I recently put out a poll on LinkedIn with intentional ambiguity. The question was the following:
Which building in NYC would you rather purchase?
- 100% rent stabilized building
- FM – but incomplete IAI docs
59% of voters would rather purchase a 100% rent stabilized building over a building with incomplete IAI (individual apartment improvement) documentation. Fascinating!
It Depends
The third choice of: “it depends” was intentionally omitted to spark conversation and thought. Allow me to explain why nuance is important.
Rent Stabilized Nuances To Consider:
- How are collections?
- Condition: what problems do you have to fix and how much do they cost?
- Do you have $1,200 rents or $1,700 rents?
- Are there preferential rents?
- Is the neighborhood on the upward or downward trend?
Your primary business thesis for buying these is: they used to be worth a lot more, and something will eventually change because this path is not sustainable.
Free Market Nuances To Consider:
- The units are only free market if the owner can prove that they are. Landlords are guilty until they prove themself innocent.
- Are there active overcharge complaints?
- How far below market are the rents?
- How much would the rents have to get rolled back in order to legalize them?
- Are there old rent reduction orders that were fixed but never closed? (Those require tenant signatures… good luck)
When we sell these buildings the first question the buyers ask is: how’s the paperwork? (The first DHCR attorney to get this question tattooed on their arm wins a lifetime of referrals from me). For example: a DHCR attorney asked me for a lease from 2006 to prove the deregulation. 2006! I couldn’t believe it; the newest members of Marcus & Millichap were in kindergarten then!
Analyzing the Results Of the Poll:
Not far from a 50/50 split! This makes for great conversation.
How Should Sellers Think About This?
Sellers of rent stabilized buildings should be pleasantly surprised that a majority of voters would rather buy their building than a building with incomplete paperwork. Most voters prefer the predictability of rent, the future upside when laws eventually change, and the ability to sleep at night knowing your downside is mostly priced in.
Free market sellers should wake up to the seriousness buyers have about deregulation paperwork. A majority of voters would rather buy a building where you cannot raise the rent than a building with potential overcharge exposure. Wow!
What’s interesting to me is that in almost every overcharge scenario a buyer gets a discount, but it isn’t 100% guaranteed that the tenant will file and win an overcharge. Meaning, buyers are getting discounts for events that more often than not, don’t actually occur!
How Can Sellers Maximize Value?
Rent stabilized sellers can and should make maximum effort to improve collections and remove violations prior to putting a building on the market. The cleaner the building presents in person and on paper – the better. If you don’t plan on reinvesting in your building, best to sell now because the sales comps for significantly deteriorated buildings are abysmal. Don’t be that guy in two years when you finally decide to sell – you’ll hate the price.
Free market sellers should spend a considerable amount of time and money preparing their building for sale by hiring a reputable DHCR attorney to audit their own building. You might ask yourself: why would I spend $15,000 finding out what problems I have? To quote George Washington: “the best offense is a good defense”. The moment you award a buyer a contract to the moment it gets executed is the most dangerous part of a transaction for a seller. You want to minimize that timeframe as much as possible because the price doesn’t go up – it usually only goes down from there on out. Having your diligence buttoned up allows you (or your DHCR lawyer) to counter arguments effectively, vacate a unit if needed, and create a competitive environment where you have all the answers buyers want – rather than one buyer taking a month to find out a proprietary piece of information he can then use against you. Spending $15k upfront will save you literally hundreds of thousands of dollars.
The Future Of Each Asset
HSTPA will eventually get reformed to allow a business model where you can raise rents in exchange for improved property. Owners of these buildings have to consider what their staying power is. I mean this financially as well as emotionally. When it happens and what it looks like is anyone’s guess.
Rolling back rents is a recipe for getting in a time machine and erasing all the improvements that the city has made since it crawled out of the 1970’s and 80’s. It’s not a coincidence that neighborhoods started improving when the 1993 Rent Regulation Reform Act introduced incentives to invest in housing.
Common sense will eventually prevail.
Best of luck and thank you to those that participated in the poll!
-Seth
