NEW YORK: An Introduction to Real Estate: Mainly Dirt
2024 New York Real Estate Overview
The second half of 2023 and the first part of 2024 included moderation from the Federal Reserve Board with respect to interest rates. However, the effects of the interest rate run-up continue to be felt. Recent indications from the Fed that rates will moderate and perhaps go lower in the future have boosted activity in the New York market although values remain flat. The New York office building market in particular continues to be plagued by a rent shrinkage, lower occupancies and mortgage defaults caused by the expiration of long-time lower interest rate mortgages.
In a recent transaction, a major New York office building owner purchased the non-recourse debt on one of its buildings for less than USD.10 on the dollar. The author has been involved in other transactions that may trade at about that level of discount. Those deals are bringing new investors as office buildings need to be renovated and pay for tenant improvement and brokerage commissions for new leasing activity. Additional optimism has been created because of the steady office absorption rate, despite the fact that the leasing rates and rents are lower than pre-pandemic levels.
In one recent transaction where the author represented the office building owner, a new office tenant signed a lease for several floors which had been abandoned by a large co-working company, accompanied by an investment by the tenant in the landlord entity, and a modification and extension of the building’s mortgage – a potential win-win for all three parties. Although the landlord in this building took a hit on valuation in the sale of the interest in the landlord entity, by stabilising the occupancy and the mortgage they created a go-to building for other tenants. It will be a survivor.
On the regulatory front, New York’s legislature has failed to pass an extension of the old tax phase-in programme known as 421-a and new rental developments have languished and values have been affected. The Governor’s office took executive action to help one rental development but has not announced others pending ongoing negotiations with the legislature. On the regulated rental front, no relief has been forthcoming for residential landlords, causing distress in that segment and much lower values. Banks with portfolios of normally safe residential loan portfolios continue to be hit hard by the stock market and regulators as no one sees a path to stabilisation. Landlords complain that the costs of renovating vacant apartments are not properly compensated by the rent regulatory regime that was amended to be much more favourable to tenants in 2019.
In one recent matter related to workout for a failed building, after signing market leases the tenants litigated to roll rents back to regulated level because the prior owner fraudulently reset rents. They won the case, destroying the current innocent owner’s value. Note that the current rent regulatory regime has no needs test.
Other segments of the industry including self-storage, biotech and data farms are taking advantage of the moderating values and are attracting investors. Opportunity funds have proliferated, and capital is available for workouts and note purchases although the New York court system remains slow due to the pandemic.
While hotels still trade below pre-pandemic levels, they have been helped by the end of the pandemic with “Revpar” increasing and many municipalities cracking down on short-term rentals such as Airbnb.
The residential resale market has been hurt by rising interest rates as homeowners with long-term lower rate mortgages are loath to give up the value in those mortgages. Yet rates are not significantly higher than at other times in recent decades so that buyers are still picking over reduced inventory. The stock prices of residential brokerage which are public companies have been hurt as transaction volume is down. The ongoing antitrust litigation recently settled by the National Association of Realtors (NAR) has also hurt prospects and the settlement will add friction and some pricing pressure to residential brokerage business across the country. The NAR settlement also does not include most the of the larger brokerage companies, so there may be more litigation and uncertainty going forward.
New York courts have handed down several decisions of note recently. In 260-261 Madison Ave LLC v WeWork 261 Madison LLC, the court permitted the landlord to pursue a claim against the WeWork parent company despite the fact that the parent company was not on the lease and not a guarantor. The decision illustrates that merely creating a stand-alone special purpose entity, without more, may not insulate the parent company from liability. Of course, with WeWork’s subsequent bankruptcy, the landlord at 261 Madison may still be out of luck but the decision is a warning to other tenants that liability for lease obligations may ultimately rest with the parent company depending on the facts and the exact wording of the lease and any guaranty.
During the pandemic, the City passed a law rendering lease guarantees for certain kinds of small business retail leases unenforceable. The Second Circuit Court of Appeals found the law unconstitutional under the Commerce Clause, which limits impingement on contracts. Among the factors cited were that the law did not restrict its benefits to tenants who were forced to shut down and was not conditioned on need. While not binding on state courts, the decision is persuasive authority.
While job growth has moderated, the overall New York economy remains healthy. Crime rates have moderated despite a few headline-grabbing events. Properly guided investors are creating long-term value by understanding the New York market and regulatory environment.