Last week, the State of New York passed laws that give tenants more protection against rising rent increases. Included in this bill are things like eliminating vacancy decontrol and closing the preferential rent loophole. Detractors to this bill say that it will make it harder for the owners of smaller and older buildings to upkeep their properties, while those in favor of the legislation argue that it will help ease the woes of the New York housing market.
A large chunk of New York City’s multifamily housing supply was built in the early 20th century. As with any 100-year-old items, they require constant upkeep and renovation.
Let’s discuss the economics of a New York City multifamily investment:
Rent stabilized multifamily buildings trade at 3% to 5% cap rates (many closer to 3%). Based on most lender’s debt service coverage ratio requirements, these properties can only support 50% to 60% leverage and therefore require either a short-term bridge loan or lots of cash.
If you do the math (NOI minus ADS), there is not much cash flow remaining after paying the annual debt service. Many investors rely on renovating and increasing rents to make their investments work.
Let’s discuss some of the practical implications of the new legislation.
Major Capital Improvements (MCI) – If an owner completes a building-wide improvement such as installing a new boiler or fixing the roof, the cost can be amortized over 96 or 108 months. These costs are billed to the tenants based on the number of rooms in their apartment.
Prior to the new legislation, the maximum MCI rent increase was 6%. Under the new laws, the maximum rent increase is 2%.
To illustrate, let’s say that an owner completes $50,000 of building-wide work for a 20-unit, 50 room building. The allowable rent increase is $10.42 per room or $41.67 for a two-bedroom apartment.
Under the old rules, as long as the apartment’s rent is above $694.44 (6%), the full increase may be realized.
Under the new rules, only if the apartment’s rent is above $2,083.33 (2%) may the full increase be charged to the tenant.
The amount of time that it will take the owner to recover the $50,000 repair cost may be substantially longer than eight or nine years. The question now is will landlords have an incentive to make important building-wide repairs?
Increases for Individual Apartment Improvements (IAIs) – if an owner does interior work or makes upgrades to an individual apartment, the owner may increase that apartment’s rent.
The formula is pretty simple; if a building has 35 units or less, rents may be increased by 1/40 of the amount spent on renovations. If the building has more than 35 units, the rents can be increased by 1/60th of the amount spent on renovations.
As an example, if an owner spends $10,000 on renovations, the apartment’s rent may be increased by $250 per month for a building with 35 units or less, or $166.67 for a building with over 35 units.
The new legislation caps the amount of work at $15,000. Any amount spent above $15,000 will not warrant a rental increase.
I’ve toured hundreds of rent-stabilized apartments. The cost to renovate apartments in New York City is much greater than $15,000. Under the new legislation, if an apartment requires a major overhaul, there is no incentive for the owner to do so.
Will this law help or hurt the housing supply?
Repeal the vacancy bonus and the longevity bonus – This is probably the harshest item on the list. Under the old laws, if an apartment becomes vacant, the owner gets an automatic rental increase of up to 20%. Under the new legislation, this will no longer be the case.
There are always winners and losers in every piece of legislation. There clearly is a housing shortage and many nefarious landlords have exploited the system. However, will limiting the incentives needed to maintain an aging housing stock be the answer? Let’s wait and see. In the meantime, I will be heavily focused on cap rates.
Note: The goal of this article is not to express a political opinion, rather it is for analyzing the practical implications of the proposed rent legislation. For more information, click here.