Rent Reform and What It Could Mean for NYC’s Multifamily Market
Last year’s New York State elections saw Democrats gain control of the assembly, solidify their majority in the senate, and retain the governor’s office for a third term. The winning party has secured a government ‘trifecta’ last seen in 2008. Campaign rhetoric from Democratic candidates and Gov. Andrew Cuomo emphasized more stringent rent regulation as a means of tackling New York City’s affordable housing shortage. With the rent law expiring in June, it is likely that a new iteration will include measures aimed at further restricting rent growth for the city’s rent-regulated housing stock. The most consequential issues introduced by the City Council include proposals to end vacancy decontrol, to remove vacancy increases, to repeal the ability to increase preferential rents to their legal level upon lease expiration, and to make MCI (major capital improvements) and IAI (individual apartment improvements) rent increases temporary.
While giving middle- and lower-income New Yorkers access to high-quality and affordable housing is something almost anyone can get behind, economic research backed by case studies show trying to do so by imposing rent ceilings carries unintended and undesirable consequences. Rent regulation reduces the quality of stabilized housing by removing incentives for landlords to maintain and improve apartments. It makes market-rate housing less affordable by removing stabilized units from the supply side of the market equation and thereby adding to the upward pressure on rents. Finally, it hurts the very people it is meant to protect as rent-stabilized tenants gradually become immobile hostages in their apartments, bound by artificially low rent while prices around them surge to unaffordable levels. Implementing one or more of the above outlined measures will amplify the extent to which these issues manifest themselves in our city by widening the divide between stabilized and free-market rents even further.
Rent stabilized buildings traditionally trade at compressed capitalization rates because investors are willing to pay a premium for the opportunity to grow a rent roll toward the market rate over time. Removing vacancy increases, rescinding an owner’s right to increase rents from their preferential to their legal rent level upon lease expiration and limiting the ability to grow rents by means of IAI and MCI effectively eliminates any of this ‘upside’ potential. If these changes come to pass, prices for stabilized buildings will drop as capitalization rates expand in response to buyers demanding yields in line with investments that do not have an inherent income growth potential. Expect values for individual rent stabilized buildings to fall in proportion to the gap that exists between an asset’s legal rent roll and its market-rate potential. Meanwhile, the price of free-market properties will rise as they become more desirable by comparison.
The average price for rent-stabilized property has already dropped by approximately 20 percent since 2015 in response to rising interest rates and already tightening rent regulations. These included the removal of a four-year statute of limitations on past rent overcharges, a new requirement for purchasers in some low income and rezoned areas to produce a “certificate of non-harassment” and the Altman v. 285 West Fourth LLC ruling, which gave tenants legal grounds for challenging market-rate rents in formerly stabilized apartments until it was overturned in 2018. Repealing vacancy decontrol in particular poses a very significant threat to the value of stabilized property. It calls for all stabilized apartments to remain so regardless of any tenant turn-over or improvements, and for units previously destabilized to re-enter the system. Combined with the previously outlined policies being floated by both state and local politicians, over time it will create an environment where taxes and operating expenses outpace rent growth to a point where the gainful ownership of rent stabilized buildings becomes untenable. The disastrous consequences of such a scenario are illustrated by New York City’s urban blight of the 1970s, when a combination of economic hardship and landlords abandoning unprofitable rent-stabilized buildings en masse resulted in entire neighborhoods falling victim to fire and decay. Many of the measures that are now back on the political chopping block were implemented so as to help the city recover by making the ownership and operation of rent-stabilized property a viable investment.
Until there is more clarity, expect to see less deal velocity and dollar volume in the rent-stabilized property market as buyers struggle to account for unpredictable legislative risk in their underwriting. In the months ahead, owners of rent-stabilized buildings should hedge against this risk by pushing stabilized rents closer to market wherever legally possible. Landlords should not defer any opportunity to raise rents by renovating vacant apartments or implementing building-wide improvements. And while rattling the boat by increasing preferential rents upon lease expiration can be a challenge, the window of opportunity to do so might soon close. Now is the time to appeal to local and state representatives and make sure they are aware of the weight and far reaching implications their rent reform votes will have.
Jakub Nowak is Associate Real Estate Broker and team leader at Marcus & Millichap.