Last month, New York’s state legislature released a round of updates to the rules that govern rent-regulated apartments. The changes were sweeping, drastic and, for many in the real estate industry, downright shocking. Owners who had fleshed out five-year plans for their assets simply had to throw them out. Despite efforts from developers, landlords and lobbyists to appeal the new laws, it looks as though they are here to stay.
Slowly but surely, a new normal is taking shape in the world of New York City real estate. Owners are working to offload assets that may not see the returns they once expected and seeking out more attractive new ones. Throughout the city, landlords and developers are girding themselves for a market that will be more sluggish and finicky.
“Even if you made a bad bet right before the new regulations, my biggest piece of advice would be not to panic,” said Arthur Adams, a partner at Mazars USA, a firm that advises some of the largest landlords in New York City. “The pace at which things change and move is slowed, and maybe the value of the property took a hit. But our clients, this is their livelihood, and they’re not leaving.”
When the new laws were released, some real estate professionals said they signaled a death knell for the NYC real estate industry. But those claims sound hollower with each passing week, Adams said, especially since many of the changes restored tenant protections that were once widespread and had been slowly eroded over the last four decades.
Adams said he had not heard of any landlords offloading assets wholesale or trying to leave the industry as a result of the changes. Instead, he has been fielding calls from landlords who are coming to grips with the idea that their five-year investments may have just become ten-year or fifteen-year investments.
“It’s going to take three times as long to get anything changed in a building,” Adams said. “And maybe the 6% yield becomes a 2% yield. It leaves the real estate industry to those who can afford to take a long-term view.”
The new laws strengthened tenant protections in over a dozen ways. However, for landlords, two items will have outsized impact.
Prior to the new laws, when an apartment’s rent hit a threshold of $2,774 per month, and the existing tenant moved out, landlords could “decontrol” the apartment and bring it up to the market rate. The new laws eliminated that threshold: the cost of a rent-regulated apartment can now grow indefinitely under the rent increases stipulated yearly by the city’s Rent Guideline Board.
Landlords have also long been able to raise rents sharply on their rent-regulated tenants in order to pay for major capital improvements, or MCIs — updates to building infrastructure like roofing and boilers — as well as for individual apartment improvements or IAIs. The new laws placed strict limits on these two rent-raising measures. MCI rent raises are now capped at 2% over 30 years. IAI costs are limited to $15K per unit every 15 years.
Adams described how some of his clients had invested in assets with a high number of rent-regulated units with the plan to refurbish them — covering their costs with MCI rent increases — and quickly bring them above the market-rate threshold.
“Those people were left totally stunned by the new laws,” Adams said. “They were saying to me ‘We don’t know what we’re going to do, should we return the capital, return the funds for the deal?’”
The new laws, Adams said, have fundamentally changed how owners think about their real estate assets. Casual real estate investors and groups that are invested in only a few buildings could soon be forced out of the industry.
“It’s the difference between being an investor and being a landlord,” Adams said. “The value-add, the quick deregulation, the capital improvements, that’s an investor view. The landlord view is to be in this for the longer haul, to generate income from the property.”
Because the new laws eliminated so many avenues for raising rent, many landlords will work to boost their income by cutting operational costs. Counterintuitively, one way to cut costs is to buy more assets. Many buildings with high proportions of rent-regulated units have taken hits to their valuation since the passage of the new laws. Owners may be able to pick up new assets cheaply and create economies of scale.
Landlords can also take a more proactive approach to tax planning. They can look more seriously at low-income housing tax credits and other federal tax credits, or have their assets undergo a cost segregation study, which could save them hundreds of thousands of dollars every year in taxes.
Unfortunately, the way that many landlords will choose to cut operational costs is by doing fewer renovations and repairs.
“Maybe they keep putting off fixing the roof,” Adams said. “Or when they do renovate a single apartment, they’re not gutting it down to the studs, they’re just refinishing.”
While he said the new rent laws were a definite win for current tenants in NYC apartments, he questioned whether newcomers to the city will be happy, or whether current tenants will be happy five years from now. Adams said the city’s building stock may begin to resemble public housing from the New York City Housing Authority, which for years has been in need of billions of dollars of funding to fix leaking roofs and faulty wiring.
“The quality of the buildings could become more like NYCHA, where tenants have to wait for repairs,” Adams said.
This feature was produced in collaboration between Bisnow Branded Content and Mazars. Bisnow news staff was not involved in the production of this content. To view all Mazars sponsored pieces for Bisnow, click here.
This article was originally published by Bisnow on July 16, 2019. Click here to view original article.