Paul Fiorilla

|

New statewide rent control laws have thrown the New York Cityapartment market into turmoil, with prices of properties impacteddropping sharply overnight and the possibility that it will lead tothe deterioration of housing stock and depress the amount ofsupply.

|

The law – the Housing Stability and Tenant Protection Act of2019 – affects 1.1 million rent-stabilized apartments in New YorkCity alone, representing somewhere between one-third and one-halfof the apartment stock in the five boroughs. The new controls havemany provisions that are troublesome for property owners, but themost critical issues involve taking away the ability to transferstabilized units to market rates and the limits on the amountowners can increase rents to pay for capital improvements.

|

Legislators drafted the laws to address the lack of affordablehousing in New York, but it could have the opposite effect byincentivizing owners of stabilized properties to take units of outstock. Owners also have less incentive to upgrade older buildingsthat need renovations.

|

The law could also crush investors and lead to an increase inforeclosures. Market players say that the values of properties withstabilized units dropped anywhere between 20-40 percent overnight.Owners with highly leveraged properties or those that are thinlycapitalized will feel the most pain, and those that suddenly findthemselves underwater might decide to hand over the keys tobanks.

Disincentivizing Improvements

There are many provisions in the act that serve to depress rentgrowth, but the two biggest changes are the repeal of individualunit deregulation and the limits on Major Capital Improvements(MCI) and Individual Apartment Improvements (IAI).

|

Unit Deregulation: Owners formerly had theability to raise rents by 20 percent when stabilized units werevacated, and they were able to deregulate units when rents reached$2,775 and/or the tenants had an income of $200,000 per year for atleast two years. Now increases are limited to a percent set by arent board that is indexed to inflation. In recent years, increasesin rent have been set at 1-2 percent annually.

|

This is a particularly large blow to owners that boughtbuildings with the expectation of raising rents as tenants change.Because property values account for future rent growth, buildingshave lost value that can't be regained unless the law is altered.Some owners likely will walk away rather than continue to operateat a loss.

|

Transaction activity has ground to a near-halt as the marketdigests the impact of the new law. The composition of the buyerbase is also likely to change, as some owners exit the market whilemore opportunistic capital sources and those that left whenacquisition yields fell to 3-4 percent in recent years will comeback looking for bargains or distressed assets.

|

MCI, IAI: Owners formerly could increase rentsin conjunction with capital improvements to properties. Now,however, landlords can only get rent increases on $15,000 ofimprovements over a 15-year period. Anyone who owns housing orlives anywhere near New York knows that $15,000 doesn't buy much inthe way of improvements.

|

To some extent, the capital improvement limits were developed tocombat fraud. Some property owners would put in for rent increaseswithout improving the apartments as much as they claimed, and thecity did not have the mechanism to enforce violations. That said,the limits on capital improvements are insidious for severalreasons. Most importantly, it will lead to a deterioration ofexisting stock. If landlords can't recoup capital spent onimprovements, they either won't make the improvements or will do itwith lesser quality materials. That is to the detriment of therenter.

|

It's also particularly critical given that the law applies toolder buildings that by definition are the most in need of fixing.New York is filled with pre-World War II apartment buildings thathave – among other issues – old roofs, decaying HVAC systems andinadequate electrical systems. The law in effect encourages thedeterioration of these buildings. Blackstone Group, owner of the11,000-unit Stuyvesant Town and Peter Cooper Village in Manhattan,has announced that it will curtail all but legally-requiredimprovements.

|

In some cases, owners will take units out of circulation when along standing tenant moves out. The apartment's rent might be toolow to justify the amount of work necessary to bring the unit backto rentable condition. A related impact is that deferringmaintenance will lead to less work for tradesmen. Stories abound ofcontractors laying off workers such as carpenters, plumbers andelectricians because of the reduction in demand for thoseservices.

|

All these scenarios lead to the reduction of the type of stockaffordable to middle-income households that legislators are tryingto preserve and/or increase. The law does not apply to newconstruction, but new apartments in New York City are almostentirely aimed at the luxury segment with market-rate rentsaveraging more than $4,100 per year, according to Yardi Matrix.It's unlikely the pipeline of new supply will be severely affected,but it is possible that some developers might decide they don'twant to build in New York in the event rent control laws aretightened in the future. Some 30,000 multifamily units are underconstruction in New York City, according to Matrix.

Making Owning a Losing Proposition

The unfortunate upshot is that rent control almost guaranteesthat the net income of stabilized properties will decline on anannual basis. Owners face a situation in which expenses –utilities, wages, property taxes, capital improvements – almostcertainly will rise more than 1-2 percent annual rent increases.That was true before, but until now owners could make up for thatwith the rent increases from units that had new tenants or wereotherwise deregulated. It's hard to imagine how many companies wantto own a property in that situation, unless they can buy it for adistressed price.

|

Housing affordability is a serious problem affecting most of therenters in New York City, and the legislature is within its dutiesto address the issue. The specifics of the law, however, willcreate as many problems as it solves and could exacerbate the issueby decreasing and/or reducing the quality of apartment stock.

|

Paul Fiorilla is Director of Research at YardiMatrix. The views expressed in this article are the author's andnot those of ALM Media Real Estate Group.

Want to continue reading?
Become a Free ALM Digital Reader.

  • Unlimited access to GlobeSt and other free ALM publications
  • Access to 15 years of GlobeSt archives
  • Your choice of GlobeSt digital newsletters and over 70 others from popular sister publications
  • 1 free article* every 30 days across the ALM subscription network
  • Exclusive discounts on ALM events and publications
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.