If you are selling an apartment building in New York City, are you selling that building, or are you really selling something else?
That might seem like a strange question, but the answer depends upon whether that building is subject to New York State’s rent regulation system.
If your apartment building is subject to rent regulation, you might think you are selling the bricks and mortar that are sitting on your parcel’s land, but that’s not actually what you are selling, and not really what the property’s value is based upon. You are really selling the boxes of paperwork that you have in your manager’s office, and the quality of that paperwork is highly correlated to the price you will get.
This is a very difficult concept for many people to understand. The draconian Housing Stability and Tenant Protection Act of 2019 (HSTPA) changed the nature of the business dramatically and has been very successful in completely vaporizing hundreds of billions of dollars of equity value in New York City’s rent-regulated housing stock.
If circumstances don’t change, one owner of several thousand units here in New York has said that the only end-game he sees is handing the keys to his buildings back to the banks or losing title in real estate tax foreclosures. This is how dire the system has become.
Effectively, expenses on rent-regulated housing are going up at a significantly greater rate than income is allowed to go up.
HSTPA marginalized two programs that incentivized the private sector to invest tens of billions of dollars into the housing stock. The Major Capital Improvement program (MCI) and the Individual Apartment Improvement program (IAI) both allowed property owners to recoup capital expenditures through rent increases. This incentivized the private sector to invest in the quality of the housing stock.
In 1978, before these programs were implemented, the dilapidation rate in New York City’s housing market was 14%. That means that14% of housing units were in such poor condition they were deemed uninhabitable. In 2019, after the MCI and IAI programs had been around for quite a while, the dilapidation rate had fallen to 0.04%. This led to better-quality housing stock and a better quality of life for the residents of those buildings.
HSTPA successfully marginalized both of those programs such that, when a previously rent-regulated unit becomes vacant today, it more likely than not remains vacant. In the pre-HSTPA days, the owner would spend $100,000 to $150,000 to renovate the unit, bring it up to modern standards and rent it for a sum that provided a return on that invested capital.
Today, that is no longer the case. It is estimated that as many as 80,000 apartment units in New York City are sitting vacant because it does not make economic sense for those units to be renovated and rented at rents that do not allow for even a minimal return on the invested capital. Therefore, supply has been taken off the market, exerting upward pressure on the rents on the units that are available. This dynamic helps to create the 1.4% vacancy rate that we currently have in New York City.
In addition, you are only able to collect those rents if you have the proper paperwork substantiating that the rent is at a legal level. If your paperwork is lacking, your asset is not worth very much. Physically, the building could be in fantastic shape, but I think that every single owner of apartment buildings in New York would prefer to have a building in poor condition that has excellent paperwork, over a building in excellent condition with poor paperwork.
It is imperative that paperwork is investigated and verified prior to understanding what it is that you are buying or selling. Today, we will not even take an apartment building to the market without ordering a thorough investigation by a expert third party to determine the legal rents.
If you are a lender on these types of properties, it is probably better to have the paperwork as collateral for the loan than to have the building as collateral for the loan. If you get the building back and don’t have the paperwork, that building isn’t worth nearly what you think it might be, or should be, worth.
Understanding the profound implication of paperwork in rent-regulated housing is a critical aspect of the way the business works today. Know what you are selling and understand the quality of your paperwork!
Bob Knakal
BK Real Estate Advisors
New York, NY
bk@bkrea.com
