Rising Rates and Inflation: What Should Multifamily Investors Do?
BY SETH GLASSER
Now that we have the HSTPA of June 2019 in our rear-view mirror and COVID-19 mainly an afterthought, owners of rent stabilized apartment buildings in New York are putting their investment plans in place for the future. Common questions owners are asking themselves are: What should I sell? What would I exchange into? How does this building fit into my long-term financial plan? What does owning this building do for me?
The answers to these questions are highly personal and depend on age, participation of heirs, tax consequences, management capabilities, opportunity cost, and where they want to spend their time and energy for the foreseeable future.
Since 6/14/2019 buying rent stabilized buildings has become essentially a fixed income commodity. Each June, the Rent Guidelines Board instructs owners how much they’re allowed to raise their stabilized rents, yet operating expenses are out of their control and seem to be rising year over year. This unforgiving business model is causing a consolidation in the market, whereby smaller landlords are selling to larger, better capitalized buyers.
So, what should you do?
Because raising NOI is so prohibitive, it’s my belief that values of rent stabilized buildings are now more than ever tied closer to interest rate movement. There is more of a direct and immediate impact on cap rates when treasuries rise. When interest rates rise, cap rates will be faster to rise on rent stabilized buildings than they will on market rate buildings. The reverse is also true, and we saw that from 2019 through 2021. Interest rates dropped and so did cap rates.
If you believe rising rates and inflation are here to stay, one option is to sell a stabilized building and 1031 exchange into a market rate building where rents can outgrow expenses. Over the years we’ve seen many clients exchange out of a stabilized building and into a market rate building – even willing to buy at lower cap rates than what they were sell for. Their goal was twofold: first, replace their current income, and second, transition into something less management intensive and restrictive.
One example of this would be a client named Bob who sold a 180 unit building in the Bronx and exchanged into 78-unit market rate new construction building on the Lower East Side. For Bob, his cash flow stayed the same, but he improved the quality of his tenancy which was the driving force behind this decision. This had a dramatic impact on his day-to-day lifestyle.
Exchanges can be done within New York or into a triple net leased property outside the city. A recent example of this would be a client named Charles who sold a 20 unit building in Harlem with a $175,000 NOI at a 5.5% cap rate. With his proceeds, he purchased a triple net leased Wendy’s in New Jersey with a $189,074 NOI at a 4.87% cap rate. For him, he was more comfortable knowing what his income would be for the next 25 years than deal with the ups and downs of New York City. Notice how specific I was here – $189,074. This is exactly what Charles will earn each year. Plus, there are 10% rental increases every five years! Charles knew that his $175,000 NOI was his best-case scenario. Excluding major capital expenditures like replacing a roof or boiler, operators in New York know that one raid to the building by HPD or DOB can riddle you with violations and cut into that NOI drastically.
Real estate investors from outside of New York City have a hard time wrapping their head around our business model: buy high and sell higher. As our market and city change we all must adjust our strategies accordingly, but at the end of the day it’s our belief in the strength and resiliency of New Yorkers to withstand all obstacles- NYC real estate investors are some of the toughest entrepreneurs in the country.
If you’re interested in hearing more about how these transformations have impacted previous clients call or email me so we can discuss what this could look like for you!
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