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What to expect when you’re expecting rent regulated returns

With the passing of the new rent regulations in Albany, drastically limiting the ways landlords can raise rents, developers have been researching new ways to do this while also complying with the law.

There has been no shortage of talk within the industry of expanding one’s portfolio outside the city.

However, for those remaining local, there is suddenly interest in deregulating units through provisions in the new law that allow apartment subdivisions and even warehousing.


Miguel Jauregui, director at the New York office of Greysteel, a firm of property advisors, said he’s already been hearing about plans to break up units to create new ones. “Owners have very few tools at their disposal (to raise rents), but one would be splitting units,” said Jauregui. 

Jauregui said he’d just spoken with an owner of a rent-stabilized building with 1,500-1,600 square foot units, who is planning to split them into two 800-square foot units.

“If you significantly reconfigure a unit, it’s considered a new unit, which means it’s free-market,” he said. “So you’ll be seeing things like that.”
But probably not too much.

“You can only do it if a building has a vacancy and it’s becoming a lot harder,” said Jauregui. “If you’re a rent-stabilized person paying $900 for a two-bedroom in Washington Heights, you’re probably going to stay there because why would you leave?”

Since the law’s signing, Jauregui said he’s also spoken with owners who plan to start focusing their attentions elsewhere.

“They’ll keep what they have, but they want to start investing in secondary and tertiary markets,” he said.


Jim Sullivan, managing director at REIT analysts BTIG, also predicted more developers will plan property ventures outside the city. But, he added, if they know what’s good for them, they’ll avoid other cities that are mulling rent controls similar to New York’s and have a Democrat-controlled legislature that’s capable of passing them.

“Rent control is not just a topic in New York City,” said Sullivan. “There’s been a lot of debate in San Francisco and although it did not pass, those housing activists are not going away. There’s a housing crisis in California. In markets like Texas, where there are less controls, the risk is lower.”

Meanwhile, an unintended consequence of the newly minted law could be more stabilized units being warehoused, Invictus Property Advisors, an investment sales brokerage firm, is warning.


Andrew Levine and Josh Lipton, the firm’s co-founders, said landlords of regulated properties still have a way of deregulating units through what’s known as “substantial rehabilitation.”

This means that if 75 percent of the building-wide systems — there are a total of 17 including plumbing, heating fire escapes, elevators and exterior surface repair — are replaced when the building is 80 percent vacant, units can be converted to market rate.

“From a valuation perspective,” said Levine and Lipton, “buildings that are at least 80 percent vacant will likely begin trading at a significant premium if they can qualify for the building-wise system improvements.”

Unfortunately for would-be renters, “the new rules may have the unintended consequence of creating a perverse incentive to keep rent stabilized units vacant with low legal rents further exacerbating the affordable housing crisis.”

Additionally, while there has very recently been a legislative “fix” to ensure that New York City’s 421-a housing program wouldn’t impact an owner’s ability to raise rents at those properties, Sullivan is predicting there will be fewer 421-a projects moving ahead.

This can’t be blamed on Albany, though. In reality, even prior to the rent regulations, 421-a projects had been doing lack-luster business thanks to an oversaturated market.

This was largely due to the last round of rent law negotiations in 2015. At that time, the tax breaks associated with 421-a developments were factored heavily into the discussion and many developers, feeling they were racing against the clock to participate in the program, applied for permits at that time.

As a result, “There was a bulge in the amount of new supply of 421-a units in 2017 and 2018,” said Sullivan. In 2017, the figure surged to 20,000. “What this did was reduce those companies’ ability to lease all those units.”

REITs like AvalonBay Communities began to leave the local market at that time.

Meanwhile, the rent laws are already having an impact.

“There’s no more value add. What you’re buying is what you’re getting,” said Jauregui.

On average, “A property that was worth $10 million is now worth $8 million or maybe $7.5 million. My back of the napkin prediction is a 20-24 percent reduction in value. We need a cap rate at the end of the day and you’ll see a lot of distressed sellers who are going to have to trade.”

He expects more foreclosures, with smaller owners at higher risk of having their properties scooped up by bigger fish. Buildings in transitioning neighborhoods like Flatbush or Mott Haven are also at risk, he said, because even if they’re doing fine in terms of revenue, owners could be hurt if surrounding properties start to become neglected.


He believes smaller owners will be hurt by the diminished amount of money they can collect from individual apartment improvement (IAI) rent increases.

Still, Jauregui acknowledged that in those very neighborhoods, some property owners played a dangerous game with rent increases affiliated with improvements, raising rents to more than what existing residents could bear. This is the type of activity the laws in Albany sought to change.

“They were bringing the rents up and pricing out people who were locals, but we’re now going through the other end,” Jauregui said. “I do think there’s a happy medium between what we had before and what we have now.”

That said, Jauregui believes the doomsday predictions abounding in the industry are at least somewhat exaggerated.

“Rent stabilized product will continue to trade,” he said. “You’re not going to see it come to a stop.”

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