Matthew Slonim

(212) 951-8405

mslonim@besenassociates.com

 

VIEW BIO

December 2015

Viewpoint: Impact of Elimination of NYC Rent Regulation on Multifamily Values

Manhattan south of 96th Street

The elimination of rent regulation would have a tremendously positive effect on multi-family market values in the NYC market, particularly in Manhattan where the unrealized rent upside is most significant. In essence, there will be a transfer of wealth from tenants in regulated units back to the owners of such units. The problem with rent regulation is that tenants in regulated units are not necessarily the ones in need of affordable housing. Displaced tenants in regulated prime Manhattan apartments will have one of three choices once regulation is eliminated: 1) relocate to smaller comparable apartments; 2) relocate to lower rent neighborhoods; and 3) if they can afford it pay a higher rent.

 

Of the approximately 3.3 million apartments in NYC approximately 64% or 2.1 million are rental units of which 50% or 1.1 million units are subject to some form of rent regulation. Thus, the largest direct impact on market values will be for buildings with rent regulated apartments which could see an average increase in value of an estimated 30-45% across the board with the elimination of regulation.  The reason is that when a building with regulated units sells, the unrealized upside from regulated units is priced into the sales price at a discounted rate. The discounted rate incorporates the risks and uncertainty, as well as the time to regain such units the potential costs to carry at lower rents, litigate, relocate, vacate and renovate such units.

 

[A common valuation metric is a Gross Rent Multiple (GRM) or multiple of the collected annual rent. The GRM for buildings sold with regulated units all else equal is higher than the GRM for market rate buildings sold. For example a building with market rate rents on the Lower East Side might trade for 9x-12x the market rate gross rent roll but buildings with significant upside might trade anywhere between 13x-20x the lower regulated gross rent roll depending on the amount of upside.]

 

Since regulated units account for approximately 1/3 of NYC’s total apartments the aggregate market capitalization of NYC apartments will have a sudden increase of approximately 10-15%. The key is that the terms of the elimination of regulation is certain, swift and clearly defined. Otherwise the impact in market value will be lower. For example, impact on market values will be lowered if existing tenants are allowed to stay for an extended time before the apartment becomes deregulated and can be moved to a market rent. In the past such loosening of regulation has not been immediate and the impact on prices not as significant. For example, many buildings that have come off the Mitchell Lama program allow existing tenants at the time of the program to remain at regulated rents.   

 

Impact on the rest of the city

The outer boroughs will follow a similar trend if regulation is eliminated, however, the impact will not be as significant as the average regulated rent has a lower percent and absolute dollar discount to market rates. The difference between regulated and market rate for prime Manhattan apartments can often be more than several thousand dollars in monthly rent whereas the difference in the outer boroughs is typically less than a few hundred dollars in monthly rent.

 

Value of market rate apartments in Manhattan

There is a tremendous amount of local and foreign institutional and private equity seeking NYC multi-family and apartment investments that will pay higher prices to purchase these newly unregulated buildings and sustain the values of existing market rate buildings.

 

Alternatively, many owners of such newly unregulated apartments will realize the uptick in rent and cashflow and simply refinance taking significant proceeds out of the buildings. Additionally there will be a increase in the number of conversions from residential rental buildings to residential condominiums with more buildings to choose from as converters will be able to execute the conversion in 2-3 years without getting stuck owning regulated units.

 

Impact on sale volume and on development of rental projects

Development will continued to be most highly correlated to the economy, building costs and financing availability and terms, however, with many more unregulated existing buildings coming on-line the probable uptick in condominium conversions may compete or take some market share away from demand for new construction. With that said conversions are not necessarily a direct substitute as some buyers willing to pay a premium for new construction are not always willing to purchase or live in an older building (even if renovated) and vice-versa.

 

Will the city be hurt with this type of product out of the mix?

Long term private owners and families control a high percentage of NYC real estate compared to other parts of the country. Many of these owners can often aggressively bid on properties and purchase at low capitalization rates (often below 4% for prime Manhattan)  with the intention of passing such real estate on from generation to generation and capitalizing on the upside or appreciation over time. There will be many private owners disappointed to lose this unique multi-family asset class. These deals typically trade at prices that pencil to estimated internal rates of return in the 8-12% range based on realistic assumptions and exit values. This rate of return is lower than the rate of return desired my most value-add and opportunity private equity funds in which institutional investors participate. Also the required hold periods are too long for the typical private equity fund’s investment horizon.