With condo surge, few developers see value in Plan B

Fall-back arrangements to turn condominium projects into rentals increasingly rare
By Mark Maurer | August 29, 2014 08:00AM

With the New York City luxury condominium market on a long hot streak — resales of condo units are now trading at a 19-year high — developers are rethinking traditional ways of doing business. One dramatic shift: Builders are increasingly plowing ahead with condo projects without putting together a fall-back plan to turn a property into a rental.

Indeed, new development marketers, analysts and other real estate experts said a Plan B is extremely scarce at this stage of the cycle. Developers are more willing to take a risk when they know the market is stable, they said.

“That’s the nature of developers,” Andrew Gerringer, managing director at the Marketing Directors, told The Real Deal. “You don’t go into this thinking you’re going to fail.”

This is in marked contrast to five years ago, when many developers opted to scrap condo plans and seek renters for units instead. And before that — prior to the housing crisis — banks routinely underwrote exit strategies for condo projects that sought a switch to rentals.

That practice has disappeared, said Nancy Packes, president of real estate marketing firm Nancy Packes Inc.

The meteoric rise in condo prices isn’t the only reason developers are casting back-up plans aside. The cost of land is also much higher than it was in 2008. Case in point: earlier this year, Harry Macklowe paid $100 million for a 90,000-buildable-square-foot development site at East 59th Street and Third Avenue, as previously reported.

“Since the current Manhattan development math largely only works as condo, I’m not sure how a plan B would be possible in this period,” said Jonathan Miller of appraisal firm Miller Samuel. “With the going-in land cost at record levels, a condo project is generally not feasible as a rental or a hotel.”

Miller said the holding period is longer because of lower-cost financing, and investors are quick to work with experienced developers. These factors have solidified the trend, he said.

A back-up plan to go rental with a project would need to generate enough cash to cover what was initially borrowed for the project. The formula for determining whether a building would be viable as a rental depends on a number of factors, with underlying land development and construction costs topping the list. The strength of the submarket the building is in is also important, as is the size of the developer; the financial standing of the lender and how much each apartment can rake in.

If a developer fails to hit a particular number of sales, “there’s nothing to do other than wait,” Miller said. He said price concessions were prevalent during the last cycle, but he has not heard of it occurring much recently.

Stephen Kliegerman, president of Halstead Property Development Marketing, said most developers look at the potential for a fall-back, but many back-up rental plans simply don’t work given the new calculus of the New York real estate market. During the economic downturn, Kliegerman said some of his clients slowed down a project while it was under construction or scaled back the size of a condo building, rather than changing direction.

Of course, some developers still see value in a fall-back plan, regardless of the surging market.

Witold Brend of Brend Development Corporation decided last year to construct a 53-unit, six-story rental property at 64 Bayard Street in Williamsburg. The initial plan devised in 2010, Kliegerman noted, was to build condos.

Brend changed his tack not out of necessity, but because the available financing favored going the rental route, Kliegerman explained.

If the property market were to take a header, developers of condos might have a struggle with lenders to hold on to their projects.

“The out-of-pocket money the developers and their equity partners would have to contribute until they can sell could be substantial, based on the amount of rent they receive versus the carrying of common charges and taxes,” Gerringer said.