By Eric Roth
A few months after being passed, New York City property owners and investors have thoroughly reviewed, discussed and analyzed the rent regulation reform bill (Housing Stability and Tenant Protection Act of 2019), which will greatly impact who purchases rent regulated properties moving forward, how they will be underwritten and how the quality of housing will be affected.
With the uncertainty of rent reform in the air, transaction volume dropped drastically city-wide in the first half of 2019. In some submarkets, volume was down as much as 50% or greater as buyers and sellers sat on the sidelines waiting for a decision on new rent regulations. The release of the new rent reform bill has not caused any thawing in the market but rather has seemingly frozen activity even further. This bill will continue to significantly impact how owners operate, maintain and invest in rent regulated properties.
How will investors underwrite regulated multifamily properties going forward?
While there haven’t yet been any rent regulated properties come to market and close since the new bill passed on June 14th, offers have been coming in on these assets and are beginning to indicate the adjustment in value. It has been theorized that this adjustment could be between 10 and 60%, depending on the asset. IAI and MCI calculations have been substantially altered restricting rent growth and disincentivizing apartment renovations and building-wide improvements. IAI improvements have been capped at $15,000 over three improvements in any 15 year period. Landlords will now recuperate this over 168 or 180 months instead of 60 or 80 months. This rent increase will be temporary and will need to be reverted after 30 years. Similarly, MCI increases will now be capped at 2% versus the previous 6% and will also be a temporary 30 year increase.
Who will purchase regulated properties?
Hold period, return threshold and management capability will all play major roles in determining who will purchase regulated properties today. New York City has historically seen long-term investment. A lack of operating income growth will likely drive investors to hold assets in their portfolios for 10 to 15 years, rather than 3 to 7 years, and could require the ability to own indefinitely. In addition to hold period, investors must be aware that there will no longer be a guarantee of appreciation. The inability to convert regulated properties to condominiums will also drive purchases to be based on in-place income, rather than price per square foot or future sellout potential, which will further alter the buyer pool. Smaller operators and owners could have difficulty keeping up with management, remediation, reporting and everything else required of them.
Because of all of these factors, we can expect the most active purchasers be larger family and local operators. Larger institutional investors may see opportunity in this asset class but current exposure in the NYC market could determine their desire to look elsewhere.
What will happen to rent regulated housing stock and how will this affect the market?
This has sparked questions concerning the effect on condition of the NYC housing stock. It is likely to be case-specific whether a landlord has the financial and operational capability to maintain assets. Landlords may rely heavily on fair market and retail rents to sustain and fund these improvements. Violations, wear and tear, expense growth and other deferred maintenance items could stack up on owners, further burdening operating income. These factors may push landlords to change management, recapitalize or even sell. Long-term, there could be a noticeable difference in the quality of assets available for purchase and will be reflected in the valuation and purchase price of these assets.
So, what now?
The 2019 rent regulation reform has and will continue to cause a secular change for regulated multifamily operators in NYC. As transactions, both debt and equity, begin to shed insight on the new market, owners and investors are reassessing and reinventing their business plans. Afterall, higher barriers to entry and a smaller buyer pool may present opportunity in a new way.
About the Author
Eric Roth is a Director in the Middle Markets Investment Sales group of Cushman & Wakefield, focusing on the Upper West Side, Morningside Heights and West Harlem. Since joining the firm in 2015, he has been involved in the sale of over 70 properties for an aggregate value of over $700 million. Eric holds a Bachelor of Science in Management from the University of Delaware.