Expanded Rent Stabilization Law Freezes NYC Stabilized Multifamily Property Market, Generates Buying Opportunities for Intrepid Investors
New York state authorities last year passed legislation designed to maintain rental affordability and housing stability in the Empire State. Mandated changes for units not currently subject to stabilization were mostly technical in nature — relating to rent increase notification periods, evictions and security deposits — but the impact on the New York City’s nearly 1 million regulated units was significant. Previously, an owner’s ability to raise stabilized unit rents was limited by a city board, except upon vacancy or after major property or unit improvements were made. These exceptions were curtailed by the legislation, largely negating the appeal of buying, renovating and repositioning older properties.
The regulations sent a chill through the recently hot New York City multifamily property market. Sales volume dropped by half last year to about $3.3 billion, with the largest declines coming after the law took effect at mid-year. Indeed, volume in the typically busy fourth quarter plunged to less than $200 million, the lowest single-quarter sales total since recessionary 2010.
Although obscured by thin volume, cap rates appeared to rise. After hovering near 4 percent throughout 2018, institutional B/B+ quality asset purchase yields gapped higher, drifting up to about 4.25 percent at mid-year and further to 4.5 percent by fourth quarter 2019, the highest level observed by RED Capital Research since 2011.
Can New York be considered a bargain at these higher yields?
Certainly, market fundamentals remain constructive. The metro economy is in robust health. Propelled by rapid job creation in the high-compensation healthcare, professional services and consulting sectors, New York City payrolls grew at an energetic 82,400-job pace during the second half of 2019. This represented 1.8 percent year-on-year growth during the period, slightly slower than the first half of 2019 but only a step behind Seattle and the Bay Area, the job growth leaders among the primary markets. The unemployment rate dipped to 3.2 percent in December, a 30-year series low by 40 basis points. Average hourly wages grew in 2019 at the fastest pace (4.1 percent) since these data were first published by the Bureau of Labor Statistics (BLS) in 2007.
Apartment market conditions were also favorable. Space availability is exceptionally low: a stabilized, same-store sample of 1,307 Kings, New York and Queens County properties (250,000 units) surveyed by Yardi was 98.39 percent occupied in December, nearly unchanged over the year. Among submarkets, only the Upper West Side recorded occupancy below 98 percent. Renters absorbed about 6,200 previously vacant units last year, representing more than 90 percent of newly completed space.
Somewhat ironically, rents recorded a third consecutive year of below average growth. After posting no meaningful increases in 2017 and 2018, average same-store rents moved about 2.7 percent higher in the 12 months ending in December 2019, 30 basis points below the U.S. major market average. Gains varied widely among submarkets but none chalked an increase greater than 3.4 percent.
The outlook is promising for unit demand for unregulated apartments. Although supply will be heavy (about 22,000 units are currently under construction), RED Capital Research demand models forecast that New Yorkers are likely to continue to absorb units nearly as quickly as they are delivered, barring an unforeseen recession. Property revenues in the unregulated sector are projected to rise at a 3.5 to 4.0 percent annual pace over the next two years, but in the stabilized segment they are expected to increase less than 2 percent.
Market-rate asset returns were weak in 2019 (we estimate about 1 percent based on aforementioned cap rate trends) but should improve going forward. RED Capital Research calculates that investors who take advantage of current cap rate conditions can expect to earn annual total returns in the 10 percent neighborhood in 2020 and generate a 7.8 percent annual unlevered return over five years. The political landscape continues to be unsettled: Mayor de Blasio recently proposed a 5 to 7 percent cap on unregulated properties. However, investors willing and able to source unregulated assets in the current environment are likely to generate attractive total returns in this the world’s most liquid property market.
— By Daniel J. Hogan, ORIX Real Estate Capital’s Managing Director for Research. RED Mortgage Capital, a division of ORIX Real Estate Capital LLC, is a content partner of REBusinessOnline. The views expressed herein are those of the author and do not necessarily reflect the views for RED Capital Group or of the author’s colleagues at RED. For further analysis on the NYC market from RED Capital Group, click here.