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Rental builders feel financing squeeze over 421-a expiration

Two weeks after the expiration of the 421-a tax program, the effects of its demise are starting to be felt, and developers claim that it has put the squeeze on an aspect of their business that’s been running smoothly for the past few years.

“Yields on new development rentals are lower, making it difficult to attract equity,ˮ said Josh Schuster, a principal at DHA Capital, which is developing the 535 West 43rd Street luxury rental building at Hell’s Kitchen.

Photo by jinkazamah/ Flickr
Photo by jinkazamah/ Flickr

“In fact, (after) losing the program, we’ve adjusted our business plan to build rentals through more groundlease structures and more JVs with existing landowners that have lower land basis.”

Over the past few years, New York City’s real estate developers have had unprecedented access to financing due to the arrival of new players like crowdfunding platforms and Asian investors. Last year, real estate crowdfunding in New York City produced a physical structure for the first time with the re-opening of AKA United Nations, a hotel-condominium building just east of the United Nations headquarters complex. Meanwhile, Asian investors have closed major deals in the city, the biggest of which was Anbang Insurance Group’s $1.95 billion purchase of Waldorf Astoria.

Experts say that the situation is about to change, and development projects may soon grapple with a shortage of cash. According to Bob Knakal, the chairman for New York investment sales at Cushman & Wakefield, developers will not have a hard time finding funding sources, they’re just likely to receive less money from their benefactors.

“I don’t think it’s harder to find financing. I think the amount of financing that you get is going to be different because the economics have changed. It’s just going to be a lower amount because your economics are going to be worse,” he said.

“I don’t know that there are people who are going to say, ‘Hey, without 421-a, I’m just not going to win on that particular building.’ They’re just going to adjust the amount they’re willing to lend.”

Steve Hochberg, a partner at real estate law firm Stempel Bennett Claman & Hochberg, is less optimistic. He said that the expiration will lead to a slowdown in the flow of projects, with firms developing an aversion towards rental buildings. “It’s definitely going to have an impact because, with the tax abatements no longer available, it’s likely that a lot of developers will not pursue certain projects, specifically rental projects. Without some type of real estate tax incentive, the deals become too expensive for developers to pursue,” he said.

Schuster’s firm fits into Hochberg’s scenario. Schuster claims that real estate taxes tack on an extra $13 to $15 dollars in operating expenses. The average rental price per square foot in Manhattan was at $52.45 last November, according to Douglas Elliman.

“With the expiration of the 421-a program, it’s much more difficult to make the numbers work in our underwriting to support rental development ,” Schuster said.

“Rental development is hard enough in the City due to the high cost of land, but losing this tax abatement has further downward pressure on our targeted return-on-cost metrics. As a result, we’re forced to construct condominiums, with end-users paying the taxes, or build micro-units to achieve higher price per square foot rents to offset the approximately $13-15 per square foot in operating expense increases resulting from paying full taxes.”

It’s still unclear if 421-a is finished or if it will resurface in a different form. According to REBNY, which was tasked with negotiating a deal with construction labor unions, the next move in the process is with the state government.

“There was nothing in the legislation beyond January 15… The ball is back in Albany’s court,” said Jamie McShane, the group’s senior VP for communications.

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