The most common question clients ask me is: what’s happening in the market today? I answer this question with comparable context.  Let’s review how interest rates, property taxes and compliance in the beginning of 2022 are different from the end of 2021. Spoiler Alert! The factors we’ll run through have negative impacts on value, but the result of my findings is that values have remained remarkably stable.

Interest Rates

The 10 Year Treasury in December 2021 hit a low of 1.34%. As of this writing it’s already reached 1.85%! Since the banks determine their lending rates directly off the Treasury, borrowers feel an immediate impact on these changes.

Let’s run through an example: A building with a $500,000 NOI is selling for $10 million and the buyer is getting 70% financing at a 3.0% interest rate. In this scenario, their cash-on-cash return after debt service would be 5.1%. Run the same numbers but change the rate to 3.50%, and their cash on cash would drop by 13% to 4.4%!  For the buyer to get back to the 5.1% cash on cash, the purchase price would have to decrease by 4%.

Property Taxes

On January 15^th, the tax assessments were published for the 2022/2023 tax year. What most owners of tax class 2 buildings (apartment buildings above 10 units) didn’t realize is that their property taxes went down in 2021 due to COVID. On January 15^th the pendulum swung back the other way.  Nearly every building we’ve underwritten since then has seen significant tax increases from the prior year. Let’s quantify the impact of tax increases using the same example as above. A $10 million building has a $1 million gross income and a $200,000 annual tax bill. If taxes rise by $10,000 that comes straight off the bottom line.  This is especially impactful on fully rent stabilized buildings where raising top line revenue has become close to impossible. A $10,000 decrease in NOI quantified at a 5% cap rate is a $200,000 loss in value! That’s a 2% reduction in purchase price.

Compliance

City Council imposes compliance through Local Laws. According to the Department of Buildings, there were 22 new Local Laws introduced in 2021 alone! Each one of these Local Laws comes with an expense for landlords. The laws range from lead remediation and façade work to upgrading stovetop knobs. Keeping up with NYC compliance is a full-time job and if you talk to some of the largest management companies in the business, they’ll tell you they have a staff solely dedicated to violation removal and compliance. One client joked that we should be putting an expense line item in our setups for NYC extortion!

The resiliency of this city and real estate industry is amazing. Despite all these headwinds, cap rates still hover in the high 4’s to mid 5’s. In a supply constrained market, it shows you that you can never count New York City out.

Policy & Market Update with Jay Martin