As the debt market goes, so goes the real estate market. Banks play a pivotal role in driving transaction velocity and pricing power. However, many banks are slow to adjust their strategies to shifts in the rent-regulated market, either failing to recognize changes or lagging a full year behind in response. With COVID-era financing reaching maturity over the next 18 months, banks must take proactive steps to facilitate refinancing, workouts, note sales, deeds in lieu, or short sales.
The Challenge with Rent-Stabilized Notes
When a borrower defaults, a lender’s first option is typically to work out the loan. If that fails, they pivot to selling the note. However, this process has become increasingly difficult due to several market factors.
Five Factors Depressing Note Sale Valuations:
- Timing: Foreclosure in New York takes a minimum of two years, and borrowers can delay the process further by filing for bankruptcy before auction.
- Incentives: With negative economic incentives, borrowers are not motivated to maintain or improve collateral during prolonged foreclosure proceedings, further depressing values.
- Paperwork: A large portion of a property’s value lies in its legal rent documentation—held only by the borrower. Without transparency, note buyers are left in the dark.
- Financing: Note-on-note financing is difficult to obtain, costly, and generally inaccessible to retail investors.
- Buyer Mismatch: Lenders seek fee-simple pricing, while the note-buying market operates with different risk expectations and valuation models, leading to substantial pricing disconnects.
The Big Takeaway: Borrowers Still Hold the Cards
Three of the five key factors above are directly influenced by borrowers. Contrary to past cycles, this leverage will likely increase over time. With thousands of foreclosures pending, New York’s courts will face severe backlogs. There is no legislative movement to improve rent-stabilized asset values, exacerbating the cycle.
Consider this: A building we recently sold for $550,000 had previously traded for $8.8M in 2017—a striking example of how the Housing Stability and Tenant Protection Act (HSTPA) has impacted valuations.
Banks Need to Rethink Their Strategy
To maximize recovery, banks must incentivize borrower participation in short sales. While this approach may seem counterintuitive to traditional banking principles, failing to do so will result in deeper discounts as distressed supply floods the market.
Hypothetical Loan Sale:
- Option 1: Sell a note for 40-50 cents on the dollar with no borrower transparency. The purchaser buys the note cheap enough that they can immediately approach the borrower and offer them 10 cents for the deed. The borrower just found 10 cents that they never were going to get until the lender was forced to fire sale the note.
Outcome: Buyer wins, borrower wins, bank loses. - Option 2: Get lucky and sell the note for 70 cents to another large institution that doesn’t really know what they’re buying. Borrower ends up doing the same song and dance with that lender while the collateral continues to depreciate.
Outcome: Buyer uncertain, borrower loses, bank secures a lucky win but not a repeatable strategy, tenants lose as collateral continues to fall into disrepair. - Option 3: The borrower is part of the loan sale process and can tell the buyer and bank they would be willing to walk away for 10 cents. The buyer can now pay 10 cents to the borrower and 70 cents to the bank (much better than what they were willing to pay in Option 1).
Ideal but unlikely scenario: If necessary, lender offers borrower 5 cents to be useful and compliant to get the buildings sold to maximize proceeds. (“Show me the incentive and I’ll show you the outcome” – Charlie Munger).
Outcome: Buyer wins, borrower wins, bank gets an extra net 20-30 cents.
The Challenge Banks Face:
Banks seeking to sell notes must balance maximizing proceeds while executing sales at scale. However, achieving both simultaneously is nearly impossible:
- Scale transactions involve multiple borrowers, complex workout scenarios, and a limited buyer pool, making execution difficult.
- Maximizing pricing requires one-off deals with borrower cooperation—something not feasible in bulk transactions.
Absent a new approach, bulk note sales will likely clear at 50 cents to Wall Street and Fortune 500 firms instead of higher values through structured solutions.
Our Solution:
The New York Multifamily Group and Mission Capital Advisors have developed a platform called “Bridge The Gap” that allows lenders to offer notes for sale while simultaneously incentivizing borrower participation in a deed in lieu or short sale. This gives lenders two potential exit paths instead of just one—maximizing recovery while expediting resolution in scale.
The key takeaway is that the lender cannot maximize proceeds without participation from the borrower, and the borrower cannot escape the assets without participation from the lender—cooperation is required.
Our Solution Won’t Work For Everyone
This is not a one-size-fits-all solution – I acknowledge it has its limitations. Some borrowers may be reluctant to participate in this program for the following reasons:
- Commitment to Fight: Some borrowers are determined to hold onto their properties and will exhaust every option before considering an exit.
- Strategic Repositioning: Others may see this as an opportunity to repurchase their own debt at a discount.
- Recapitalization Play: Some borrowers may use the situation to bring in a new equity partner at a lower basis, wiping out the LP while allowing the GP to collect additional fees.
- Tax Implications: Low-basis sellers face significant tax burdens, including depreciation recapture, making a walkaway financially unappealing.
This approach isn’t for everyone, but for those seeking a structured exit, it offers a viable path forward.
What’s Happening & What Should I Be Thinking About?
The wall of maturities of rent-regulated buildings in 2025 and 2026 is enormous. This is a problem that can no longer be swept under the rug. The 10-year treasury is floating around 4.25% and seems just as likely to rise as it does to go down. Powell indicated no changes are likely at least until the second half of the year. DSCR are up to 1.30 on tighter underwriting and higher expense ratios. Capital expenditures are adding up, and the market hasn’t yet priced in lead remediation—this will start to happen in the second half of 2025 once fines start being assessed.
Political Considerations:
- Federal: Real estate prefers red over blue, but when Trump won in 2016, NYC revolted and elected DeBlasio and AOC. Progressives lost big-time in November 2024, and I hope voters in NY continue to remove these people from office.
- State: Hochul is up for reelection in November 2026—a lifetime away. She’s neither friend nor foe to rent-regulated housing. A pro-growth real estate mind hasn’t entered the picture yet. Ritchie Torres is rumored to be considering the position, which would be fantastic for rent-regulated housing.
- NYC: Mayoral election November 2025. Who knows if Adams will even be in this race. Consider the candidates and their positions on our industry. They appoint three out of nine RGB members and set the tone to the media and local council members. Six years after he signed HSTPA into law, ironic isn’t a strong enough word that our industry might rely on Cuomo to bail us out of the mess he made. Lighten up!… if you don’t laugh, you’ll cry.
2025 Outlook:
Q1 is significantly better than Q4, as evidenced by higher BOV counts, more listings coming to market, more debt maturity, and motivated sellers looking to move on. Buyers are more and more likely to make a bet that something will have to change within a reasonable holding period of 5-10 years and are crawling out from everywhere for the right opportunities.
We are entering a perfect storm where expectations are being met, low-levered sellers are tired and open to less burdensome opportunities, and buyers realize that buying the dip in New York is a good idea.
2025 is off to a busy start! If you’re navigating the challenges of the rent-regulated market, we offer strategic solutions to help maximize value. Contact us to explore your options and look out for more advocacy moving forward from our team on your behalf!
