High praise and hyperbolic accolades are all too common among sports commentators and pundits that they have all but lost their meaning.
Last week, however, the truly remarkable happened in the baseball world: Japanese-born baseball player Shohei Ohtani joined the 50-50 club and is, for now and perhaps always will be, its sole member. He did the undoable by hitting 50 homers (he is currently at 52 as of this writing) and stealing 50 bases in a single season. And there’s still more baseball to play.
Like Michael Jordan who was pure joy to watch, true poetry in motion, Ohtani may be, as the Marlins manager stated after the game, “the most talented player [he] has ever seen…[and maybe] the best ever to play the game.”
The meaning of “50-50” has changed forever—at least for me.
Many rejoiced last week when the Fed cut the overnight lending rate by 50 basis points and the stock market responded as expected by breaking record highs.
For mortgages and corporate bonds, the Fed funds rate is less relevant than the 10-year US Treasury yields and they actually ticked higher the day after the Fed’s move. The increase is a reminder that the Fed doesn’t control all borrowing costs.
Longer term yields are largely driven by future expectations as to where rates will be and not where they are now. So, when Fed officials signaled that they were optimistic about the economy and suggested future rate cuts would only be 25 basis points, the 10-year yield increased. A so called “soft landing” may be good for the economy but it means mortgage rates may remain flat or decline at a much slower rate than the Fed cuts.
The 10-year yield is also determined by “term premium” or the amount of extra compensation investors demand to hold longer term Treasurys over short term debt. Investors generally expect a 1% difference between short and long term US Treasuries but sentiment about the future can be fickle, impacting the term premium.
While real estate investors must keep an eye on 10-year yields, they should keep the other focused on the spread lenders charge borrowers above the yield. One-eyed investors ought not invest alone.
It turns out, lenders need to eat too and the borrowing rate is always some amount above the 10-year yield. The good news for borrowers: the extra differential lenders charge tends to shrink when the Fed cuts rates.
For commercial real estate investors, the Fed cuts are a good thing for sure and directionally positive for borrowers but it doesn’t tell the whole story as to where borrowing costs will ultimately land.
Discussing tax rules and regulations may be about as exciting as watching paint dry but I’ll do my best. Bear in mind, however, that sometimes the most impactful moments, economically speaking, are wrapped in a bundle of boredom. So, pay attention if you own any type of property in New York City.
Overview of NYC’s Property Tax System
For decades, many have correctly pointed out that NYC’s property tax system is fundamentally unfair as it imposes unequal tax bills on similarly appraised properties that bear little relationship to actual market value. For example, have you ever wondered why a $12 million townhouse in the West Village has an astoundingly low annual tax bill while a six-unit fully rent stabilized property in Ridgewood, Queens with a value of $800,000 could be excessively high relatively speaking?
To answer, I need to take you back to 1981 when NYC passed Article 18 of NY’s Real Property Tax Law. The law slotted every building into one of four different tax classes and allowed the use of so called fractional assessments of the property’s market value for purposes of determining its taxable value. Class One properties, or one to three families, are assessed using 6% of their market value while the other three classes are assessed at 45% of their market value.
Calculating Property Taxes in NYC: Two Examples
To illustrate how this works in practice, let’s go back to that $12 million townhouse in the West Village and compare that annual tax bill to a 45-unit multifamily property in Upper Manhattan with a market value of $5 million. To calculate, the city starts with the market value ($12 million/$5 million) and then applies a 6% fractional assessment to the townhouse (i.e., a $720,000 assessed value) as it falls in Class 1 and 45% to the multi-family as it falls into Class 2 (i.e., a $2.25 million assessed value). The varying tax rates are then applied to each of the assessed values so, in the case of the townhouse, ownership would pay approximately 20% of the assessed value or $144,000 and, for the multi-family, 12.5% of the assessed value or $281,250. To me, it doesn’t seem terribly fair that the owner of the $12 million townhouse pays about half in property taxes than the landlord of the $5 million multi-family.
The Benefits of Owning Condos and Coops Built Pre-1974
To further highlight the nonsensical approach employed by the city, one need only look at how they assess condos and coops for tax purposes. NYC compares condos and coops constructed before 1974 (about 98% of all NYC coops) to rental properties built before 1974 which are typically comprised of a bevy of rent stabilized units with market values significantly below any condo or coop. In many cases, this approach leads to the city using market values for coops and condos that are between 50%-80% lower than their true market values. As a result, these properties are taxed at levels that are completely out of sync with their true market value.
Enter Tax Equity Now NY to Fight the Good Fight
Fed up with the lack of political progress, Tax Equity Now NY (TENNY)—a coalition of real estate, civil rights, and housing advocacy groups—is taking its push for property tax reform to the courts. In a ruling earlier this year, an appeals court allowed several TENNY claims to proceed with an upcoming court date scheduled to commence on September 17, 2024. The continuation of the case is an acknowledgment by the court that inequities exist, setting the stage for a comprehensive review of the current property tax regime in NYC.
In short, NYC’s property tax system has been an unmitigated disaster for some time and when factoring in the recent rule changes surrounding rent regulation and good cause eviction, ownership of commercial and multi family properties isn’t what it once was. However, with this new TENNY case, pressure may be mounting on city officials and legislators alike for change. We are long overdue for an equitable redistribution of the tax burden among the various property types based more on true market value and less on convoluted tax classifications and fractional assessments impenetrable to all but the few tax attorneys and accountants who no doubt relish these puzzles and the high fees they command. I tip my hat to these professionals but simplicity and fairness are in order your honor.
No matter the field, top talent is highly coveted, not easily found and costly when you bring them onboard.
The Starbucks Example: A High-Stakes Hire
Take the example of Starbucks which recently poached the CEO of Chipotle, Brian Niccol, and they are paying him a whopping $100 million, the ability to work from home in Southern California and access to a private plane for those occasions when he decides to come to the Seattle office. This sounds excessive, but is it?
Investor Confidence and Market Reactions
Starbucks may have gotten him on the cheap, at least according to investors. When the news broke of his pending arrival, shares in Starbucks shot up 25%, increasing the market cap by $20 billion in a single day—and Niccol hadn’t even started. These are venti-level expectations for one person amongst an employee base of 380,000. That said, if his past performance at Chipotle is indicative of his future at Starbucks, it’s not a bad bet. Under Niccol’s leadership at Chipotle, the stock increased nearly 800%. His record of significantly increasing revenue, profitability, and market share at Taco Bell only adds to his credibility.
Superstar Paydays in Different Industries
Superstar paydays are nothing new. Legendary basketball player Michael Jordan earned $33 million in his final ‘97-’98 NBA season, equivalent to about $60 million today, surpassing even today’s highest-paid player, Steph Curry, who earns $55 million. Jordan’s Nike contract reportedly still pays him $100 million annually. In the financial sector, hedge fund titan Bill Ackman of Pershing Square Capital Management earned over $1 billion in 2020 through performance and management fees. These astronomical figures span multiple industries.
Valuing Top Talent: A Complex Equation
Whatever industry you work in, there’s always the question of how to value and reward top talent. Whether you’re a prospective employee determining your economic worth or an employer making a hire, it’s important to think about these things.
The 80/20 Rule in Real Estate Brokerage
In the real estate brokerage space, it’s often said that 20% of agents originate and handle 80% of the deal volume. If true, brokerages need to find ways to attract this top 20%, but identifying who they are is no easy task. It’s not uncommon for multiple agents to claim sole origination of the same transaction.
Challenges for Boutique Brokerages
As a boutique brokerage, you face the question of whether to home-grow junior agents or hire experienced agents (which is easier said than done). Do you pay a signing bonus for a multi-year lock-up for a superstar and throw in a guaranteed base salary? Perhaps, but that requires an agent to leave behind a more established firm and take a chance on you. It also requires significant capital, which many boutique brokerages may not have. Another challenge is how much of an agent’s success is tied to the brokerage they work for, making the hiring decision even more complex.
Cushman and Wakefield’s Approach to Hiring Talent
Even Cushman & Wakefield—which previously paid significant signing bonuses to relatively unproven junior agents and jaw-dropping figures to megastars like Doug Harmon and Adam Spies—has reportedly pulled back from the practice. Perhaps the old adage that money can’t buy love, loyalty, or happiness holds some truth, or maybe loyalty only lasts for the duration of the contract.
A Different Path Taken By Top NYC Broker
Some were surprised when Bob Knakal—arguably one of the best investment sales agents in NYC—decided to launch his own brokerage rather than accept a lucrative signing bonus from a larger firm, like Harmon and Spies did. It’s possible he missed the window of opportunity, as his departure from JLL came during a significant market slowdown.
The Debate: Ideal Compensation Structures in Commercial Real Estate
I’d love to hear from agents in NYC’s commercial real estate space about the ideal structure from both the agent’s and the brokerage’s perspective. What’s the right mix of fee splits, signing bonuses, and perks?
NY state lawmakers are patting themselves on the back for a job well done after creating a legislative framework that created one million additional and much-needed apartments in under twelve months. Ok, the bit about newly created apartments is not true, but lawmakers are still patting themselves on the back. Governor Hochul signed into law last year a bill that created heavy new penalties on those landlords who fail to register their rent-stabilized apartments with the Division of Housing and Community Renewal (DHCR) starting with the July 31, 2024 deadline.
The penalty increased from the rarely enforced one-time $10 surcharge to $500 per month per apartment. Now, the failure to register 45 rent stabilized apartments, for example, would result in a whopping penalty of $22,500 per month. What about the rent stabilized tenant who fails to pay rent for nine months? Well, they are provided complimentary legal services from attorneys adept at lawfully delaying their clients’ rental obligations.
“Massive Increase in Rental Registrations…”
And the new measure seems to be “working” as more than 919,000 apartments have been registered in the 2024 cycle which is up by more than 100,000 units from recent annual filings. The problem with DHCR filings, however, runs much deeper than owners failing to register the units in a timely manner. The real issue is that there is no formal acknowledgment by any government agency that the filings are correct. Missed and incorrect filings over several decades across multiple owners makes a correct accounting of the registered rents nearly impossible.
Few cared about this issue prior to June 2019 and rarely focused on it when properties traded hands. Today, the situation is different, and investors are acutely aware of flawed DHCR filings and often back away from deals so afflicted.
Amnesty for Owners?
I’d love to hear proposals from owners, investors and astute observers alike on how to fix the DHCR debacle that has further frozen trades in an already troubled asset class. One idea that comes to mind would be an amnesty for the current owner on all prior DHCR filings before his or her time of ownership. Another may be a formal acknowledgment by DHCR that the filings are correct and if not, how so, and within a reasonable period of time post-filing? If there is no response within six months of the filing, then ownership has the legal presumption that the registered rents are correct.
These agencies are funded by the taxpayer and we should demand more of them.
Few in NYC are jumping at the chance to live in a building with shared bathrooms, kitchens and a mere 80 sq. ft. of living space seemingly talor-made for a Lilliputian. SRO properties have been synonymous with poverty, overcrowding and substandard living conditions. Let’s face it, these properties aren’t pretty but they have played a pivotal and longstanding role in addressing—at least in small ways—the city’s affordable housing crisis.
Historical Role of SRO Properties
During the industrialization era, SROs accommodated the vast influx of workers and migrants seeking opportunities in NYC. They also provided refuge for those facing economic hardships and financial devastation during the Great Depression. They fell out of favor during the post-WWII economic boom, reemerging once again during the homelessness crisis of the 1980s.
More recently, the properties have been largely neglected by investors and owners alike who have had little use for them other than as single and two-family conversions or for housing program tenants. That may be about to change, however.
SROs Relevant Again As Short Term Rentals
In today’s “rent everything” generation, the short term rental model has exploded in popularity with Airbnb leading the pack. For a while, NYC landlords benefited but the passing of Local Law 18 in 2023 imposed severe restrictions on the practice all but killing the business for most. Officials blamed the noise, trash and danger short term rentals invited as reasons for the regulation but influential hotel groups certainly played a role.
For SRO property owners, however, Local Law 18 was a blessing as these “Class B” dwellings are exempt from its requirements. SRO owners are free to operate their properties under the Airbnb model. From a practical standpoint, transforming SROs into profitable short term rentals requires owners to vacate existing tenants—a task often fraught with legal and practical complexities.
Nonetheless, for an asset class with very limited use cases, call this is a small victory for the SRO community.
The great Spanish painter, Pablo Picasso, suggested you “learn the rules like a pro, so you can break them like an artist.” With the recent passing of good cause eviction (GCE) in NYC, landlords should find their inner artist and paint the town red identifying a relevant GCE exemption. And one exists and it’s glaring.
Getting an Exemption
If an owner has received a temporary or permanent certificate of occupancy (C/O) after January 1, 2009, a thirty (30) year exemption from the GCE rules applies. And how do you achieve a new C/O for your existing property? The answer: through an Alt 1 (now Alt CO) permit when there is a change to the use, occupancy or egress of the building.
There are many alterations that fall under an Alt 1 but arguably the most relevant for multi-family owner/operators would be to increase the number of apartments in a residential building (i.e., subdividing units) or adding a roof deck to the property in certain cases.
If I were an owner of apartment buildings in NYC with free market tenants, I would be on the phone with my architect asap seeking ways to legally and ethically apply for an Alt 1 that would allow me to obtain a new C/O exempting my property from the GCE restrictions on rent increases.
No doubt the process is more involved than I let on but certainly worth exploring.
Someone much more famous than me—with whom I concur—once said, “if you obey all the rules, you miss all the fun.”
In the world of real estate investment sales, it is rare for the broker to suggest ownership ask less than the market value. But maybe more of us should. In an industry of low probabilities at every turn, it would take brass to suggest such an approach. So few do it even if it maximizes price and yields better outcomes. A few reasons to reconsider:
1. Asking Whatever is Foolish: Many believe asking for the moon will land at sky-high pricing. It won’t; instead it keeps otherwise interested groups at bay. Asking $7 million for a $5 million property won’t get you $6 million…only a stale listing.
2. NYC is a Sophisticated Market: Investors may and often do overpay for the “right” asset but not by nearly as much owners often think. And a good broker matches the owner’s property with the “right” investors—that’s the skill. Groups willing to overpay will quickly move on from a supremely overpriced listing and overpay elsewhere.
3. Price Maximization Requires Competition: It’s true that broad exposure invites competition but it isn’t sufficient. You can spread the gospel far and wide but if the message reeks, few will follow. Pricing matters…a lot. If too high, groups will move along and focus on better opportunities. Why make your property easy to dismiss?
4. Get ‘Em Half Pregnant: Asking less than market invites an abundance of interest. A well-priced asset has legs and spreads faster than a salacious high school rumor. It also invites investors to dig into the due diligence and inspect the property. An active investor with time and resources allocated to a property is one step closer to consummation.
5. Sending the Right Signal to the Market: Overpriced listings or marketing materials riddled with phrases like “ownership seeking proposals” is a sure pass for any serious and well capitalized group. The message (realized or not) is clear: pay me a stupid premium and I’ll sell. If you are a seller, be a seller!
To be clear, the ask price should not be foolishly low—consider a 5% discount to market (but be sure your broker knows the market). A pool of rowdy and eager buyers chomping on the bit to buy beats the alternative. I have several anecdotal stories where we employed the above with phenomenal success achieving, in each instance, above the ask price.
Owners: let your brokers disrupt the old model. It works, is more fun and gets you to your goal of selling sooner for more.
The white paper put out by Maverick Real Estate Partners raises serious, and perhaps even grave, concerns for both owners and lenders of rent stabilized properties in NYC.
Healthy banks will adjust their exposure to this asset class and live to see another day while regional banks may not.
Smaller owners of these assets will face a similar fate of the regional banks. With lower valuations and higher interest rates, landlords will have to “ante” up in the form of more equity if they want to stay in the game and see “fourth street” or the “river” and many owners don’t have the financial wherewithal to do that.
How this unfolds: many mom-and-pop owners will lose their assets in foreclosure, title will revert to the lenders who will then aggregate these buildings in large portfolio sales to institutional investors at sizeable discounts.
The irony: hundreds of rent stabilized buildings (and perhaps more) end up in the hands of a few institutional owners (i.e., the proverbial small guy is wiped out).
Leadership matters!
Sources: Rent Stabilization in New York City – Maverick Insights. (n.d.). https://insights.maverickrep.com/rent-stabilization-in-new-york-city/
Over the weekend, legislators passed the NY state budget and Governor Hochul will soon approve it. Despite the high praise politicians involved are heaping on one another, the budget passed nearly three weeks after the deadline. Hochul suggested that a good deal is better than a fast one. True, but New Yorkers got neither. Let’s examine good cause eviction (GCE) and, later in the week, Individual Apartment Improvements (IAIs) and 485-x, which replaces 421-a.
Good Cause Eviction
Lacking any creativity, NY legislators adopted a version of GCE very similar to California’s (perhaps a pre-emptive move to overcome any constitutional legal challenges). Specifically, free market rental increases are capped at the lesser of: (i) 10% and (ii) 5% plus inflation. NYC must apply GCE (with certain exemptions) while other localities can choose whether to opt in. Tenants who fail to pay rent or are a nuisance can be evicted (which shouldn’t need clarification but in this environment landlords can take nothing for granted).
Exemptions to GCE
GCE passed with certain exemptions and one in particular that seems misguided (discussed below). Any new project (built in 2009 or later) is exempt from GCE for 30 years from completion, and expensive units (those affordable to folks making 245% of the area median income) are also exempt from GCE. Owners of small portfolios comprising 10 apartments or fewer are exempt from GCE.
Takeaways and Open Issues
Defining Ownership: What does it mean to own 10 units? Sounds simple, but most commercial properties are owned through an LLC (to minimize personal liability and contain issues with troubled assets from infecting an entire portfolio) and how will the state or city pierce the corporate veil and ascertain ownership? Furthermore, LLCs are very flexible structures often having multiple membership interests with different ownership stakes complicating matters. What if you own a 20% membership interest in a 40-unit property? Do you own 8 or 40 units? To me, the answer isn’t clear but one thing is: the future holds more paperwork/filings and, as a result, more costs for landlords.
10 Units or Fewer Exemption Defies Logic: In an attempt to lessen the bite GCE may have on smaller landlords, Albany enacted the 10-units or fewer exemption. Accordingly, a free market tenant “unlucky” enough to find herself living in a unit of a mom-and-pop owner will not have any protections afforded by GCE. To illustrate, her rent of $2,500 could be increased to $5,000 upon lease renewal. But isn’t this the exact “price gouging” the new rules are meant to protect against? Some may suggest this scenario is unlikely as the market wouldn’t support a doubling of rents. Ok, but then why have GCE at all? It’s clear that legislators want their cake and to eat it too by simultaneously protecting tenants and also smaller landlords. However, protecting the latter hurts certain members of the former.
Price Ceilings Have Unintended Consequences: Rent stabilization and now GCE are forms of price ceilings—a concept that isn’t new. Cities such as Stockholm, Berlin, San Francisco and Mumbai, among others, have implemented some form of rent control. And it’s true that regulating rents provides short-term relief for certain tenants but it can lead to issues with housing supply, building maintenance and quality over the longer term. Time will reveal what unintended consequences come to pass from GCE in NYC.
So, the dirty little secret is that Albany has been tinkering with supply and demand economics with adverse consequences for some time now. Through rent stabilization, nearly one million apartments have been effectively removed from the supply side of the equation putting undue rental pressure on the remaining free market units. The supply issue was exacerbated when legislators allowed 421-a to sunset nearly two years ago. Few new rental projects were built and the price of free market apartments unsurprisingly increased dramatically as demand for NYC living remained robust.
To ameliorate their missteps, Albany is now asking landlords—through the adoption of GCE—to cap the foreseeable and inevitable rent spikes resulting from bad policy. Politicians have merely shifted the increase in housing costs and risk onto landlords: the perennial punching bag.
Sources: Rebong, K. (2024, April 21). Housing deal finally passes; here are the details. The Real Deal. https://therealdeal.com/new-york/2024/04/20/housing-deal-finally-passes-here-are-the-key-details/ Smith, R. H. (2024, April 22). How ‘Good Cause’ Could Give Some Tenants New Leases and Lower Rent. THE CITY - NYC News. https://www.thecity.nyc/2024/04/22/tenant-eviction-good-cause-rent-limits/
