Immediate impact of Rent Regulation Changes

Thanks for the real world update. I will be curious to see the medium/long term impact of these changes on the overall market condition.

Does your cap rate estimate above include capital reserves to maintain the building - roof, windows etc?

Personally I am glad that I resisted all temptations to buy a multi-family with rent stabilization purely on principle as I did not want a constant reminder of socialism in form of rent stabilization. My take is that cap rate will be appx 4.5 percent after accounting for periodic expenses to maintain the building and reasonable managing agent fee. In most cases, advertised cap rates in NYC are overstated by 50-75bps. So in market parlance, low 5 percent.

And none of the performa bull shit.

Very sad to see the construction jobs being impacted.

When this policy actually results in less rental inventory and worse quality over time, I'm sure the exact same groups will be shocked and demand even more rental protection. Reminds me of the debate in SF over skyrocketing rents, where the proposed solution was even more rent control.

30Y / 300: Question for you - wouldn't this encourage landlords to try to sell these units instead? Maybe even more inventory headed to the market soon?

These units are not vacant. So does not add to the coop/condo inventory. Guessing that is not the inventory you were asking about.

As far as small size ($2-$10mm) multi-family building inventory with rent stabilization, the market will be flooded with inventory but frozen for a while the new cap rate gets discovered, new buy out package levels get somewhat established, and lenders gets used to new cash flow projections.

Thoth,
A lot of owners think these will be overturned on way or another (I don't agree, maybe some pieces but by and large I don't think so). I would think a likely result of that is that they will simply leave very low rent apartments which they can no longer increase rents substantially in vacant and wait. If they do this it will drive up the vacancy rate and they will argue that Rent Stabilization should be abolished.

As far as selling units:
If a building is already a Coop or Condo, then vacancies of Rent Stabilized units already fall out of the program so there wouldn't be a need to sell them as opposed to renting them. However we were just talking in the office today that this could spur a new wave of Coop/Condo conversions to get out from under RS just like occured in the 1980s.

As far as buyout package levels I don't see how they could go up since you can't even justify the current levels if you can't raise the rent substantially. And if they go down I don't see anyone taking them. Especially since the low rent units just got more valuable to existing tenants since their protections got increased.

Some landlords who have tons of preferential leases have really gotten hit if they were planning on moderate increases and now will be constrained to RS numbers.

This might be a good side for the RE market. There are less market rate units entering the market, then rents go up, it will push selling prices go higher.

IT is also a good thing that there are less jobs for contractors, so they might be willing to lower renovation prices for competition. That's good for potential buyers to jump in, coz renovation cost often kills the deal.

30Y: Yes, I was thinking of conversions of the building as a whole. If I'm a landlord faced with a building where a lot of units are protected, what stops them from deciding to convert the entire building into condos because of these new laws? Is there anything in place that would prevent this?

Even if you convert to condo, rent stabilization stays but not sure what rules in terms of escalations and major capital improvements related charges apply to rent stabilized tenants after conversion.

1 is the cost, the second is that you would have to get 15%of the Tetons to actually subscribe to your plan in the case of not eviction or 50% in the case of an eviction plan.

300 / 30Y: Thank you. It's expected, but still tragic that no one seems to have considered an alternative of allowing more development to increase supply. What a novel concept.

Rent-stabilized tenants will have to pay market rent for new development instead of free loading. I would have thought that at least luxury decontrol was untouched. It is just a legal form of taking away selected private property.

I think it's important to understand how we got here. There were some building owners who were clearly using extralegal measures to increase vacancies/revenue (like constructive eviction through construction harassment, filing for work permits signing that buildings were 100% vacant when in fact they were largely occupied). We also had owners taking tax abatements in return for agreeing to Rent Stabilization Regulations and then simply ignoring those commitments. It got to such an agregious point that the backlash threatened to unseat legislators. So, like everything else in Real Estate, it's never even but swings from one extreme to the other. The 1993 Rent Regulation Reform Act and subsequent City Council bills went too far in opening a door to landlord abuses and now legislators who probably don't really understand all the repercussions of their actions have swung things back in the other direction.

Well, the city should have cracked down on illegal measures. But I understand the power of votes and politicians’ incentives when a small percentage pays a large percentage of taxes. Free loaders are very vocal.

What happens when the tenant dies? Will the apt. still be regulated with the same renovation limits as opposed to the tenant leaving/ moving out? Also will the concept of owner buying the lease from stabilized tenant become a thing of the past?

AFAIK there is no di

Difference if the tenant moves out alive or dead. Tenant buyouts can continue, but the incentive for landlords to do so is greatly diminished since their ability to raise rent has been curtailed.

What about the newer 80/20 buildings...

All those 80% apartments are stabilized... if developers were banking on improvements to keep rents at market rates they'll likely be below market within 5 years.

More importantly, a lot of those 80/20 had all the "market" tenants of preferential rents. So even though they were technically Rent Stabilized they were getting real annual increases. No that preferential rent is gone....

https://therealdeal.com/2019/06/18/analysis-heres-what-the-new-rent-law-will-do-to-the-average-stabilized-apartment/

https://www.wsj.com/articles/community-bank-stocks-hit-by-new-york-rent-reform-11560855601

Yes, I had the same response as 30 years had. So many landlords abused even their lenient rules, that the pendulum swung back, perhaps too far.

WSJ article talking about 20-40 percent price drop for rent stabilized buildings. I think it will be closer to higher end. A large percentage of bank loans are likely safe as they were underwritten on current rent roll and LTVs from the limited set I have seen got to only 65 percent or less. If landlords do not have any incentive to manage the building as they do not have equity, banks may take another 5-15 percent hit on their loan in foreclosure scenario putting the property price down 40 percent for rent stabilized.

https://www.wsj.com/articles/new-york-landlords-in-a-financial-bind-from-new-rent-law-11561201200?mod=mhp

That ignores to so called "Predatory Equity" loans (defined as a loan where the current rent roll can not support the operation of the building plus debt service so the borrower would NEED to displace Rent Stabilized tenants just to hang onto the building). And before you go saying the Wall Street Journal said that doesn't exist, it is common enough that there was a law passed last year to safeguard tenants - https://www.nysenate.gov/legislation/bills/2017/s8675
Which was the precursor to the recent revamping.

30, I do not trust anything a bank executive says about soundness of their own company in the face of bad news. No one goes to jail for making optimistic statements or optimistic business decisions. Dick Fuld being a perfect example.

But curious about your estimate of predatory equity loan percentage for rent stabilized multi family.

It's a low percentage, but not infinitesimal. Even if it's only 10% (and I have a feeling that it's more), it's weighted in certain neighborhoods and 100% of them are stuck underwater permanently. There are also a lot of owners who have been doing cash out refis with questionable docs (especially ones anchored by a single retail tenant).
You are absolutely right that the majority of loans are safe. But do you know what happens to markets where "only" 10% to 20% of loans go tits up?

Where would you put range of percentage decline for properties which are appx 50 percent rent stabilized? And say more than 75 percent rent stabilized? No retail component.

Or where would you put the cap rate on existing cash flows less allowance for periodic maintenance, legal costs which will not be covered by rent increases. I think 1 percent spread over financing rate.

there will not be a rush to coop or condo these buildings as there was in the 80's because they changed those laws as well. It used to be that if you got 15% of the units sold (did not have to be to tenants) then the plan could be declared a non eviction coop. New law says 51% have to buy and they have to be insiders. Will be too difficult to do

That means less inventory, and will push the price higher?

She's back! Hi KM!

I thought it had to be 15%/51% of each class.

Hopefully this will work: this is (if it shows up) a screen capture on the Loopnet activity for 12 unit RS building in Woodside:

https://photos.google.com/u/1/album/AF1QipMbILSXOiMG5KK2nNRjvxPpCP8Kt1s1PPAh_KvI

Question: what do the wise minds here think will happen to small multi-family in great area of Manhattan, delivered vacant and with no RS issues.

The simple answer is "whatever happens to the rest of the market" but I also think there may be some impact from this because if it knocks a significant amount of the players in the "I buy small buildings" market out, they won't be buying buildings without issues either and then that affects overall demand for the product.

anecdotally it seems like multifamily deals have fallen off a cliff

https://www.crainsnewyork.com/real-estate/slump-multifamily-sales-costing-millions-tax-revenue-rebny-finds

https://rew-online.com/2019/09/multifamily-values-%CA%BBsucker-punched%CA%BC/

We're certainly living in interesting times...

Where do people see CAP rates for fully rent stabilized multi-family with most rent raising improvements already in place in "still a little iffy" areas of BK where the market will start to trade again? I realize it will take at least 6 more months for the market to start moving again.

I am thinking 6-6.5 cap rate (vs say 4.5 cap rate before the rent law change) based on current NOI as NOI will only decline slowly as the expenses and taxes go up faster than Gross Income.

Depending on the building and neighborhood that might be a little on the low side. If the building is in East New York or other areas where there is a higher probability of collection issues plus in bad condition that might not be enough.
I can tell you that a building that I had a contract out on when the law changed at 5% cap rate would take >7.5% cap rate to transact today and that's in a relatively decent neighborhood (Woodside) and in decent condition.

To give an idea of how things have changed I'll illustrate using my usual benchmark of Stuyvesant Town/Peter Cooper Village. For the past several years availability has generally ranged between 140 and 250 units (seasonal variations). Right now their website shows 97 available. So there are probably 40+ units which they are either carrying vacant or having to rent substantially below market which is probably chopping $500k to $1 million a year off their income (and that's just for the current set).

Thank you. I think 2.5 cap higher vs before is reasonable. The cash flow growth is negative. So IRR may be better approach using projected cash flows.

And if the current taxes are very low relative to rent roll, could be 3 to 3.5 cap higher vs before to maintain the same unlevered IRR (probably 6-6.5 percent) as the city will keep on raising the taxes by 5-6 percent every year till the time taxes are in line with other multifamily of appx 30 percent of rent roll. Media will say that cap rates are all over the place as cap rates are not a meaningful measure any more.

Also a lot of cap rates presented by brokers are totally bull. Last week I looked at an ad for a listing in the East Village which had little info except an asking price, a nice claimed cap rate, and total expenses of $69,000. But when I looked up the current RE taxes they were over $60,000.

Of course. Listed cap rates are off by at least 50bps in 90 percent of cases. No one accounts for “capex reserve” which is meant for periodic rather than routine needed repairs such is window replacement, boiler upgrade, roof replacement etc. J51 abatement is included as if it will continue for ever. Most people will do their own numbers any way.

I'm still seeing listings talking about units in RS buildings as "free market" and "projected rent rolls" including increases way more than any legal under the new regs.

Speaking of RS, what do you think this one is worth?

https://streeteasy.com/building/116-west-81-street-new_york/

Entirely RS, attractive facade. Prime UWS park block, not recently renovated but good bones and well-maintained. The 5 units above the duplex together pull in $6400/mo. The duplex is RS too, but if owner-occupied, perhaps is worth the equivalent of $7000 (more if renovated). Expenses are estimated at $7700/mo by the seller. Net income $5700 incl the owner's duplex. At a 4% unlevered cap rate, it's worth $1.7M, a far cry from the $4M list price. Curious what others think.

I am assuming that duplex can be owner occupied without any issue. Renovated rent for someone who want to have a garden in a town house is $10-12k after $600k nice reno. Call it 11k. $17,400 rent roll less $7700 expenses. $10k appx. $2.4mm ($3mm less $600k reno) at 4 cap. Financing for 10y will be appx 2.7 percent if owner occupied vs 4.1 percent for normal multifamily. So some may pay 3 cap. $3.4mm. That is probably market. Then there is a possibility of owner use of the floor above parlor floor after vacancy.

I like a little more space than the duplex offers - say 500 more square feet. Otherwise, I would personally buy I close to $3mm plus extra $500k for 500 sq ft if it were to have that space - and I am always low balling when I buy.

I like a little more space than the duplex offers - say 500 more square feet. Otherwise, I would personally buy IT close to $3mm plus extra $500k for 500 sq ft if it were to have that space - and I am always low balling when I buy.

I agree with you George, no reason to be handcuffed via rent-stabilized leases at this price point for the luxury of living in a duplex. Plenty of fish in the sea that won't be so restrictive. I'd rather just rent or buy a nice condo/co-op. Actually, I would just buy a very nice home in Brooklyn!

Interesting that the group came up with much higher prices than I did for this one, particularly since only a few messages ago people were throwing out cap rates as high as 7% (albeit in iffy areas). I guess my $7K assumption for the unrenovated ground floor is too low, but note that all the photos were virtually staged except the kitchen; the place is in estate condition. Ultimately I came down like Kevin - the handcuffs of RS leases mean I'd want better than a 3% cap, and I don't put as much value into the park/museum block as some others. From a personal perspective, if I didn't occupy the duplex, it would still be RS, and fetch only about $2800, in which case the building is almost underwater.

Ha. The key difference is owner occupancy (assuming without any hassle) in a prime area in a beautiful townhouse. It changes the cap rate completely. 7 percent cap rate I mentioned is for full stabilized crappy but good condition building with currently low taxes relative to rent roll. For this one, the taxes are already pretty full at 30 percent or so of rent roll so taxes will not continue to increase for ever. Just go to Bed Stuy. You will get your 4 cap easily without rent stabilization.

I am assuming that you read this which lowers the cap rate
“ Financing for 10y will be appx 2.7 percent if owner occupied vs 4.1 percent for normal multifamily”.

As far as I know what wasn't changed was the ability of an owner to reclaim RS units for personal use. The play is to use that to turn this into a single family.

That is much harder now without vacancy.

Owner-use loophole - Under new laws, landlords and their family members will no longer be able to remove rent-stabilized tenants from multiple units to use as their own residences, a method to evict tenants and commonly used to raise rents. Now tenants who have lived in a unit for over 15 years or more will be protected from eviction by the owner. Landlords will be held accountable to claim “owner use” for only one apartment to use as their primary residence. Exceptions will only be made if there is “an immediate and compelling necessity” for the landlord to use the building.

https://www.cityandstateny.com/articles/policy/housing/what-do-new-yorks-new-rent-regulations-mean-literally.html

30, Where do you think it will trade?

The upside here is to vacate the place thru buyouts and vacancies when tenants die (not evictions), then do a big reno into single family. That can be reflected in a cap rate. The fact it's on a nice block should go into the rent an owner pays himself, not the expected yield on an asset (or cap rate)

George, What do you think the buyouts will cost in total?

Is there any way to tell? One apt and the duplex are vacant. That leaves four. One tenant is very old and can't climb stairs easily. The others might be tough.

Don't forget there are succession rights as well.

And an older person marrying a younger person just to spite the landlord.

https://www.propertyshark.com/Real-Estate-Reports/NYC-multifamily-sales

https://www.nytimes.com/2019/12/26/opinion/new-york-evictions.html

https://commercialobserver.com/2020/01/its-tough-out-there-for-smaller-landlords-in-the-wake-of-the-rent-reforms/

https://therealdeal.com/2020/01/07/d-day-for-landlords-high-court-hears-rent-overcharge-cases/

It's not surprising given the target readership, but I had to laugh at the banner ad at the top of the TRD article, offering a free trial period for "eviction assistant", an online tool for filing and managing eviction cases.

Probably some pissed off VC there ;)

This is kind of the definition of "Predatory Equity" (where a bank lends more than the current Rent Roll can support on the assumption that the borrower will be able evict long term tenants and substantially raise rents) and the results could have easily been predicted under the new rent laws (but this actually occured well before that and the litigation screwed all the principals).
https://therealdeal.com/2020/01/21/raphael-toledanos-ghostly-east-village-portfolio/

https://nypost.com/2020/01/30/more-bad-news-for-nycs-housing-market

https://www.wsj.com/articles/buyers-return-after-rent-control-slams-new-york-apartment-values-11580817601

Some disinformation in this article:
"“This is bad news for a city and state already facing down big budget gaps,” Mr. Whelan said Monday, arguing that a “fire sale” of regulated buildings would mean lower valuations and thus less money in the form of property taxes collected by the city."
Valuations going down doesn't impact the amount of Real Estate Taxes New York City collects. The City decides how much money it wants to collect from Real Estate Taxes and Assessed Valuations merely decides how the bills are apportioned.

However the real takeaway from the article is now that both buyers and sellers have adjusted to a new reality in terms of prices, the speculators which defined the market are being replaced with the long term owners who were always the bread and butter of the deals on these types of properties.

The rent-stabilized properties have another 10-20% to fall on top of 25% down as reported. Taxes and expenses will go up but the rents will not go up enough to offset.

I think a lot of that depends on how many are under water in terms of current rents not covering current expenses (including debt service) because almost all of those have to sell (some may be able to afford to float the difference for a while but my guess is that most can't). For those that are in the black but were selling because they were getting offers too high to turn down I think they will simply go back into long term hold mode. For those they simply won't transact at the new market prices, especially because selling will trigger huge tax consequences.

Rents not covering expenses will only get worse at current prices. So prices have no where to go but fall for rent stabilized assuming no change in law and historical rent increases allowed by the city.