Multifamily Meltdown


Many say multifamily development in New York City rests on the 421-a tax abatement (Carlos Zamora)
Many say multifamily development in New York City rests on the 421-a tax abatement (Carlos Zamora)

It is a question clanging around the minds and meetings of residential lenders this spring: What if the state repeals the decades-old 421-a tax abatement? The law, a staple of New York City multifamily finance, has been renewed continually since the 1970s, but comes up for renewal this June. Such a scenario has lenders pondering a financing ecosystem steered almost exclusively toward condominiums and commercial developments such as hotels, or toward that rare development firm that could finance most of its rental project solo.

Indeed, the great multifamily minds of the city generally agree that the abatement is a key crutch propping up development here. And the one thing upon which politicians, lenders, renters and developers all agree is that new housing and improvements in existing apartments in New York City is necessary.

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Without 421-a? “All rental development would stop, and the only thing that would be viable are high-end condos,” said Alan Weiner, managing director of Wells Fargo (WFC)’s multifamily capital group.

“If you take away 421-a, Manhattan’s definitely gone, right?” said Steve Cox, a managing director at lender Hunt Mortgage, adding that parts of Brooklyn, even Queens, would also become prohibitively expensive for those looking to build multifamily rental projects. Developers, he added, would look beyond the city, to secondary markets as far afield as the Midwest or keep their powder dry until a more favorable financing climate comes to pass in the five boroughs.

The state launched the 421-a tax abatement in 1971 to encourage development in a New York City headed toward its late-20th century nadir. It ensured lower property taxes for up to 25 years for approved new apartment buildings as well as similar breaks for condo owners in new developments that 421-a covered; developers can and have used such breaks in marketing new-development condos.

And it worked spectacularly, spurring residential building, including of thousands of units of affordable housing, throughout the city. As recently as last year, the program subsidized some 70,000 new apartments, according to a study from the Association for Neighborhood Housing Development.

As the city recovered, lawmakers amended 421-a to limit its use in more affluent areas of Manhattan. Developers also had to build a certain number of affordable-housing units in a development to qualify for the break. The state last renewed 421-a in June 2011.

Opponents of its renewal this time point to recent high-profile examples of developers getting the tax break for building relatively few affordable-housing units—or none at all, for projects in the “outer boroughs,” which include booming Brownstone Brooklyn. The most famous luxury tower to nab the incentive is likely One57, the Midtown condo tower that received a 421-a abatement by building 66 affordable-housing units in the Bronx. That break translates into hundreds of thousands of dollars less annually in property taxes for owners of One57’s multi-million-dollar condos for years to come.

Opponents of 421-a’s renewal may point to this as an example of why the state needs to end the program. Proponents, including those lending for new development, instead see the 66 affordable-housing units created as a positive result. Besides, they add, breaks on the odd ultra-luxury development do not negate the incentive 421-a provides for building rental housing. And without it, developments such as One57 would not have to build any affordable housing. 

Too Many Taxes?

The reason for the alarm over 421-a’s possible demise is perennial and paradoxical: Land is pricey and getting pricier, given the ever-higher returns on new apartments and, especially, condos. The median Manhattan apartment rent increased 8.9 percent In February 2015 to $3,375, according to appraiser Miller Samuel. The median apartment sale price was $980,000 in the final quarter of 2014, its highest point since right before the 2008 economic crash.

Meanwhile, the price per buildable square foot in Manhattan hit a record $511 in the first half of 2014, which was up more than 35 percent from a year earlier, according to investment sales brokerage Massey Knakal. Several recent transactions in the borough, too, have crested the formerly unassailable $1,000-a-foot mark. In the latter half of last year, 719 Seventh Avenue traded for $1,462 a buildable square foot, 16-18 West 57th Street for $1,262 and 985-989 Third Avenue for $1,118. At least a few more sites will command such numbers in 2015, according to media reports.

New York City’s byzantine real estate taxation structure does not help matters, from the developer’s perspective. A 2012 report from NYU’s Furman Center for Real Estate and Urban Policy found that the effective tax rate for larger rental buildings is five times that of the rate for one- and two-family homes. This means that rental developments end up providing a disproportionate bulk of property-tax revenue for the city—another argument marshalled by proponents of renewing 421-a.

“Our multifamily assets that are at this point fully taxed, over 33 percent of our gross revenues are paid in real estate taxes,” said Jeremy Shell, head of finance and acquisitions at TF Cornerstone, a development and property-management firm. “You can’t support a development when you lose a third of your revenues to the government.”

The higher taxes only add to the construction costs, including labor and property purchases. These costs already run, in Manhattan and parts of Brooklyn, to more than $450 per buildable square foot for union-labor projects; anything more than $300 or so a foot, analysts say, makes rental construction an unattractive option compared with condos or another use, such as a hotel. (And raising the rents even higher than current rates would not necessarily make rental development any more attractive—there comes a point when occupancy falls as rents get too high for prospective tenants—even in Manhattan.)

The only other scenario for more rental development post-421-a, lenders say, would be for developers to put in that much more equity to a project—60 percent, say, rather than 40 percent or less—a scenario that observers say is unlikely. Again, though, given the construction costs, it would make more financial sense to build condos or a commercial project such as a hotel.

“With the exception of the very highest-end rental property in the core of Manhattan, the 421-a makes a difference between a project that is remotely feasible and infeasible,” Mr. Shell said. “Without it, with the current state of real estate taxes that are imposed on the multifamily asset in New York City, there is no way to develop apartment houses without the tax abatement.”

Changing the Rules of the Game

The savings from 421-a can be significant. The city in 2014 forfeited $3.3 million, for instance, from the five-year-old condo building at 535 West End Avenue, developed by Extell Development, according to a March report from the Municipal Arts Society, a non-profit that collects data on New York City buildings as part of its effort to promote livability here.

In exchange for that break, which it can pass along as an enticement for buyers, Extell subsidized six affordable units. The buyers’ taxes are lowered until 2023.

The Lucida condo at 185 East 86th Street, another recent Extell development, got a $5.8 million tax break in 2014 for building 24 affordable units; that break continues through 2021.

All total, according to MAS, the city lost $1.1 billion in tax revenue in 2014 due to 421-a breaks.

These savings, supporters of 421-a say, are what make the abatement essential—no break, no affordable apartments. The Real Estate Board of New York issued its own report in March showing that the end of 421-a would translate into 5,484 fewer affordable apartments. “The loss of these units,” the report said, “would cause a significant setback to the city’s affordable-housing program.” Mayor Bill de Blasio has pledged to create or preserve some 200,000 units of housing during his tenure. (Mayor de Blasio has yet to take a position on 421-a—infuriating both those who want to clarify their business plans for 2015 and activists who want a more muscular approach to developers.)

As the June decision in Albany approaches, there are also those calling for modifications to 421-a that stop well short of abolishing it. Rafael Cestero was a housing commissioner under Mayor Michael Bloomberg and is now CEO and chairman of the Community Preservation Corporation, a nonprofit developer specializing in projects in less affluent areas. He wrote an op-ed for the New York Times in February calling for tax changes such as increasing the so-called mansion tax on home trades of more than $1 million, rather than scrapping 421-a.

The de Blasio administration is analyzing 421-a ahead of its June expiration and is expected to release its recommendations on it before then.

Vicki Been, the city’s Housing Preservation and Development commissioner, seemed to hint at the administration’s evolving position during a late January appearance before a City Council committee. She said 421-a was a valuable tool for affordable-housing development in “high-value, high-demand” neighborhoods; otherwise, according to a report of her appearance from The Center for New York City Law, Ms. Been said 421-a needed changes to bring it more in line with the mayor’s housing agenda.

“While luxury development in Manhattan gets all the attention,” Mr. Cestero wrote, “developers across the five boroughs are using the 421-a program to develop rental housing for hard-working New Yorkers.” (Mr. Cestero declined a request for further comment.)

With these bedfellows of the real estate industry and nonprofits—and legislative allies, particularly in the state Senate’s GOP caucus—supporting some sort of continuation of 421-a, the real financial anxiety may lay less in its ultimate demise and more in any changes (though the possibility of an all-out end does remain).

“I think what’s creating a lot of uncertainty in the market now is what the rules of the game will be,” said Drew Fletcher, an executive vice president at brokerage Greystone Bassuk. “As a result of that, actually, there are a lot of folks just sitting on the sidelines.”

Condo Conundrum

Those in the game currently, though, are focusing mostly on luxury condos, a focus that will intensify if a repeal of 421-a makes rental development that much more difficult, lenders say. High construction costs have for years been driving developers toward the remuneration that comes from condos.

At least 6,500 new condo units are expected to start sales below 96th Street in Manhattan in 2015, according to the Corcoran Sunshine Marketing Group. That’s up from 2,500 in 2014. Some 13,000 condos will have hit the Manhattan market between the third quarter of 2014 and the end of 2016, according to Corcoran Sunshine. And, while sales at the ultra-luxury end ($10 million and up) have stalled somewhat, the sales and, especially, price trends in the condo market overall point to continued strength.

The perennial popularity of luxury condos is another argument that 421-a opponents often deploy. Even if prices dip, that would not do all that much for the city’s millions of tenants.

“If you sell the condo for $2 million instead of $3 million, how does that help affordable housing?” Mr. Weiner of Wells Fargo said.

It doesn’t. That spur to affordable housing may prove the single, biggest impetus to keeping the abatement in some form. If Albany opts not to keep it, then look for a marked shift in financing to condos and other commercial uses. After all, New York will not suddenly cease being a good place to invest, even if it becomes a difficult place to build apartments.

“Developers are continuing to enjoy tremendous access to capital,” Mr. Fletcher of Greystone Bassuk said. “New York is really a magnet for investment globally, so the number of capital sources that are looking to invest in real estate in the United States is significant, and they all have an allocation for New York.”