New York City owners of rent-stabilized apartment buildings are facing a perfect storm as a tidal wave of mortgage maturities and resets is fast approaching for properties purchased before the passage of the Housing Stability and Tenant Protection Act (HSTPA) of 2019.
The Most Vulnerable Properties
Sharply higher interest rates combined with the impact of the regulation have resulted in a decline in valuations. Most vulnerable are the approximately 795 rent stabilized buildings with 41,000 units acquired between 2016 to 2019 before HSTPA was passed, according to an Ariel Property Advisors analysis of sales of New York City buildings with over 10 units. The HSTPA regulations (summarized at the end of this article) essentially pulled the rug out from under the owners of these buildings, who had counted on the ability to renovate and improve often long-neglected apartments and buildings and offset their investments with appropriate rent increases. Those unable to weather the storm may be left with no alternative other than to get out in any way possible.
Lower Valuations Attract New Money
For owners seeking to refinance, the majority of these deals will require additional equity to move forward, even at the higher rates. Risk standards will dictate this reality in most cases, with bank regulators keeping a close eye on all lending activities.
The silver lining is that these ‘cash-in’ refinances will enable rescue capital to participate, specifically in bigger transactions, and enjoy a lower-basis and more secure position compared to equity.
Victor Sozio, my partner at Ariel Property Advisors, said in a recent Q&A in the Commercial Observer, “The active investor profile for rent stabilized buildings has shifted more so to private high net worth individuals and family office investors with patient capital. Institutional investors are shunning rent stabilized assets due to the stringent regulations plus rising interest rates and expenses that can’t be offset by higher rents.”
Sozio said the shift is showing up in the numbers. Investor interest in rent stabilized assets fell from 27% of $2.87 billion in multifamily sales in 1Q 2022 to 11% of the $3.57 billion in multifamily buildings that traded in 3Q 2022, according to our firm’s quarterly multifamily research reports.
“While rent stabilized assets didn’t account for a significant portion of the transactional volume last quarter, we are of the opinion that a deep buyer pool for these properties still exists,” Sozio continued. “However, the price points at which we see that depth in the market have decreased substantially as investors require strong going-in yields and cushion for rising expenses and deferred maintenance.”
Throughout 2022, New York City still saw some significant transactions in the rent stabilized sector. For example, A&E Real Estate Holdings acquired rent stabilized buildings valued at $394 million including a Queens Village multifamily portfolio for $130 million in the first quarter; Chestnut Holdings of New York purchased about 27 rent stabilized buildings valued at $140 million; and Elysee Investment Corporation invested in 19 rent stabilized buildings valued at $124 million.
Unintended Consequences Should Lead to Change in Regulations
No doubt the rent-stabilized multifamily market will also need significant legislative changes in order to create a new, more viable business model moving forward. Until owners have a better way to recapture their investments to properly maintain and renovate their buildings, both tenants and investors will continue to suffer as building conditions and values deteriorate further.
Over time, tenant advocates and regulators are starting to realize that the unintended consequences of HSTPA are actually hurting tenants. Renovating and upgrading a rent-stabilized apartment after a long-term resident moves out can cost as much as $100,000, but the low rents permitted under HSTPA barely cover basic operating costs. The result is that neglected buildings with long-term deferred maintenance purchased prior to 2019 by investors hoping to improve them and share in the positive results, will become further worn and unsafe. This is a major reason over 40,000 rent stabilized units remain vacant because owners have no incentive to invest capital in them.
There are some clear and immediate solutions proposed by the Community Housing Improvement Program (CHIP), a trade association for owners of over 400,000 rent-stabilized rental properties across New York City’s five boroughs. For example, HSTPA could be modified with a Vacancy Reset to encourage the rehabilitation of vacant units by providing a meaningful increase in rent. Clearly, this provides some hope for current landlords who have suffered the consequences and some upside potential for the new capital coming in. The question is always when?
Outlook for the Multifamily Sector
Around 45.5 percent of the 2.2 million rental units in New York City are rent stabilized or rent controlled and about 11.7 percent are subsidized by another government entity. That leaves less than 43 percent of the city’s rental apartments free market, and with demand for housing far outstripping supply, rents for these units have skyrocketed. But the fact remains that the city will need an estimated 560,000 new housing units by 2030 simply to keep up with anticipated population growth.
Long-term opportunities will continue to exist in the multifamily market, as evidenced by the interest of institutional investors in this sector, albeit mostly in free market properties. The next 18 to 24 months will likely see a substantial financial restructuring in rent-stabilized buildings and an uptick in sales. Fortunately, the New York City real estate market is resilient and has a pocket of capital for every type of asset, and rent-stabilized buildings are no exception.
It is New York City After All
While institutional investors are pivoting, new (and old) long-term investors with patient capital, mostly private high net worth individuals and family office investors, are staying with rent-stabilized assets. This capital is attracted to the much lower basis compared to pre-HSTPA and replacement costs, the current positive cash on cash return and the future potential. Lastly, although the regulatory environment (HSTPA) has eliminated economic incentives to invest in existing units, a positive regulatory change that will further align interests is inevitable. In our opinion, this is not a question of will it happen, but when, which presents a great value proposition for patient capital.
Summary of Key Regulations in the Housing Stability and Tenant Protection Act (HSTPA) of 2019
Summary of HSTPA.