pays a high price for the properties purchased and uses lots of leverage. I'm not saying any tenants have been pre-maturely sent to the next life by avaricious landlords trying to get them out, but landlords have incentives to make current tenants of rent controlled or stabilized units less than comfortable, shall we say, thus pulling forward their move out dates. Of course, these perverse incentives, coupled with avarice and leverage seem to have resulted in some anti-tenant behaviors, which one would of course expect. To wit, complaints against landlords accusing harassment of tenants rose almost 31% in 2008, according to a quote in the Daily News by by Leslie Torres the State Deputy Commissioner of Rent Administration.

A backlash has been brewing as a result of these trends.

The New York Times pointed out in an early May article that "Private investment firms have been amassing what seem like unusual stakes in New York real estate: they have bought hundreds of apartment buildings with thousands of rent regulated units across the city that produce decidedly meager returns. As regulatory filings and promotional materials show, the companies expect to generate higher returns quickly by increasing rents after existing tenants vacate their units. Their success depends upon far higher vacancy rates than are typical in rent-regulated apartments in New York."

The Village Voice did an article in late May titled "Wall Street Takes Dead Aim at Affordable Housing in New York City" To paraphrase the article, "Some 30,000 rent-regulated apartments are lost yearly due to rising rents. Now, Wall Street investors have devised a strategy poised to take an even bigger bite. Under this approach, private investment firms, backed by large banks, purchase buildings in working-class neighborhoods and then aggressively challenge the identity of as many tenants as possible. The apparent aim here is to replace as many people as possible with higher-paying residents, while taking advantage of the lax enforcement of rental-housing laws. So far, it appears to be working. The Association for Neighborhood and Housing Development reports that the turnover in many buildings purchased by these private-equity firms has been as high as 25%. We are not talking about small time players here - see the New York Times article on Tishman Speyer Properties' record breaking $5.4 billion purchase of Stuyvesant Town and Peter Cooper Village and the heavy handed tenant treatment supposedly being meted out.

A recent article in Crain's New York highlights several pro-tenant bills that are being considered by the New York State Assembly Housing Committee as a result.

Bill A.74I6A seeks to repeal the vacancy decontrol aspects of rent control, whereby, once an apartment rent exceeds $2,000 per month, the unit becomes deregulated once the tenant vacates. Bill A.10055A would reinstate prior restrictions regarding changes to preferential rents. Perhaps most onerous of these bills for those looking to step up rent regulated rents to free market levels is Bill A10647, which would increase the threshold rent level at which apartments would become free market, upon being vacated by a tenant, from $2,000 to $2,700 per month. It would also raise the annual income that would disqualify a renter from eligibility to occupy a rent regulated apartment to $240,000 per year for two consecutive years, versus the prior $175,000. The new levels would also be indexed to inflation.

Finally, Bill A.799 would significantly impact smaller rent regulated buildings' conversion to free market status. This bill would limit the ability of landlords to take more than one unit of a building for personal use. It would also bar the landlord from taking such a unit from a tenant who has been in residence for twenty or more years. For those who want to understand more about these bills and read the justifications for them cited by lawmakers, click here and enter the bill number.

The proposed rent increases for this year for rent regulated apartments, as promulgated by the New York City Rent Guidelines Board, look to be on the higher side of recent history, as well they should. The final of three rent control guideline board meetings will take place on June 16, with the vote to be held June 19. This chart from the NY Post shows, what the rent increases have been over the last several years and the proposed rent increases for 1 and 2-year leases to be renewed between October 2008 and September 2009.



With oil hitting new highs daily and natural gas going along for the ride, you can imagine that landlord fuel costs are rising quickly. Imagine for a moment that you bought a building on a highly levered basis, projected increased rents through high rent regulated tenant turnover and moderate expense increases....I promise you many building buyers did. The combo of soaring fuel costs, a crackdown on tenant harassment and tighter bank lending could put a serious squeeze on some building owners in the years to come.

So, you say, what does this have to do with me, the residential real estate buyer? To which I am forced to reply: not all that much. If you are currently a renter of a rent regulated apartment, don't be surprised if you get bullied by your current landlord as a result of their quest for turnover. Additionally, don't be surprised if your landlord ends up in financial trouble and your building eventually changes hands as a result of some investors quest for free market rents being foiled by new regulations. If you have a great rent controlled apartment, hold onto it like it's your long-lost twin, it really is better than T-Bills, despite your rent probably getting jacked up a little this coming year. Additionally, the quality of life issue comes into play, unhappy residents, being harassed by landlords or buildings being foreclosed on by banks because owners can't refi their loans, just aren't good trends for New York City. I know that's not all that much, but for readers who are interested in the New York commercial real estate environment and news on how investment opportunities are changing, I hope this piece was educational.

From the Blogosphere:

Tenants say investment firm is harassing to cash in

Without Major Action Housing Crunch Will Only Get Worse

The Fight For 47 east 3rd Street

Rent Stabilization - part of this neighborhood

Some Slack?