Real Estate Weekly
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High land prices pushing rental developments out of Manhattan

By Konrad Putzier

In other cities, a 75-percent growth in average rents over ten years might herald a new development gold rush – but not in New York.

Despite record rents, developers are increasingly complaining that ground-up rental projects in Manhattan and parts of Brooklyn are no longer profitable. As firms switch to more lucrative condo projects, the city is facing a rental development drought.

“When you look at the new development market in Manhattan, it’s almost entirely condo. If it’s not condo, that’s because the site was purchased a number of years ago,” said Jonathan Miller, of appraisal firm Miller Samuel.

Jonathan Miller
Jonathan Miller

The explanation lies with a spike in land prices, driven primarily by the city’s luxury condo boom. As foreign and domestic investors are flocking into condos, their average price in Manhattan has risen by 18 percent over the past year, according to Jonathan Miller’s second quarter report for Douglas Elliman.

The average price for luxury condos – defined as the top ten percent of the market – rose by a staggering 38 percent. Land prices – which reflect a site’s potential profitability – have risen accordingly.

Average rents in Manhattan, however, have risen at a much slower pace of 5.4 percent over the same period. This means buying land for a rental development is becoming less profitable by the week.

“Land prices have risen so rapidly that unless you’re in a prime location you certainly find it hard, if not impossible to build rental units,” said Gary Malin, president of residential brokerage Citi Habitats.

Gary Malin
Gary Malin

TF Cornerstone, arguably the city’s most prolific developer of rental buildings, is feeling the pinch. “This is first time in long time where we don’t have a new project coming up,” said the company’s executive vice president Sofia Estevez.

The firm is currently developing Manhattan’s largest rental building, a 1,189-unit behemoth at 606 West 57th Street. But Estevez explained that the project had been planned for a long time and that the firm had already held the site’s ground lease.

The same goes for the nine rental buildings TF Cornerstone recently completed in Long Island City, on land it bought ten years ago. If the firm had bought the land at today’s prices, rental developments would be far less appealing, Estevez said.

For now, TF Cornerstone is sticking to its rental-first strategy. But Estevez said she doesn’t see the market for rental developments substantially improving anytime soon. “The rental market is pretty tight, and in Manhattan there’s going to be a limited number of rental developments,” she said.

Unlike Manhattan, rental buildings still account for the vast majority of new developments in Brooklyn. But rising land prices are starting to push developers towards condos in the outer boroughs.

Slate Property Group bought three development sites in Park Slope earlier this year with plans for rental buildings on all of them. “We’re not big condo guys – not because we don’t like it but because we haven’t had to go there,” Slate’s founding principal Martin Nussbaum said at a recent breakfast panel hosted by Ariel Property Advisors.

But he explained that the potential for price growth in the booming Brooklyn market make the economics of condo development potentially more enticing. So the company has started to rethink its strategy and is now looking at condo projects in Park Slope and Gowanus.

Underlying the turn away from rental developments are fears that average rents may be reaching a ceiling – at least in Manhattan. A report by residential brokerage Citi Habitats found that Manhattan average rents fell slightly in July.

“The rental market has plateaued at a very high level,” said Citi Habitats’ Gary Malin. “Rental pricing can’t get much higher than it is if you want to attract clientele, that’s why went down.” The underlying issue is slow growth in wages and hiring, according to Malin.

Appraiser Jonathan Miller disagrees. He argued that the factors that have driven rents up in the past – banks holding back on mortgage lending, employment growth and little new supply of rental apartments following the recession – are still in place and bound to continue.

But even if rents continue growing, developers may still be left with the much larger obstacle of high land prices.
“Land prices only fall if demand cools for luxury condos and or the city mandates some sort of inclusionary zoning,” Miller said. Both are possible, but for now demand for condos is growing and Bill de Blasio has so far shied away from mandating that all developers include affordable units.

In the meantime, developers in Manhattan and parts of Brooklyn are forced to change their strategy. Simon Baron Development has long been known for its rental projects. But in February the company made headlines when it bought a 13-story rental building at 12 East 88th Street in Manhattan for $105 million and announced plans to convert it into condos.

“We look at most of our deals as rental from the get-go,” said Simon Baron Development’s president Matthew Baron. “Unfortunately, the realities of the market are such that make it very challenging.”



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