They can’t buy if there’s no supply

When the dollar volume of multifamily building sales in Manhattan dropped sharply this summer, some observers looked for political reasons. Was the decline the result of the passage of the Rent Act of 2015, which raised the threshold for deregulating an apartment to a monthly rent of $2,700 from $2,500? Or maybe it was the Rent Guidelines Board vote for a zero-percent increase on one-year lease renewals for rent-stabilized apartments?

Both issues are worrying to investors, as are fluctuations in the stock market.

An analysis by The Real Deal of city data found that sales of elevator buildings in July totaled about $100 million. That’s just a fraction of the more than $1 billion per month reached for sales of multifamily properties as recently as December. Walk-up sales dropped below $200 million in July, from a high of over $500 million in March.

This month, TRD asked commercial brokers and executives about the downward trend, and they said the main reason for the drought was simple: lack of inventory.

“In New York City today, the supply of available buildings constantly lags demand,” Ariel Property Advisor’s Shimon Shkury said. “Whenever we take a new multifamily property to market, we receive dozens of offers, so clearly demand is not the issue.”

Investors from around the world in fact fight fiercely for New York City’s multifamily properties, which are considered among the safest assets to hold. Today’s global economic turmoil is only increasing buyer interest in brick and mortar, which in turn is driving up prices.

And while there is continued interest in multifamily properties in the outer boroughs, Manhattan remains king, with buildings on the Upper East Side leading in sales.

“If you have something for sale on the island of Manhattan that in any way comports with reality, it sells,” said Meridian Capital Partners’ David Schechtman. “You only see a decline in multifamily investment if the seller’s pricing is ludicrous.”

For more on why the Upper East Side is so hot and why are sellers are growing more bold, we turn to the experts.

Adelaide Polsinelli
Senior Managing Director, Eastern Consolidated

The Real Deal crunched data for the 12 months ended in July and found that multifamily sales have fallen off sharply in Manhattan. Does that reflect what you’re seeing in your business right now?

We’re not seeing a decline in multifamily sales in Manhattan below 96th Street or in the other submarkets. In fact, our multifamily activity since the beginning of the year has been quite robust. Some of our multifamily deals since the beginning of the year include a luxury rental in West Chelsea for $44.2 million, or nearly $1,000 per square foot; a $50 million portfolio of three contiguous mixed-use properties on the Lower East Side for $50 million, or over $780 per square foot; and a Greenwich Village walk-up apartment building for $6.6 million, or $1,072 per square foot. We’re seeing record pricing and have sold multifamily buildings above the average price per square foot in every submarket.

TRD found that the most trades happened on the Upper East Side. Why is that neighborhood more appealing to multifamily investors right now?

Adelaide Polsinelli

The Upper East Side is a great value and its buildings have a tremendous amount of rental upside. One of the residential market reports showed that the median rent on the Upper East Side was $2,500 in July, which is lower than Harlem. Only Washington Heights had a lower median rent. I believe there is definitely a great deal of opportunity in this submarket and investors are realizing this.

Is the construction of the Second Avenue subway playing into interest in the Upper East Side?

According to the MTA, phase 1 of the Second Avenue subway is slated for completion in December 2016 and is expected to serve 200,000 riders daily, which will definitely make properties east of Third Avenue more desirable for renters, buyers and investors. I recently sold an 18,000-square-foot condo-conversion building in the 80s, between First and Second avenues, for $23.2 million, or nearly $1,300 per square foot, so I believe the Second Avenue subway has started figuring into investment decisions.

Is the interest multifamily investors are showing in other boroughs factoring into the decline in Manhattan sales?

We’ve seen a number of families that have acquired properties over many years and even decades, and we’ve seen institutional investors that have met their investment goals sell portfolios outside of the core of Manhattan. Part of this may be due to the fact that there are fewer rent-stabilized buildings in the core of Manhattan compared to the Bronx, Brooklyn and Queens. An NYU Furman Center study showed 166,961 rent-stabilized units in Manhattan’s core (Community Districts 2 through 8) compared to 231,754 units in the Bronx, 306,374 units in Brooklyn, 194,536 units in Queens, and nearly 120,000 units in upper Manhattan.

Are developers eyeing existing multifamily rental buildings for teardowns or conversion to condos? Do you expect that interest to be a major factor in multifamily sales going forward?

With land and construction costs rising, we’re seeing some developers planning condo conversions, because they’ve calculated a conversion is less expensive than ground-up development.

David Schechtman
Senior Managing Director, Meridian Capital Partners

Do you expect that with rent regulations renewed and the summer lull over, the market will pick up?

I do. I can tell you that for the first time in several years, real estate executives took longer breaks this summer, and while we remained very busy, the last two weeks of August were at times like the European version of a holiday — people really took a break. Fortunately, I can tell that they are already back and even hungrier.

Is the rent freeze passed by the Rent Guidelines Board weighing down interest from investors?

Fortunately we have not seen it yet. But I continue to be concerned because in the aggregate, this freeze, the general anti-landlord sentiment and now the concept of $10,000 to $20,000 fines for landlords who make good faith cash offers to tenants to relocate or move, are all additional regulations that really demonstrate an incredible lack of understanding of our housing in New York City.

Are the recent stock market fluctuations having any impact on multifamily sales?

It’s too early to tell. But notwithstanding, the obvious imminent changes in the market, and the alleged parallel tracks of finance and real estate, mean that investors could flock to brick and mortar, as they have in my experience, in times of stock market uncertainty.

How much of an issue is inventory availability? Are there enough properties available for sale, or is the lack of properties weighing on the market?

There is a lack of intelligent pricing — opportunity abounds, as always — and fortunately, there are investors with longer-term hold outlooks or lower-return thresholds willing to buy, but sellers are growing more audacious daily. A mild dose of reality in pricing would create a landslide of even more deals.

Is the interest multifamily investors are showing in other boroughs factoring into the decline in Manhattan sales?

Not at all. If you have something for sale on the island of Manhattan that in any way comports with reality, it sells. Even if it is record pricing, it will sell. You’ll only see a decline in multifamily investment if the seller’s pricing is ludicrous.

Are there any unexpected factors playing into the sales situation? Do you expect these factors to be resolved soon?

I sense that people are focused more on Europe than they are on local government’s lack of realization that many sellers are not tremendous institutions, but families who pass real estate down from generation to generation and who are finding current law to be very challenging.

Peter Von Der Ahe
Multifamily broker, Marcus & Millichap

What are some of the reasons behind the decline in multifamily sales in Manhattan?

There are always seasonal fluctuations associated with closings, especially if you look at the end-of-the-year spikes. That said, I do think investors are watching regulatory changes, what’s happening in the world economy — China for example — and keeping an eye on interest rates. While these factors impact our business, they also impact other investment alternatives in a more negative way, which has kept New York City multifamily at the top of everyone’s list as a good investment.

Now that rent regulations have been renewed, what do you expect the impact to be?

This is a significant issue, but its effects are different for different markets. In the better neighborhoods, it changes the business plan. In emerging markets, it’s just another thing to deal with. Interestingly, it made buyouts much less lucrative, so many tenants who could have received large paydays will now get smaller ones, if at all.

Is the rent freeze weighing down interest from investors?

Yes and no. This is more of a mindset issue. No investor ever bought a building for the guideline increases, but it’s a sign of our political climate.

Why is the Upper East Side more appealing to multifamily investors right now?

The rents have been depressed there for a few years, partly because of the construction associated with the subway, partly because young people would rather live in Brooklyn than the Upper East Side. We have sold many of those trades over the past 12 months. I like the value in the area over the next three-to-five years.

Which buyers are most interested in Manhattan multifamily properties right now? Are big investment organizations overtaking individuals and smaller owners?

Depends on the property, size, condition, and so on. But there are many foreign and domestic groups looking for ways to park money and find a stable investment.

Marion Jones
Senior Director, The Ackman-Ziff Real Estate Group

What are some of the reasons behind the decline in multifamily sales in Manhattan?

New York City has a natural ebb and flow within market cycles. At the height of the market, many investors will prefer to focus on emerging areas outside of Manhattan, where cap rates are slightly less compressed and the value-add opportunities seem more compelling. Inventory is also a challenge. Manhattan sellers specifically are notoriously discretionary. So it follows that where there is less product available, there will be fewer trades.

Do you expect that with rent regulations renewed and the summer lull over, the market will pick up?

While it is certainly true that investors are digesting the new rent structure and the political environment that fueled it, Manhattan is still a market mostly defined by supply constraint. Before the highly discretionary Manhattan multi-family owner will sell, he or she will review a long list of factors beyond the recent rent regulation renewal, including the likelihood of the Fed raising rates, to the availability of desirable 1031 opportunities, to the political disposition of potential contenders in the next mayoral race. In short, it’s probably wise to expect continued supply constraints overall, but based upon our conversations with potential sellers, we expect the Manhattan market to show some level of uptick in sales offerings through year-end.

Is the rent freeze weighing down interest from investors?

There is no question that the zero-percent growth for one-year leases and some of the components of the Rent Act of 2015 are unpopular among investors, but I do not see it diminishing investor appetite for multifamily product. However additional rent freezes going forward could negatively impact the market as a whole, as  it will potentially hinder owners’ ability to maintain and add value to rental buildings.

Are you seeing more price fluctuations in elevator buildings or walkups?

Walkups in the same submarket will generally show greater variability in pricing depending on a few factors, including the unit mix — fewer studios will often yield more aggressive investor underwriting, the ratio of rent regulated to free market units, and the overall physical condition of the building.

Are lenders more or less willing to finance multifamily sales than they were six months ago, a year ago and a few years ago?

Lenders love multifamily deals in New York City, and debt capital for this asset group remains historically cheap. We see an abundance of capital sources just as aggressive as ever, from life [insurance] companies and traditional banks, to a wide variety of debt funds. We just completed the sale of the Kestrel, a new 126-unit building at 33 Caton Place in Brooklyn and also arranged the financing. With a high sales price of $76 million and the asset’s status as a pioneer of new construction within an emerging submarket, lenders were lining up to compete. They understood the changing neighborhood dynamics and saw the value very quickly. This is equally true of the Manhattan apartment buildings we have financed recently.

Why is the Upper East Side more appealing to multifamily investors right now?

I think investors wisely see a lot of opportunity on the Upper East Side. It will always be a great neighborhood, given the schools, the museums, Central Park and the transportation infrastructure. The only major subway expansion in 50 years really benefits the eastern part of the neighborhood, and Yorkville was probably undervalued before the subway expansion started.

Which buyers are most interested in Manhattan multifamily properties right now?

Long-term holders, including institutions and families, can occasionally be more competitive in this environment. Investors with 5 to 7 year money often report to be fatigued by Manhattan pricing, but here’s a little secret: they are still usually among the top bidders and often successful. 

Are developers eyeing existing multifamily rental buildings for teardowns or conversion to condos? Do you expect that interest to be a major factor in multifamily sales going forward?

Developers love conversion deals. Ground-up construction generally means a high land acquisition basis, uncertainty around 421-a and longer construction periods that contribute to risk with market timing. I expect we will continue to see buyers favoring conversion for the foreseeable future.

Shimon Shkury
President, Ariel Property Advisors

Do you expect that with rent regulations renewed and the summer lull over, the market will pick up?

Investors are still figuring it out, but we do not see any connection between rent regulations and a slowdown. Regardless of new rent regulations, unless a tremendous amount of units are created, we believe multifamily assets will appreciate in value. With the city now adding 75,000 residents each year, new housing supply must increase at an even faster rate than what’s currently being built, or prices will continue to rise.

Shimon Shkury

Is the rent freeze weighing down interest from investors?

Owners certainly aren’t happy with it, because operating costs and taxes continue to go up, but they are more concerned about a broader regulatory regime that is very anti-landlord and anti-building stock. That said, most rent increases come from MCIs (major capital improvements) and apartment improvement increases. Rules for those aspects of rent stabilization were not affected by the new legislation, so there is still a lot of opportunity to add value by improving properties. 

What are prices like right now in Manhattan? How does that compare to six months ago, and a year or a few years ago?

Prices continue to rise — 2015 values are modestly higher than 2014 levels and are well above what we saw in 2013. 2015’s average price per square foot stands at just over $900 per square foot, which is 50 percent higher than 2013’s average of $600. Comparing other 2015 pricing metrics to 2013 levels, cap rates compressed 102 basis points to 3.61 percent, and the gross rent multiple increased to 19 times from 15 times.

Are you seeing more price fluctuations in elevator buildings or walkups?

Both asset types are prone to fluctuations. Buildings with elevators are more likely to be candidates for conversions, so we tend to see more aggressive values for them than walkups. However, when a walkup building has a lot of air rights, you could see inflated prices on a per square foot or per unit basis for the existing building, because the buyer is really pricing in the air and is putting more value on the development potential than in-place cash flow.

Why is the Upper East Side more appealing to multifamily investors right now?

One natural advantage the UES has from a multifamily perspective is the sheer number of residential buildings in the neighborhood. Buyers are attracted to the area’s current ability to consistently attract tenants for good rental rates, and there are large-scale projects in the works that will contribute to tenant demand over the long term. The upcoming Second Avenue subway and the Cornell Tech Campus on Roosevelt Island will drive more and more residents to the Upper East Side, which leads us to believe the area is undervalued right now.

How much of an issue is inventory availability?

In New York City today, the supply of available buildings constantly lags demand, which helps prices maintain elevated levels. Whenever we take a new multifamily property to market we receive dozens of offers on a property, so clearly demand is not the issue.

Is the interest multifamily investors are showing in other boroughs factoring into the decline in Manhattan sales?

Although multifamily is a hot commodity all over New York City, we do not see any reduced demand for Manhattan assets. If some buyers change their focus to other boroughs, there are plenty of other buyers out there to take their place. … Multifamily is in demand anywhere in New York City. We sold a 177-unit residential complex in Staten Island earlier this year and the interest came from owners throughout the Metropolitan area. While prices may be higher in Manhattan and some people might be seeking a higher return in the outer boroughs, we believe any slowdown in Manhattan sales is a reflection of supply and not demand.