RENT STABILIZED APARTMENT BUILDINGS, BRONX, NYC
With a few exceptions like its Riverdale neighborhood, theBronxis where you live in NYC, if you are financially challenged. There are about hundreds of thousands of apartment units in theBronx, typically in 50 unit mid-rise buildings that are still under rent stabilization. A rent stabilized means that the landlord can raise the rent a maximum of 3 or 4% per year, with the permission of the rent stabilization board. However, if you spend money to upgrade the buildings common areas, mechanical systems, unit interiors and such, you can increase the rent in accordance with certain formulas. Rent stabilized apartments in the Bronx sell for about $70,000 to $100,000 per unit which is pretty cheap when one compares it to the purchase price per unit of $700,000 to $1,000,000 inManhattan.
For many decades, the only people buying, managing and selling rent stabilized apartments in the Bronx, were tough oldBronxlandlords who often spent little money on repairs and maintenance and skirted the rules and regulations. At some point, say the year 2,000, certain adventurous institutional investors decided that buying units in theBronx, upgrading them and increasing the rents, and then selling the units at a nice profit, was not beneath them and in fact was a damn noble thing to do. The institutional investors did spread sheets and proved to themselves that if they employed enough debt leverage and spent enough money on capital improvements to allow for significant rent increases, they were likely to achieve a 20-25% leveraged IRR over three to five years.
And it didn’t hurt that a lot of institutional equity money was looking for ways to preserve and upgrade affordable, work-force housing.
Initially everything went just fine. Tens of thousands of units were acquire and capital improvements were being made. However, things began to deteriorate a few years into the program. Two factors conspired to make a nightmare of this business:
The first factor was that the projected rate of tenant turnover, say 10% a year, was proven unrealistic. When an apartment turns over, the rent stabilization regulations allow for a 20% increase in rent – well above the 4% allowed otherwise. The tenant turnover rate was naturally closer to 5% per year. And if the landlord employed various techniques to goose the turnover rate up to 10% and in some instances as much as 20%, all hell would often break loose. Big tenant protests, bad newspaper publicity, squawking politicians – in short a nightmare for image conscious institutional investors.
When the first factor cited above was combined with a second factor, described below, the result was buckets of blood flooding the floor. The second factor was the old nemesis of overleveraging. First mortgages for 60% of purchase price were readily available at 5% rates, which made perfect sense since the properties were being purchase at 5% cap rates. But why stop there? How about second mortgages or mezzanine loans, at say 12%, with partial or total accrual of interest. Since the projected leveraged IRR was 25%, 12% interest on a mezzanine was perceived to be entirely rational.
Of course, tens of thousands of units went into default over several years and yesterdays geniuses became today’s poor fools. Acquiring rent stabilized apartments in theBronxis no longer an attractive proposition for most institutional investors – no matter how great their desire is to preserve affordable, work-force housing.
Blue advised on the acquisitions of thousands of rent stabilized units in theBronx. Our clients borrowed 60% of purchase price at first mortgage rates. We prevailed upon them to be humble and settle for 12% IRRs. These deals, with only a few exceptions, weathered the storms and are in good shape to this day.