Six months after Albany passed its sweeping tenant protections, the city’s multifamily market is feeling the strain

Soon after Albany passed its overhaul of the state’s rent law in June, real estate firms with big rent-stabilized holdings took a major hit.

Months earlier, David Bistricer’s real estate investment trust Clipper Equity, which owns more than 3,000 regulated units in the city, had presented an ambitious deregulation plan to investors. The firm was aiming to bring its seven-building Flatbush Gardens — which represented 38 percent of the landlord’s holdings at the time — closer to market rate, according to the pitch.

Clipper bought the 21-acre complex for $138.2 million in 2015, and rents there have gone up significantly since then, to about $24.50 a square foot as of last September from $13.25 at the time of purchase.

Evictions at the complex surged in 2018, with marshals issuing notices to nearly 80 residents. But now the deregulation plan is on ice, according to the property’s most recent tax bills, and its nearly 2,500 regulated apartments remain stabilized.

Clipper’s shares tumbled from a November 2018 high of $14 a share to about $8.50 last October and had climbed back to just over $10 as of late December. And the REIT appears to be taking matters into its own hands. Clipper, according to multiple sources, is bankrolling a challenge to the rent law by smaller landlords that echoes a federal lawsuit filed by the Community Housing Improvement Program and the Rent Stabilization Association in July.

Executives at Clipper declined to comment.

Sam Zell’s Equity Residential, which owns 9,600 apartments in New York, is another publicly traded landlord that’s feeling the pain. On a recent earnings call, Zell said the firm’s losses — including a drop in rental renewal increases and a $400,000 loss on application and late fees — will have a “chilling effect” on capital going into new multifamily development.

Hailed as a victory for tenants and an unexpected blow to the real estate industry, the changes to New York’s rent law are impacting everything from property values to investment sales and financing deals. The sweeping reforms severely curtailed the amount that landlords can be reimbursed for renovations, eliminated nearly all pathways to flipping regulated units to market rate and greatly expanded liabilities from rent overcharge cases.

The first two quarters of last year were the slowest for the multifamily market since 2011 — and the numbers got even worse after that. Deal volume fell by 31 percent in the first half of 2019 compared to the same period in 2018, while the dollar volume of building sales fell 51 percent year-over-year in the third quarter, according to a recent report from commercial brokerage Ariel Property Advisors.

“It’s definitely harder to get deals done,” said Aaron Jungreis of the multifamily brokerage Rosewood Realty Group, noting that banks are more hesitant to finance multifamily transactions.

“[Net operating income] hasn’t changed, but the upside certainly has,” he added.

A multifamily fire sale

A&E’s November purchase of the massive Kestenbaum portfolio — at a 38 percent discount — signaled for some that the city’s multifamily market had completely tanked.

The portfolio traded for $150 million, including $129.5 million for the rental apartment portion, as well as development rights and business interests the family owned, a source familiar with the matter told The Real Deal at the time.

One affordable-housing developer, who asked not to be named, gave a withering assessment of the sale and its implications for the city’s multifamily market.

“We are far from the bottom,” the developer said. “I still think [A&E] paid way too much for it.”

But a few other observers called the trade a positive sign.

Tim King, managing partner of the commercial brokerage CPEX Real Estate, said the discounted sale may have been an example of overly aggressive pricing.

A higher offer had been on the table in late 2018 but was rejected by the seller, who was seeking a figure above $210 million, according to several inside sources. Given the political storm that was brewing in Albany at the time, that asking price may have been wishful thinking.

“I can’t point to this one sale and say it’s proof the world is ending,” King said. “The reality is, the sale is almost a healthy indication. I don’t see [$129.5 million] as a bad number. Overall, it’s reasonable and in line.”

A&E and Jungreis, who represented the buyer in the deal, declined to comment on the acquisition.

In one example of a botched sale over the changes to the rent law, North Hudson Realty sued landlord Steve Croman in September, saying he backed out of a deal to buy a five-story multifamily building in Greenwich Village. The sale was supposed to close on June 27, but instead unraveled when Croman said the seller misrepresented the stabilization status of one of the nine units, according to the lawsuit.

The attorney for the plaintiff, Lucas Ferrara, said at the time that if Croman was “backing out of deals, that certainly doesn’t bode well for the regulated housing market in general.”

“Those who wanted to get out were either able to find some way out or were forced to close,” said Michael Dabah, a founding partner of law firm Stein Adler Dabah & Zelkowitz.

Meanwhile, capitalization rates — investor returns that are gauged when dividing a property’s NOI by its purchase price — have steeply risen since June, said Time Equities CEO Francis Greenburger.

“Before, people would buy properties in New York at very low cap rates — below 4 or even 3 percent,” said Greenburger, who had built a business around converting rental apartments to condos. “Today, I think buyers’ expectations are closer to 6 percent, which means a dramatic drop in the value of properties.”

Loan to moan

Within the past six months, there have also been at least two loan defaults on multifamily properties where the owners were banking on major rent hikes.

The missed payments on the mortgages — which alternative lender LoanCore Capital issued to Emerald Equity and Sugar Hill Capital — are largely regarded as outliers, according to multiple sources. All three companies declined to comment.

But more widespread defaults are expected to occur within the next few years, as more high-stakes multifamily loans come to term. Jim Costello, senior vice president at the data firm Real Capital Analytics, said the most stress will be on apartment loans originated in the last two years — when prices were at the highest levels.

“Potential defaults will come from trying to sell and not being able to get the same price as before, with lenders unable to step up to provide capital in the same way,” Costello said. “Then they’ll have to find outside equity to help cover them.”

Now, with so few large multifamily sales since June, most lenders are taking a wait-and-see approach.

Even if borrowers start to default en masse, sources say, many banks and other lenders may opt to extend terms or renegotiate rather than pursue an arduous foreclosure process only to become the owner of a multifamily property that’s shedding value.

“They’re going to, using a 2008 term, extend and pretend,” said commercial real estate attorney Michael Lefkowitz of the law firm Rosenberg & Estis.

But some changes are starting to happen.

With the market in dire straits, lenders are dissecting the new rent law and keeping an eye out for future risks.

Real estate attorney Joshua Stein said some banks have started to include new nonrecourse provisions as they underwrite multifamily loans to protect against potential losses. Risks could arise from the law’s expanded lookback period, which allows tenants to challenge rent overcharges going back six years, he noted.

One executive at a bank that lends on New York City rental buildings said the new carve-outs act as a safeguard against malfeasance, but also shield banks from “honest mistakes” that landlords may make.

Even in cases where landlords have adhered to the law, they could still be liable for the misdeeds of prior owners under the previous law, sources say. As a result, investors and lenders are doing more due diligence before signing on the dotted line to make sure those buildings don’t come with a history of illegal deregulation or other overcharges.

Soon after the changes to the rent law were enacted, reports surfaced of landlords holding vacant units off the market rather than renting them out at below-market rates.

But lenders warn against the practice of “warehousing” units, because it crimps a landlord’s cash flow, putting loan payments at risk, according to Lefkowitz.

“I’ve heard anecdotally as well about landlords keeping units off the market, hoping the unit next door comes vacant to combine [them],” he said, referring to the practice of sidestepping rent-hike restrictions by consolidating empty apartments to set a new first rent.

“These assets are cash-flowing because rent is in place,” Lefkowitz added. “If you keep units off the market, you don’t have rent, you can’t pay your debt.”

Gun-shy lenders

The decline in property values has hit all of New York’s top multifamily lenders as commercial real estate loan volumes plummeted in the third quarter of 2019.

Even before Gov. Andrew Cuomo signed the changes to the rent law, New York Community Bank, Signature Bank and Dime Community Bank had lost a combined $2.5 billion in market capitalization between March and June. The sudden free fall in the banks’ stock prices came as the debate over rent regulations began to paint an increasingly grim picture for the city’s multifamily market.

In several earnings calls since then, New York banks have been quick to reassure investors that while they’re responsible for the lion’s share of multifamily lending, their underwriting doesn’t assume outsized rent increases.

The same, however, can’t be said for some of the alternative lenders that issued large multifamily loans at higher interest rates, backed by robust deregulation plans.

Between January 2017 and December 2019, nonbank loans on apartment buildings and portfolios worth more than $2.5 million totaled $29.2 billion, compared to $35.4 billion in bank loans during the same period, according to an RCA analysis.

“We slept well even when we read the new laws,” one multifamily banker said on the condition of anonymity, noting that some alternative lenders who bet heavily on an “expectation of upside” have had a rougher time.

But while the rent law overhaul certainly disrupted things, that doesn’t mean a total death blow to the city’s multifamily market, argued Ayush Kapahi, co-founder of the debt brokerage HKS Capital Partners and private lender SKW Funding.

He added that rock-bottom interest rates may be blunting the impact — for now.

“You hear rumors that multifamily is a declining class, that NOI will decline over the next five years,” Kapahi said. “The crux of it is, it’s too early to tell. The one thing keeping everyone afloat is that interest rates are low.”

Disruptive opportunities

SKW and Bain Capital launched a $500 million fund targeting distressed debt in 2019, and Kapahi said in June that the changes to New York’s rent law could create new opportunities.

“Everybody’s looking for a good deal,” Lefkowitz of Rosenberg & Estis noted. “One person’s problem could be another person’s good fortune.”

Nate Lowy, founder of the advisory firm Juniper Capital Group, said more landlords are leaving the five boroughs to find upside in other markets, but they’re not going very far with looser rent restrictions in cities like Albany and Syracuse. The new limits on rent-stabilized buildings in the Big Apple also mean more owners are looking to boost rental income on their nonregulated units.

“The free-market buildings had kind of stalled until the rent law kicked in — now I’m hearing rents are really climbing,” Lowy added.

And as smaller owners who bought multifamily assets with plans to deregulate feel the heat, a growing number of firms with deep pockets are on the hunt for multifamily bargains in the boroughs, sources say.

“Folks who feel well-positioned to take advantage of the drop in prices are once again seeking to raise equity for multifamily in New York City,” Dabah said. “And others are simply moving to other markets outside of New York.”

Landlord Robert Morgenstern, who owns about 600 rent-regulated units in the city, said it’s not surprising that private equity money is starting to chase multifamily, since it’s now an impaired asset class.

“All of the guys who have opportunistic money — debt funds, hedge funds, private equity — are looking for things that aren’t plain vanilla,” Morgenstern said. “A tremendous shakeout may happen.”