The Scene in 2019: What to Expect in the NYC Multifamily Market
“In the past, censorship worked by blocking the flow of information. In the 21st century, censorship works by flooding people with irrelevant information. In ancient times, having power meant having access to data. Today, having power means knowing what to ignore.”
—Yuval Noah Harari
New York City multifamily owners are bombarded with an overwhelming amount of information they need to process. What information really matters? As our team looks at the current environment, we believe 3 trends deserve focus in 2019.
1. Rent-Stabilized Buildings are Less Profitable Compared with 10 Years Ago
The profitability of rent-stabilized buildings is influenced by legislation. Almost 21 years ago, New York City’s “Rent Regulation Reform Act of 1997” created new opportunities through a new rent-increase formula, changes to succession rights and other provisions.
Since then, policy adjustments in 2011 and 2015 (remember the rent regs act of 2015?) have chipped away at those opportunities by again changing the method for calculating rental increases. That 2015 law expires in June 2019, and we expect new legislation to further erode opportunity in the rent-stabilized space.
Today, investors of rent-stabilized properties are:
• Paying higher real estate tax increases on rental growth
• Facing costlier buyouts
• Enduring higher compliance costs
• Experiencing higher renovation costs
For example, in the past an investor who raised rents through vacancy decontrol and Individual Apartment Improvements (IAI’s) would realize about 80% of the increased rent as profit.
Today, only about 40% of rental growth falls to the bottom line, primarily due to phased in RE tax increases and the other factors referenced above. This is an impediment to values growing.
2. Free Market Buildings Offer Higher Cap Rates and Lower Risk
As the opportunity around rent-stabilized properties decreases, investors are finding that free market buildings offer higher cap rates with lower risk.
I recently met with an investor who is changing his approach. In the past, he’s only invested in certain areas of Manhattan. Today, he’s under contract on a very large new construction asset in Queens. His rationale: Why buy a building at a 2% cap rate and try to raise it to 5% when he can purchase a 5% cap rate as-is.
Repositioned assets come with 3 major benefits:
• No Work: There are no renovations to be made.
• No Turnover: The tenants remain much more stable.
• No Risk: Your investment isn’t affected by new legislation.
When you choose free-market properties over rent-stabilized opportunities, there are additional challenges to navigate. But, in 2019, we expect to see more investors choosing those free-market challenges over the challenges rent-stabilized properties present. I have explored this subject further in a past post you can find here.
3. “Cash-In” Refinancings Will RELUCTANTLY Force Buildings to Market
As interest rates have risen, certain owners and their banks will be faced with tough choices this year. For example let’s take an investor who purchased in 2014, with financing at approximately 2.75%. Since many loans had five year fixed terms, he’ll need to refinance in 2019. Today that loan will quote at around 4.5% and—to maintain loan covenants— the bank will also request a loan paydown. So he is now forced into making a choice between of the best of two bad options. Refinance at a higher rate and invest more cash, which will reduce free cash flow OR sell at a break even or potential loss.
This is going to happen across New York City in 2019 and 2020. Interest rates have risen about 1.5% since the number of sales peaked in 2014 and 2015. Many of those loans will start coming due next year.
The lesson: always finance late-cycle purchases with 10-year debt. In the meantime, the expiration of these 5-year loans may reluctantly push properties to the market this year.
On the positive side of market news, in the next 12 months we will see a dramatic reduction in the new supply of rentals across NYC. For example, in 2018, 22,448 new units were slated to be delivered to the market…..in 2019 that number drops to just above 5,000! A drop in the bucket compared to the size of our market.
Even though it doesn’t feel like it today, rents are poised to grow in the next 24 months. The future economic growth of this city is undeniable — as evidenced by the Amazon announcement and Google’s latest expansion. Overall, the long-term opportunity for investors continues to be outstanding, one will just have to be more selective!
Best of luck in 2019!
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