The Real Deal New York

Rental development outpaces new condos, even as demand lags

October 11, 2007
By Carl Unegbu

In Manhattan’s residential real estate market, a curious trend is unfolding, as developers seem to be reading the market on a different page than the rest of us.

One would think that with the rental market lagging and the condo market strong due to low interest rates, developers would be rushing to build for-sale units rather than rentals, or quickly converting their rental buildings to condos.

But recent numbers show different thinking, with developers putting four times as many rental buildings as condos on the market in 2003. Of a total 5,303 residential units that went online last year, 4,566 were rental units and 739 were condos, according to figures from the Real Estate Board of New York.

While the rental market may be tightening, much of the recent upsurge in rental properties may be related to the long-term business strategies of developers, rather than immediate market conditions. Rentals also continue to be a draw because they allow developers to build their portfolios and receive tax advantages, as well as government incentives, particularly downtown with the Liberty Bond program.

Miki Naftali, President and CEO of El Ad Properties, a Manhattan high-end condo developer with extensive holdings in Canada, said last year’s preponderance of rentals was simply the “end product” of development activities begun two or three years ago in a booming rental market. He said he expects the bull market in condos to last another year at least.

Despite the hot sales market, many expect developers will continue to put greater numbers of new rentals on the market than new condos in the next few years, especially with the improving economy expected to provide more jobs.

“Rentals will continue to be the majority over the next few years in the near term, but sales may gain some market share because of so much rental property in the market,” said Jonathan Miller, president of Miller Samuel, the Manhattan residential real estate appraiser.

Miller said rental property development is good for long-term players, who can take advantage of low interest rates now, confident of the “rental market coming back in the long term.” He said the ability of these developers to secure lower cost construction loans in the current interest rate environment, coupled with their expectation of an improved rental market as the economy picks up, makes it worthwhile. Also, many long-term players also want to avoid the tax implications of selling condo units, he said.

The desire for a stronger portfolio in the long term is also an important factor for other developers. “Many developers would rather build rental properties so that they can grow their portfolios and rentals have an income tax advantage compared to selling homes,” said Shane Neuringer, associate director of acquisitions at Rockrose Development Corporation, a residential developer that has increasingly shifted its attention to rental development since the mid-1980s. “With apartment buildings, you get a non-taxed loan; the proceeds of the loan are not taxed.”

The changing character of certain sections of Manhattan has also made it easier for developers to execute their long-term strategy of building a portfolio through rentals. In so-called “emerging neighborhoods,” developers have taken advantage of lower land prices and low interest rates to build more rental properties, an opportunity not available to them in more established neighborhoods.

“The more established neighborhoods, such as the Upper East Side, Upper West Side, and Greenwich Village will see more condos due to high land cost there,” said Neuringer. “But in emerging neighborhoods like the Far West Side and the financial district, land is less expensive, so it is more feasible to do a rental project.” Neuringer added that his company is probably the biggest landlord in the financial district, with properties like 2 Gold Street, boasting 50 floors and 650 units.

The government has also played a part in this scenario, fueling rental development through the Liberty Bond Program and 80/20 tax-exempt bonds. “In New York City, there is a powerful incentive to develop rental properties under the 80/20 tax-exempt bond program. Not only is the cost of capital attractive, but there are low income housing tax credits and city real estate tax benefits that are part of the program,” Neuringer said. “Also, downtown Liberty Bonds have been a big incentive to do rental projects since the interest rates are attractive and condos are not permitted under that program.”

For developers who want to convert their rental buildings to condos after their building is completed, a change in midstream can be expensive, said Daren Hornig, president and CEO of residential brokerage Dwelling Quest.

“The rental market typically caters to smaller size units, and the units are not as highly finished,” Hornig said. “With the condo market, you are going to want that Sub-Zero refrigerator, and granite instead of formica countertops, and switching over can be expensive.”

Rental developers who haven’t fared well recently might be able to take solace in the fact that the hot condo market won’t last forever. Robert Rissetto, director of the residential division of the Olnick Organization, which builds rentals in Manhattan, said the condo market may actually be cooling somewhat and that the buying binge brought on by low interest rates has “gone on long enough,” having been impacted by other factors like the uncertainties of the job market and companies moving out of New York and others coming in, factors he said favor a decision to rent rather than buy. “Those who can [purchase condos] did, the ones that are left can’t for a variety of reasons,” he said.

Rissetto said that the rental market bottomed out from around mid-2002 through the end of 2003. He said rentals have been tightening up lately and that the vacancy rate for his company’s rental portfolio is consistently below 3 percent now.

But condo developers, for their part, said their units will continue to be red hot, and noted that many buildings are being converted to condos. “What we see is that more and more developers are shifting to condos in the past year because of the high prices of land or property for development in Manhattan, which makes it unprofitable to develop rentals,” said Naftali of El Ad Properties.

In addition to low interest rates drawing hordes of buyers, Naftali said the condo market today is better priced-wise and has a better level of activity than five years ago.

He cited the quick turnaround sale of his company’s 43 high-end condo units at 49 East 21st Street over an eight-week period between November and January, a holiday period that is normally slow for business.

“The condo market is very strong now,” Naftali said, noting the preponderance of first-time buyers shifting from renting to buying. “Basically, what they figure is that the monthly payment if they take a 75 to 80 percent mortgage will be equal to or lower than their rent, and that if they can come up with the down payment they can own a very high-quality apartment in the best city in the world.”

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