The Fever’s Down, But New York’s Rent-Stabilized Market Is Still Ill

New York City’s rent-stabilized housing stock has an increasingly serious economic problem. 

For years, the operating expenses of these buildings have been rising much faster than their revenues. Insurance premiums, real estate taxes, water and sewer charges, fuel, labor, repairs and maintenance have all increased significantly, while the ability of owners to increase rents has been severely constrained. 

The Housing Stability and Tenant Protection Act of 2019 eliminated or restricted many of the mechanisms owners previously used to recover investments in their buildings, and now we have a rent freeze layered on top of that. The result is not complicated. When expenses consistently grow faster than revenue, eventually the two lines cross.

New York City’s Article XI is increasingly being discussed as one possible solution. The program can provide an extraordinary property-tax benefit to qualifying buildings for as long as 40 years, replacing conventional real estate taxes with a substantially lower PILOT, or payment in lieu of taxes. For a distressed rent-stabilized building, the impact can be dramatic. A building paying 25 percent or more of its gross revenue in real estate taxes might see that burden reduced substantially. 

Suddenly, a property that was barely breaking even, or even losing money, can generate positive cash flow again. For an owner facing a mortgage maturity, foreclosure or the prospect of handing the keys back to the lender, Article XI can be a lifeline. But a lifeline is not a cure.

Think about a patient suffering from a serious infection and running a dangerously high fever. You give the patient Tylenol. The fever comes down. The patient feels better. Everyone is relieved. But, if you haven’t treated the infection causing the fever, what happens? Eventually, the fever comes back. 

Article XI can bring the financial fever down, but it does not necessarily cure the underlying disease. The disease is not simply high real estate taxes. The disease is a regulatory structure in which the revenue generated by a building can be prevented from keeping pace with the expenses required to operate that building.

Consider a simplified example. Suppose a rent-stabilized building generates $1 million in annual revenue and has $900,000 in expenses (including debt) as well as $250,000 in real estate taxes. It produces only $100,000 of net operating income (NOI), leaving little cushion for debt service, capital improvements or unexpected repairs. Now give that building Article XI and dramatically reduce its property-tax burden. Perhaps expenses fall from $900,000 to $700,000. Presto! NOI increases from $100,000 to $300,000. The patient looks healthy again.

But what happens next?

If rents grow at 0 or 2 percent annually while insurance, utilities, payroll, maintenance, water charges and other expenses continue increasing at 5, 6 or 7 percent, the mathematics haven’t changed. We merely moved the expense line farther away from the revenue line. The two lines are still traveling toward each other. Eventually, they cross again. 

Maybe Article XI buys the building 10 years. Maybe 20. Maybe longer. That’s certainly better than having the building fail today, but it doesn’t answer the fundamental question: What happens when the fever comes back?

There is another problem that receives less attention. When the city dramatically reduces the real estate taxes collected from one building, that money doesn’t magically appear somewhere else. New York still has a budget to fund. Unless government spending is reduced — and history suggests how difficult that is — the lost revenue eventually has to be made up through higher taxes elsewhere, additional fees, other revenue sources or borrowing. 

If Article XI were expanded dramatically across thousands of distressed rent-stabilized buildings, the program would create another form of fiscal pressure. The more buildings that need rescuing, the more tax revenue the city potentially relinquishes. The more revenue relinquished, the greater the burden that must ultimately be absorbed somewhere else.

None of this means Article XI is a bad program. Quite the opposite. For an individual building facing financial distress, it may be exactly the right medicine. Preserving existing affordable housing is an important public objective, and preventing otherwise viable buildings from falling into foreclosure or physical deterioration benefits owners, tenants, neighborhoods and the city. 

But we should distinguish between saving a particular building and fixing the system that caused the building to need saving in the first place.

If thousands of rent-stabilized buildings eventually require extraordinary tax abatements to remain economically viable, shouldn’t we ask why extraordinary intervention became necessary? If the government must substantially eliminate one of the largest operating expenses it imposes on a property because regulated revenue can no longer support that expense, isn’t the subsidy itself telling us something about the underlying economics?

There are ultimately only so many ways to address a persistent gap between revenue and expenses. Revenue can increase. Expenses can decrease. Someone can subsidize the difference. Or the asset eventually becomes economically unsustainable. Article XI chooses the third option. It transfers some of the burden from the individual building to the broader public balance sheet. That may be entirely appropriate in certain circumstances, but it doesn’t repeal arithmetic.

Article XI may be good medicine. It may lower the fever and give a distressed building years—or even decades — of additional financial health. But, if expenses continue compounding faster than revenue, the underlying infection remains. Eventually, the fever returns. Then what? Another subsidy? Another tax abatement? Another government program?

At some point, we have to stop asking how to keep treating the fever and start asking what is causing it.

Buildings don’t care about politics. Buildings respond to arithmetic.

Robert Knakal is founder, chairman and CEO of BK Real Estate Advisors.