NEW YORK: An Introduction to Real Estate: Mainly Dirt

New York – An Introduction to Real Estate: Mainly Dirt 

Recent interest-rate hikes and regulatory difficulties hurt New York’s real estate industry over the last year. Rate hikes combined with continuing lower levels of office leasing post-pandemic have been particularly hard on New York’s office buildings. Office building values have dropped significantly as businesses remain reluctant to commit to office leases given some employees’ recalcitrance about returning full time to the office. While large financial institutions and other segments of the office market, including more recently law firms, have taken measures to require three to four days in-person office attendance, employees of other market segments remain more significantly remote. The lack of full time return to offices has also impacted retail leasing activity and rents which continue their long term stagnation.

Office buildings also diverge: newer and more amenitized buildings are more popular, reversing a trend of just a few years ago, when older building with more personality were favored by the tech industry and others.

Regulatory Difficulties 

Regulatory difficulties are affecting both the commercial and residential markets. For commercial loans for example, some bankers are complaining that bank regulators are treating all real estate loans as high risk even where the loans are current and still have modest loan-to-value ratios.

In residential, the continued political push to tighten rent regulations has reduced incentives to improve or renovate existing rental housing stock. Meanwhile, rents for free-market residential apartments continue at very high levels historically, but high regulatory hurdles and NIMBY reactions by local community boards continue to stymie many development plans. The governor’s recent push to liberalize several regulatory hurdles was defeated by the legislature in recent budget negotiations. Despite having a governor and mayor who are both moderately pro-growth, the state legislature and city council have not provided much legislative help.

An example of government gridlock has been the failure to address old building codes and zoning laws to permit underutilized, inefficient older office buildings to be redeveloped for residential use, including mandated affordable housing.

Another example is the expiration of the state’s 421a partial tax abatement program and the legislature’s failure to renew it, leading to a significant drop in building permits for new-construction residential properties, despite high rents in the free-market buildings, the very significant demand for market-rate housing and the need for affordable housing.

Market Activity 

New York’s real estate industry also lost a solid lender when the FDIC took over Signature Bank. The bank had a fairly conservative approach to real estate loans and had few losses on those loans. None of that seemed to matter as it was caught up in the crunch that higher interest rates had on banks.

In other segments, hotel occupancy levels are up significantly over 2021 but still below pre-pandemic levels and the revenue per room measurement known as RevPAR has not moved significantly. Multi-family free market rental properties are trading and, while higher cap rates have put pressure on pricing, values remain comparatively steady. In land transactions, vacant land for condo development in the traditional condo areas remains comparatively healthy while there are few transactions for land zoned for commercial. Self storage properties also remain strong and some older office building in secondary areas are being redeveloped for self storage in areas they wouldn’t have just a few years ago.

The residential ownership market remains healthy although transactions are down due to the unwillingness of sellers to lose favorable mortgage rates and the price pressure put on buyers by the rate increases.

Investor Opportunity 

This turmoil means opportunity for properly positioned real estate investors. Lenders may be forced to sell underwater office building loans at significant discounts and, despite hybrid work schedules, businesses will want employees in the office regularly and usually together—which means they will need space. Some investments will be comparatively clean discounted note purchases with the borrower’s cooperation but others may involve bankruptcy sales, involuntary bankruptcies and the purchase of interests in troubled entities with complex agreements and an infusion of new cash. Many of these alternatives involve unusual structures or diligence but carry with them significant potential long term profits.

A few recent examples of the complex structures and issues we have been addressing for client include strategizing a consensual bankruptcy filing by a borrower and a mortgagee to rid the property of claims arising from a rent regulatory morass; negotiating among tenants in common and the lender on how to best workout an underwater mortgage; and helping a borrower structure a loan write down to minimize taxable cancellation of debt income.

New York’s dynamic qualities—including its vibrant street life, efficient mass transit, and arts scene—all continue to make New York a favorite of the young and mobile. These factors and, of course, the fact that the city remains a financial capital of the world, invariably mean that the current mixed economic and political environment will not stop New York from changing, growing, and surprising us all, as it has so many times in the past.