From the early 90’s until June of 2019, NYC real estate only got better. There were a couple of bumps along the way, but those were relatively short lived. Enter HSTPA and owners need to adjust entirely to the new reality. Those that adapt survive, and those that wallow with indecisiveness risk everything. For the most part early adopters of change have been rewarded.
For 25 years, the buildings provided cash flow, upside, AND asset appreciation. The trifecta! NYC rent laws were adjusted in 1993 to allow for individual apartment improvements, and two decades of declining interest rates poured fuel on the fire. HSTPA eliminated the upside and appreciation. Inflationary pressure on expenses and rising rates eliminated cash flow. Now we’re left with no upside and no cash flow.
So… now what?
I suggest owners ask themselves this question and answer it honestly:
What does owning the building do for you? (Your answer should impact your actions.)
The answer usually comes down to one of two things: cash flow or appreciation. Knowing which one you’re prioritizing changes everything about how you should be thinking about your next move.
“I don’t need to make money on the building today; I’m in it for the long game and eventually I’ll pass it on to my kids.”
If this sounds like you, then a few things come to mind:
- You are a legacy owner holding on for appreciation – consider expanding your portfolio with other assets that seem historically cheap. Don’t let a good recession go to waste!
- Be prepared to hold on for 10 years or more before meaningful change happens.
- Expect to write significant checks to remain in compliance with local laws; some of which don’t even exist yet – but will.
- Don’t take on too much debt – it might sink your battleship and force your hand.
“My family relies on the cash flow but I’m having a harder and harder time keeping up with the compliance, and my expenses are rising faster than my income.”
If this answer lines up more with your situation, then consider the following:
- Understand the tax consequences if you were to sell.
- Understand the value of the building in today’s market and how much equity you have after sales costs. Selling is expensive – transfer taxes, brokerage and legal fees, prepayment penalties and unpaid violations/bills could be 7-10% of sales proceeds.
- You might not feel overleveraged at the moment but if you refinance at today’s rate, you might.
- You might be 70% leveraged and “have equity” but after sales costs you’re 80% leveraged and need to replace debt for an asset that can only handle 60% LTV. You are either writing a check to add more equity to satisfy the 1031, or you are writing a check to Uncle Sam for capital gains taxes.
Every year values decline, your leverage position quietly gets worse. A building worth $5M with a $2M loan is 40% leveraged. That same loan on a $4M building is 50% leveraged. Values dropped 20% – but your LTV jumped 25%! That gap is what makes a 1031 exchange harder every year you wait.
And don’t assume the exchange solves your cash flow problem either. If you’re selling an 8-cap in NYC and paying off a 3.50% loan, then buying a 6-cap triple net and replacing that debt at today’s rates doesn’t guarantee your cash flow improves, but it’s worth having the discussion with us and finding out.
Those willing to have honest conversations with themselves and family members will be best prepared to act. Those that wait risk finding themselves with limited options.
Answer the question honestly. Then act accordingly.
— Seth
