Choosing Plan B: When going condo to rental makes sense

For certain developers, switching from condos to rentals makes financial sense

Jul.July 01, 2008 04:38 PM

While condo buildings throughout the city are going rental to deal
with the economic slowdown and fewer buyers, the decision to make that
switch comes with complicated financial realities that vary from
project to project.

Historically, condo
projects went rental as a backup plan, but that is far from a
universally safe bet today — and sometimes, it’s flat-out financially
impossible. Obviously, the developer must consider how much rental
income can be generated from the building. In many cases, that amount
is not enough to turn a profit — and sometimes, not even enough to
cover what was borrowed for the project in the first place.

The formula for
determining whether a building would be viable as a rental depends on
several key factors: the underlying land development and construction
costs; the strength of the submarket the building is in; the size of
the developer; the financial standing of the lender; and, of course,
how much each apartment can rake in.

Barry LePatner, a
leading construction lawyer, noted that large and established
developers often have enough of a financial cushion to ride out a soft
market, even if means warehousing empty apartments.

But, he said, other
developers who launched during the peak of the condo boom are in tough
spots, because high carrying costs can make it hard for their numbers
to work with monthly rental income.

So exactly when can a
developer rely on renting out units to bring in enough money to tide
them over a rough economic stretch rather than try to sell the units?

Many experts
interviewed said the original price of the land acquired is key — so
it’s more financially feasible to execute the rental option in
Brooklyn, Queens and in less prime areas of Manhattan, because
acquisition and land prices are lower. The option of simply building a
rental tower also works for some of the old-time, established real
estate firms that have been sitting on land for years and don’t have to
factor in today’s sticker shocker prices.

Still, real estate experts said rental backups almost never bring in what they would if the developer were selling condos.

According
to Susan Hewitt, president of the Cheshire Group, a firm that
restructures co-op and condo buildings, if an apartment is selling at
$1,000 a square foot, and the developer wants a 10 percent return on
investment, that would require the rental equivalent of $100 a square
foot.

“I can promise you that
is well above the rental level anywhere in the city,” said Hewitt.
“That is why [almost] nobody was building rental buildings over the
past 10 years.”

Paul Massey, chief
executive of Massey Knakal, reiterated that point, estimating that
rents would only bring in $30 to $60 per buildable square foot in many
locations. “Land values went up, and construction costs went up to such
an extent that in most parts of the city, you couldn’t afford to build
a rental,” Massey said.

Scott Stringer,
executive vice president of the Singer & Bassuk Organization, a
firm that arranges financing for developers, said banks typically
require a 125 percent coverage factor to lend money on condo projects.
That means the net operating income — income minus basic expenses like
taxes, insurance, management fees and repairs — must be 25 percent
higher than debt service, which includes mortgage payments made by the
sponsor to the bank.

In first-class
Manhattan locations, it often makes more financial sense for developers
to stick wtih condos because prices, while softening, are still holding
up fairly well. As a result, many of the recent rental conversions are
taking place in more up-and-coming locations like the Financial
District, Harlem and parts of Brooklyn and Queens, where rezonings or
relatively low land costs have allowed smaller developers to establish
a toehold during the recent boom.

Just two years ago, a
small Harlem-based developer called North Manhattan Construction Corp.
secured a loan to develop a small, two-building condo project called
the Bridges. The seven-story buildings were to be developed as 31
apartments, ranging from one- to three-bedrooms, plus 25,000 square
feet of ground-floor retail space.

After being declared
effective by the Attorney General’s office in December, the developers
were able to close on the first building, called Bridges South, at 2279
Third Avenue, off 124th Street.

Halstead Property is
marketing the site, where prices range from $449,000 for a small
one-bedroom to $927,000 for a two-bedroom, two-bath apartment. But the
developer has decided to be more cautious with the Bridges North and is
going rental, according to Steve Kliegerman, executive director of
development marketing at Halstead.

“[The developer] has
enough equity in the job and potentially enough income from the
commercial space to carry the building as a rental,” said Kliegerman.

Kliegerman said he is
working on more than 20 different projects right now and that lenders
are demanding solid fallback plans to operate condo projects as
rentals, unlike in the boom times, when they abandoned traditional
financing standards.

He said the Bridges is the only one of his projects that has converted an entire building into rentals so far.

Halstead
began listing apartments in the Bridges North in May, with rents
starting at $4,000 a month for a two-bedroom and ranging up to $5,600
for a three-bedroom.

Meanwhile, in Long
Island City, where about 4,000 apartments are either under construction
or have recently opened, hundreds of units have gone into the rental
market either directly from the sponsor or as investor-owned
apartments. The same phenomenon is happening on a smaller scale in
nearby Astoria.

Charles Sciberras,
associate salesman at ReMax Today in Astoria, estimated that two-thirds
of the condo developers in the area were speculators trying to cash in
on a hot market, but when the market turned, their base of young
Manhattan professionals could no longer qualify for a mortgage.

Sciberras said he spoke
to one Astoria developer, whom he declined to name, who has sold only
12 apartments in a 200-unit building. That developer said he plans to
convert the remaining inventory into rental apartments. Other
high-profile buildings, including Arris Lofts in Long Island City, have
placed unsold apartments directly on the rental market, according to
brokers.

The developer Crescent
Street has decided to go rental with nearly one-third of its units at
View 59 at 24-15 Queens Plaza North. The condo, designed by Andres
Escobar, has been on the market through the Developers Group since
October 2006. Two-bedrooms are starting at $410,000.

The developer sold 27
units, but by late May decided to offer the remaining 11 two-bedroom
apartments as rentals ranging from $3,800 to $7,900 a month. According
to Mary Crocker, a sales agent at Prudential Douglas Elliman, the firm
was brought on to handle those rentals.

In Brooklyn, several
neighborhoods — including Downtown Brooklyn, Williamsburg, Dumbo and
Greenpoint — have seen condo inventory enter the rental pool.

Developer Two Trees
Management recently began listing its unsold inventory at 110
Livingston — the former Board of Education building that was converted
into 300 condos — as rentals.

Asher Abehsera, vice
president of sales and marketing at Two Trees, said the company sold
its first 260 units and decided to go rental with the remaining 40. He
denied the decision had anything to do with slow sales, but he said the
units can command $50 a square foot in rent.

StreetEasy lists 223
recorded sales in the building, at prices ranging from $365,000 to $1.4
million. Asking rents, meanwhile, range from $2,500 for a studio to
$6,850 for a three-bedroom, two-bath unit.

In Manhattan, some luxury rental buildings work because they were never expected to be condos in the first place.

The
Chelsea Landmark, a 38-story luxury rental building developed by Rose
Associates and Marine Estates, is one of them. Rents at the building,
which is located on Sixth Avenue and 25th Street, range from $3,400 for
studios to $4,400 for one-bedroom units.

Bob Scaglion, managing
director of Rose Associates, said because they built the tower as a
rental rather than converting it and trying to shoehorn a condo layout
into their vision, they were able to design an efficient unit mix and
size that generates more revenue per square foot. He said the building
brings in $80 a square foot in rents, whereas competing buildings are
generating only an average of around $55 a square foot.

Whether other
developers, especially those starting with condo plans, will be able to
replicate that success is another question.

“The rental scenario
will be very, very marginal,” said David von Spreckelsen, senior vice
president at Toll Brothers. “It will be difficult to stomach. Some may
go rental; some condo people will reduce prices and take what they can
get.”


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