How to avoid distress in RS multifamily

Some ideas to share with the rule makers in Albany and in the City Council

Spoiler: Change policy

You know the story. The mom & pop owner refinanced the mortgage on their 20-unit apartment building in 2017, and now said owner’s mortgage is coming due in the next 12 months. The seven-year note was offered on the outer-borough building in a time when lenders competed vigorously for opportunities to be chosen by borrowers as their capital partners. The blue skies went on for miles ahead and being a multifamily investor was near synonymous with profit making. And then, somewhere along the way, the train veered off course. The 2019 rent laws seriously limited opportunities for rent growth. Covid-era inflation and supply chain challenges, combined with the surge of natural disasters sent expenses through the roof. Finally, interest rates on mortgages went up to their highest levels since the year 2000.

Rent stabilized buildings have seen rents capped, expenses go up, and costs to service debt go up a lot (capped rents, expenses up, and debt costs up). The leading bidder (several working in partnership) for the Signature loan portfolio Related, Community Preservation Corp. (CPC), and Neighborhood Restore are aware of this. Yet, they are boldly moving forward to buy the debt underwritten by these properties. Does the trio know something we don’t? How will they make money?

Before I dive into that, I think it’s worth explaining how rent stabilized properties could make more money and see their values brought back up to par, which I define as 2018 valuations. If someone were to ask, how can distress be wiped away from RS multifamily buildings, my thoughts are below on some possible ideas:

1. Allow uncapped rent increases on vacant apartments

   NY Senator Leroy Comrie and NY Assembly member Kenny Burgos introduced the Local Regulated Housing Restoration Adjustment (LRHRA) program that would allow building owners to raise the rents on their empty units…

   UP TO WHATEVER THE RENT COMPS SAY.

   The catch?

   Owners must make sure their units a) meet certain requirements for eligibility, and b) that the units become lead-free and undergo “code-compliant modernization.” Owners should take this trade 7/7 days a week. If losing the Frankenstein loophole was the door that needed to close in order to reveal this door, well, I think that would be an interesting turn of fate. This Assembly bill A06772 is currently sitting in limbo inside the housing committee of the NY Assembly.

2. Allow tax deductions on vacant apartments that are renovated and rented

   This is the same idea as the LRHRA (beautiful acronym, btw) except it would shift the financial burden onto the city government. I envision this working in the following way.

   • Allow owners to renovate apartments using similar methodologies as pre-2019 HSTPA allowed for (tax reduction = 1/40 of the capital expenditure on the apartment).

   • Record the allowable tax reduction. Rent the apartment to a tenant at the same rent as it was rented prior to renovation. No change in the legal rent.

   • Receive either a tax credit from NYC for 1/40 the renovation cost or see the RE taxes reduced by the tax reduction amount. Or both.

   • If the # of renovated units delivered to market is large enough, then the property taxes could be reduced to 0. Thereafter, tax credits could be applied to property-level net incomes, to reduce the amount of state income tax liability.

   Would this create incentives for foul play. Maybe. But there would be far less incentive for foul play than ever before if you codify the law well. Require certain years of vacancy prior to renovation. Require photo evidence. Don’t make it an obnoxious laundry list of items to get it done but ask for common sense evidence of sorts to make sure the apartment vacancy wasn’t obtained via fraudulent means. If messaged the right way, NYC officials could take credit for creating workforce housing and the tax reduction/credit could be pitched as a capital solution of sorts that wouldn’t cost the NYC government a penny of cash outlay.

3. NYC purchases air rights

   Many, many pre-war, rent stabilized buildings in NYC have close to 100% occupancy and won’t really be using their God-given air rights. Unfortunately, owners of nearby properties don’t always want to buy these air rights. And that’s value lost. Empire State Development (ESD) could pony up and buy the air rights of rent stabilized buildings throughout the city. The ESD could require Area Median Income (AMI) limits to preserve affordability. And ESD could do so in a way that the existing rents allow the property to remain south of that AMI level organically. Political win + equity in the hands of owners who’ve seen 30% of their equity values wiped out. That extra cash helps when it comes time to pay down the loan.

4. Subsidize building expenses

   Community Housing Improvement Program (CHIP) spokespeople have suggested the city offer some kind of backstop for insurance costs for multifamily property. I think we can take the idea further than that. Workforce, rent stabilized housing should be viewed as a public good. Capped rents, expenses up, and debt costs up. That’s the organic affordable housing in NYC. I am referring to those elevator buildings in Grand Concourse, Bronx or Midwood, Brooklyn with 60+ units. Housing providers keep those lobbies clean and make sure the properties are safe to inhabit. These folks are answering the call to keep housing affordable in NYC. So, subsidize building operations. Support the public good that’s being provided. Water costs and taxes are things that the city has direct oversight for so those are easy places to begin. Subsidies could also be offered for heating and insurance costs. The work is already being done to provide affordable housing. Incentivize workers to keep doing it, and to want to keep doing it.

Do you agree? Did I miss anything in this list that deserves attention?

Related and peers have probably considered the above possibilities, which would seriously limit the distress inside of RS multifamily, but they are likely not banking on any of these scenarios playing out in their base cases analysis – so what might be their business plan? I’ll write about that next week.

Source: PoliticsNY, NY Assembly