By Josh Lipton & Andrew Levine,
Invictus Property Advisors
Achieving success in NYC real estate is rarely a passive endeavor, or for the faint of heart.
New York is a playground for the bold seeking assets where they can add value through sweat equity and the repositioning of an asset into a “higher and better” use.
Value-add opportunities come with greater risk as they typically require greater capital and leverage to execute. They are often underperforming assets that require years to stabilize with risks such as construction and renovation downtime, challenges associated with re-tenanting apartments with higher paying tenants and general market and interest rate risk.
Such value-add properties also typically exhibit management or operational problems that require physical improvements long-neglected due to ownership’s capital constraints.
Historically, investors seeking value-add opportunities focused on the “upside,” or potential rent increases they could achieve through re-positioning of the asset and/or turning over low paying tenants with higher paying ones.
In NYC, nearly one-third of all rental units in the City are subject to some form of regulation and, accordingly, these apartments offer imminent rental upside if they can be vacated.
Similarly, unrenovated free market units represent upside for new ownership if the units can be renovated.
Other times, the value-add opportunity can only be realized in the mid or longer term and require more creativity and new concepts.
Specifically, apartment turnover is becoming more challenging in NYC. Long term retail leases locked in at below market rates are also tough to break without a landlord-friendly termination or demolition clause.
Recently re-zoned neighborhoods often add hundreds of thousands of additional air rights or buildable square feet to an area overnight; however, such value can be unusable or “trapped” in the short term if the property has rent regulated tenants or long-term leases in place.
Investors are having to get more creative in finding ways to maximize value. Below are five strategies currently being employed by owners/to drive the most value out of their assets:
In recent years, co-working space has become the darling of the real estate industry with its “plug and play” offices for the everyday entrepreneur or startup seeking to rid themselves of the burdens of a long-term lease.
Of course, there is a price in NYC for convenience and entering into a short-term lease can be expensive for tenants but a tremendous value driver for companies like WeWork and its competitors.
Seemingly overnight, the co-working space business model has increased potential revenue streams for office building owner-operators by as much as 25 to 50 percent.
The advantage of a co-working arrangement is not only in the premium charged for short-term monthly memberships, but also in the ability to maximize the rentable space with pre-designed build-outs. A single desk for the sole practitioner/entrepreneur at a WeWork could garner $350 per month, which is more than any traditional class A office building can achieve for the same amount of space.
But the model works and is deemed fair as individuals and small start-ups have traditionally had a challenging time finding nice, affordable office space.
Like the co-working space concept, landlords that allow retail pop-ups have found a way to maximize the value of their space in a new and unique way.
Retail pop-ups allow the owner to achieve a rental premium while the retailer can test out a new concept or new products on a short-term basis often for a week or less.
This method is most effective if the sponsor has relationships with multiple retailers. As it is often challenging to fill the space immediately, this technique can be management intensive.
If executed well, as is the case with 260 Sample Sale, shoppers are presented with a different intriguing brand every week. These anticipated sales create an entrenched customer base that follows the space to the benefit of the brands that populate it and the owner of the real estate.
A recent phenomenon with fast casual restaurants adopting the micro-chain mentality, scaling back on their footprint and menu options in exchange for gaining greater exposure with more locations throughout the City.
Marketplaces such as Urban Spac showcases a variety of food and beverage retailers.
For landlords, this model is incredibly effective in segmenting a large open space and allocating portions of the space to individual tenants that would otherwise attract one large tenant on a lower price per square foot.
Large spaces can rent at a 25 to 30 percent discount to market for smaller footprints in the same general neighborhood. Food halls are a win-win for both the landlord, who is maximizing the rent on a price per square foot, and the tenants, who are able to occupy a very small portion of the total floorplate and expand their brand throughout the City.
In New York City, there will always be a need for housing that is affordable but not necessarily regulated.
Micro-units are often the answer for those living in the big city with a static bank account.
In 1910, NYC passed the Tenement House Act, which requires a residential unit to measure no less than 120 s/f, and in 1987, the Department of City Planning passed the Quality Housing program, requiring units in newly-constructed development projects to not be less than 400 s/f.
These regulations, although well-intentioned, do not reflect the practical reality that the population of New York City is growing while the available housing stock is not, or at least not as rapidly.
The regulations remained unquestioned until 2013 when Mayor Bloomberg noted that “the growth rate for one- and two-person households greatly exceeds that of households with three or more people, and addressing that housing challenge requires us to think creatively and beyond our current regulations.”
Existing micro-units grandfathered into the housing stock garner a premium on a price per square foot from renters and are sought out by investors looking to maximize their rent roll.
Look to see a loosening of the regulations on micro-units and more development projects that comprise such units in the coming years.
Flex Apartments/Student Housing
Pre-war apartment buildings often consist of large units with layouts well configured for adding one or more bedrooms. Say, for example, a 950 s/f two-bedroom apartment in West Harlem could rent for $3,000/month, and an owner were to add another three bedrooms and another full bathroom, the apartment could end up renting for as much as $1,000/bedroom, or $5,000/month to Columbia University or City College student/roommates.
This value-add technique is often utilized in submarkets that have a younger population who are more likely to welcome apartment sharing for a lower rent than a less appealing and higher-priced studio apartment.