The Pleasures of Battling City Agencies – My Adventures with SCRIE

I guess it’s a combination of the summer and just being very busy with business, but I suddenly fell out of the habit of doing regular blog posts. I suppose I had also exhausted the low-hanging fruit in terms of potential topics relevant to owning and managing multifamily and mixed use buildings in New York City. However, my recent adventures that led up to a rather sensational article in The Daily News this week, seemed like it would make a worthwhile read for you all.

This whole matter revolves around something called SCRIE–the Senior Citizen Rent Increase Exemption program. This is a pretty significant safety net program that the City runs for seniors which, though noble in its cause, is subject to abuse. Under SCRIE, seniors at least 62 years old with less than $29,000 in annual income who spend at least 1/3 of their income on rent can get their rent frozen. Landlords are still entitled to the full legal rent and future increases, but any amount above the frozen rent of the tenant is paid to the landlord, eventually, via a tax abatement. The city accounting for all this is rather hard to follow, as is the timing of when payments happen. Thus, in my case, I do make sure the City has the correct monthly TAC (tenant abatement credit) in their records (the difference between the frozen and legal rents), but it’s just too much effort to really determine for every tenant if we are truly, in the end, getting the right total credits.

Landlords who have qualifying tenants must accept the program, even though it is quite a pain. If tenants renew their leases, they have to submit paperwork showing that there was a rent increase in order for you, the landlord, to get that increase as a further abatement. Until the NYC Dept. of Finance has approved the application for an increase, the landlord has to take the cash flow hit. If, after six months, the tenant has still not refiled, you are allowed to charge the tenant the full rent. But then, once they wake up, they can still file with SCRIE, who will make you adjust your records and back out any extra charges. The same issue holds when there is an MCI increase. You can’t charge the tenant, but have to make sure that SCRIE gets proper paperwork in order for you to get the increase as a tax abatement. If the tenant doesn’t do it, which they usually don’t, the onus is on the landlord to file the additional form.

Note that in one of our buildings, close to 30% of the tenants are on SCRIE or DRIE (a sister program for people claiming disabilities). As a result, the total tax abatements exceed our tax bill! Thus, around this time of year every year, I have to jump through hoops to get the Dept. of Finance to send me a rebate check so that I can physically get the money due to me and not have it forever sitting as a credit balance on the City’s books. Of course, it requires yet another form to be filled out to get this refund and you have to wait 4-6 weeks for it to be processed. (I’m smiling and shaking my head as I write this.)

Most SCRIE beneficiaries are nice older people who really only survive because of this program. Typically, they pay their frozen rent in a timely fashion, right after their social security check arrives. However, I’ve had two situations where I’ve seen the program abused, through a scam that I’m sure repeats itself with many other landlords. The basic idea is that the old person has alternative housing elsewhere, and, in essence, let’s some younger relative piggyback off the benefit. For the landlord, it’s generally too hard to prove that the senior is not there. Additionally, if the younger relative has been living there with, say, his grandmother, for the last two years in a regulated apartment, he typically has succession rights to the apartment. Thus, even if the landlord ousts the senior, the apartment still can be passed to the grandchild, though without the SCRIE benefit. For the landlord, it’s more or less the same bottom line, so not worth much of a fight.

However, my feeling, as an owner, is that this sort of fraud actually hurts your ability to grow the value of your building. In insulates the “heir to the apartment” from any increases in rent, ever, and makes it so there is no chance that they will ever move. That doesn’t really fit our program. Additionally, it’s a taxpayer rip off, which I’m not keen on.

Prior to the case that got Daily News coverage, I had another situation where my super kept telling me, “The old lady doesn’t live here. She’s back in the D.R. Only her grandson and maybe one other guy seems to live there.” I heard it enough times that we moved a security camera to focus on the appropriate landing and I started to religiously download surveillance video. After looking at close to a year’s video, I discovered that the grandmother indeed was not really living there, though she visited every few months. With their lease coming up for renewal, we started a non-primary residency case in landlord/tenant court. Though the tenant of record’s son admitted to me in court that his mother was at the apartment for only a fraction of the year, their feeling was that it was still “her apartment” and that she was entitled to keep it.

Rather than having an extended legal battle that could go either way (those of you who have been in landlord/tenant court know nothing is a given), I took another tact. I had been speaking to SCRIE and was told that if there was more than one person on the lease, SCRIE would look at the combined income in determining eligibility. I offered the grandson an opportunity to be added to the lease (something he had previously turned down prior to getting them into court) and required that he fill out a normal application. In his application he represented making $40K per year, which should have disqualified the household from SCRIE. However, in the end, the grandmother and grandson took their new lease to SCRIE and got approved. This leads me to believe that you can simply tell SCRIE whatever you want in order to qualify. As long as you are not receiving any government payments that they can see, there is no way to verify your income. And in the case of a younger person, they can simply say they are a student or unemployed, sign an affidavit, and no one will question it.

The case reported in the Daily News was a little different. In this one, the grandmother and grandson were indeed living together since we bought the building. Over the years, we’d had a number of complaints of suspected drug dealing, noise, and the renting out of rooms. We did find an illegal deadbolt lock on one of the bedrooms which substantiated the last claim. As a result, we moved a camera to the top of the stairs at this landing approaching the 4th floor. I didn’t really monitor it much until the grandmother moved out last fall, after having her second leg amputated due to diabetes (note again that the apartment is on the 4th floor), and I started getting multiple complaints from long term tenants about Apt. 4B. There were stories of fights, partying, police visits, etc. It was enough that it would have been irresponsible and a potential liability if we did nothing.

In the meantime, the grandmother was being moved from hospital to hospital and falling behind in rent as neither her daughter or grandson had access to her bank account, I believe because she was afraid of having her money stolen by family members. This was confirmed by a social worker who got attached to her case for a while and called me to consult on what to do. Ultimately, we ended up starting a non-payment proceeding in court once she was four months behind. When we got to court, no one showed up on behalf of the tenant. After multiple adjournments, we asked the court to assign a guardian ad litem so that we could move forward with the case with a court appointed guardian to stand in the tenant’s shoes.

Through this several month process, some payments came in, but they weren’t from the grandmother. In fact, the grandson even admitted at one point to having one of his roommates go get a bank check because “I’m not good with money.” In any case, things continued to get worse and there was no sign of grandma ever being there. One night there was a police visit where a girlfriend was arrested for parole violation. Another night, a baby shower brought a parade of people in and out of the apartment all night until morning and, I’m told by neighbors, three visits by the police. The next morning there was spilled beer and cigarette butts all over our common areas.

We observed residents of the apartment and visitors coming and going at all hours. Often they would be smoking in the halls, carrying open bottles, or just loitering. At times they gave “the finger” to the cameras, indicating that they would do whatever they wanted and were untouchable. The grandson received numerous letters about this and I personally explained to him, “Jose, just behave respectfully, don’t make noise after 10PM, don’t you or your guests smoke in the hallways, and don’t give others a reason to complain to me, and we’ll be cool.” Yet, the guy continued his behavior.

All along, he professed that his grandmother was staying with him on weekends and spending the week at his mother’s house in Queens (where the Daily News reporter confirmed she lives and was told, by the daughter, is suffering form Altzheimer’s). When we recently put in an electronic key system, the grandson asked for a key for his grandmother. I told him I had to give it to her myself and would be back to the building on Saturday. He stated that she couldn’t make it that Saturday, of course! So I wrote to the grandmother directly, telling her to call me so I could make a special trip to the building to meet her. As you may have guessed, no call has come.

Ultimately, I got so fed up that I went down to SCRIE’s office and file an “inquiry” so that perhaps they could stop paying to have a 34 year old and his buddies get a cheap rent. When SCRIE eventually said this was a “landlord/tenant issue,” I’d had enough. I Googled “SCRIE fraud” and found that in 2011 the Daily News had reported that a NYC Finance audit had found at least $3 million in SCRIE benefits that had been paid to dead people. I contacted the paper and they liked the hook of my story enough to take someone away from the mayoral race to write an article.

As for SCRIE, I sent a copy of the article to the director of the agency the day it ran and, miraculously, she wrote back to state that they had already written me a letter that morning stating that they would be investigating this case. In the meantime, I’ve had a bunch of back and forth with them and they are going to reopen the other case I mentioned as well. It’s a shame that I had to turn to the media to make an agency do what they should have done in the first place. Let’s hope they do the right thing this time around, so that program benefits are only going to those who deserve them.

 

 

The Rent Guidelines Board Public Testimony Meeting Is Coming – June 13, 2013

A number of NYC associations serving the multifamily building owner community have been offering encouragement for owners to participate in this year’s public testimony hearings in front of the Rent Guidelines Board (RGB). Since I rather enjoy pontificating about the challenges and headaches of building management, particularly in a regulated environment, I figured I’d give it a shot this year. As I understand it, these meetings have been a bit toned down in recent years, but traditionally have been a circus of tenant activists and politicians who think it realistic to ask for 0% rent increases. Typically, owners/landlords are under represented, but I keep hearing that our participation can make a difference. If you are an owner and reading this blog, consider coming to the Emigrant Savings Bank Building at 49-51 Chambers Street (Between Broadway and Centre Street) on June 13. Testimony starts at 10AM and, I believe, may continue all day until 7PM. If you’d like to get on the speakers list, you can call the RGB directly at 212-385-2934, or just drop a line to Courtney Ronner, Director of Communications at RSA,  cronner@rsanyc.org. (I think going through Courtney, as I did, is the easier route.) Click here to download RSA’s RGB Talking Points if you need a little help formulating what you want to say.

The following is my intended talk:

Good morning. My name is Michael Vinocur and I come here as a modest-sized landlord with a fractional interest in a few
buildings in upper Manhattan. The early 20^th century walk-ups we own were decrepit when we first purchased them, with hundreds of HPD violations each. They now are significantly improved buildings, with zero or close to zero violations. We consider ourselves good landlords and good stewards of the housing stock we manage. However, these improvements happened only by digging into our own pockets and forgoing any real return on our investments, as RGB increases have continually lagged our increased operating costs.

Though I appreciate the struggles to pay rent encountered by some of our lower income tenants, many of them are, in fact, well insulated from rent increases though things like the SCRIE and DRIE programs. And I’ve been amazed at how readily those who find themselves in court for non-payment of rent can get “one shot” deals wherein the city will pay their back rent if they get themselves in a jam.

I know there is little sympathy for landlords in this room, but I’m here to appeal to you to consider an increase this year that at least keeps pace with the Price Index of Operating Cost. Though this index understates the real cost of maintaining a building, leaving out things like capital expenses and legal costs related to difficult tenants, it still, as you know, was pegged at 5.9% this year. Thus, I think it fair that your one-year renewal rate should at least be in this ballpark. I’d also encourage you to maintain a minimum dollar increase for apartments under $1000, of which we have quite a few. Subjecting a $600 apartment to a straight percentage increase just doesn’t generate enough dollars to be fair to the landlord.  

From 2007 to 2012, the Rent Guidelines Board one-year renewal increases have totaled 17.5% while my water and sewerage bill has gone up almost 76%. That’s over a 4 to 1 ratio! Heating costs have gone up far more than 17.5% during that time frame. So have material costs for repairs. So have salaries for supers. Insurance premiums are climbing faster than recent RGB guidelines, and this was further exacerbated by tropical storm Sandy. I have one building where my tax bill in recent years went up over 80%, despite less than a 20% increase in my rent revenues.  And don’t forget that in many parts of the city now, taxes are pegged to around 30% of gross rent revenue. So, when you grant us a 5.9% increase, realized that only leaves a little more than 4% after property taxes to cover operating expense increases.

In light of last year’s absurdly lean 2% increase, I ask you to, at a minimum, allow us to keep up with our increased annual expenses. If you want a healthy housing stock in New York City, RGB increases should genuinely keep pace with the real increased cost of properly operating and maintaining our nearly 100-year-old buildings. Thank you. 

Finding a New York City Rental Property Management Company…With So Many Out There, How to Choose?

Since we indeed run a Manhattan-based Property Management Company, this posting might be viewed as a self-serving attempt towards increasing our website’s SEO (search engine optimization), which to an extent it admittedly is. However, having lived through several years of having an outside management company looking after multiple buildings for us, coupled with many war stories I’ve heard, I’m well qualified to put together some thoughts on the topic.  I got into NYC real estate in 2000 as the money/business side of a partnership that purchased Harlem brownstone shells and renovated them into 4-family rentals. Once the renovation work was complete, the management was pretty easy. We did renovations which, at the time, were nicer than most everything else in the Harlem market, and had no trouble attracting great tenants. Since we did all the tenant screening ourselves and were able to pull in people at the top of the demographic for that market, management was pretty simple. Tenant’s paid their rent on time, without even having to send a rent bill. Maintenance was minimal, as everything inside the shell was brand new. We automated our lease generation processes and put together a self-authored website to promote our buildings. However, when we ventured into investing in larger, multifamily buildings in Washington Heights, we realized that we were going to need outside management. We weren’t all that familiar with the rent regulation laws in New York City and didn’t really have the infrastructure to handle billing and rent collections. Prior to closing on our first larger building, my partner and I were at a restaurant where the owner introduced us to a fellow patron, who was a managing director of a large fund who was an active buyer in Northern Manhattan. We ended up buying him dinner in order to get to pick his brains and he told us, “You’ll never find someone who will manage as well as you would, so your goal is to find the least bad management company.” I think he was right to an extent. No management company, for a 5-6% commission, is going to have quite the vested interest in your property as you do, and there are many mediocre companies out there, but not all are “bad.” We ended up going with a large multi-generational owner/manager who was recommended by the commercial broker that sold us our building. Soon after buying our first larger building, a 21-unit walk up, we heard story after story from tenants about how terrible the previous management company had been. They will remain nameless, but they are a VERY large, well known management company who is quite active in the industry. The prior owner was an old, absentee landlord, based in Florida, and had left the management company to its own devices. The new property management company we put in place certainly knew the business better than we, with a couple thousand units under their ownership and/or management. The firm itself was honest (something that is far from a given in this business), though, over the years, I suspect some of the agents were finding ways to enrich themselves beyond their salary. The problem was that the agents, on balance, were just not that good. In the course of several years with this company, we went through 6 agents. Some were better than others, but none really worked the buildings like we would (and we were pretty hands on so agents didn’t even have to deal with major capital improvements, individual apartment improvements, or renting of vacant units). I also had plenty of interaction with my old guard tenants and used to hear countless stories of unanswered phone calls, disrespectful interactions, etc.–stuff that made me cringe. So, based on these experiences, having taken our management in-house, and having taken on third-party management assignments as well, I put forth the following list of what to look at when sizing up a prospective property management company for your New York City multifamily rental property. Quality of Agent The quality of the agent is primary to how your tenancy is going to react to your management company. If you decide to go for a smaller firm, like ours, where the principals will be actively engaged in visiting the buildings, you have a better idea of what you will be getting, but in this case, you will want to thoroughly interview the principals and understand who will be doing what as it relates to your building. In the case of a larger firm, I would strongly ask up front who will be assigned to your property and interview them directly, probably without their boss present. Ask them how often they will visit your building, what their procedure is for apartment inspections, and if they plan to visit each unit to determine the real census of who is living there. You should also get a sense of how equipped they are to answer calls, emails, and texts from tenants at all hours. Ask what happens on weekends or after hours when a call comes in. If they aren’t adept at using a smart phone in this day and age, I’d move on immediately. Quality of Management Software The cost and pain of upgrading software is significant, so many old-school management companies still run on platforms that work, but are rather outdated. Tenants now expect to be able to communicate with management through the Internet. They want to be able to pay online, check their tenant ledger online, and enter maintenance requests online. An online work order system also ensures that all parties, from management, to agents, to supers are all always in the loop whenever a repair request goes out. Reports can automatically be generated so as to make sure everyone knows what items are open and can share in any notes that have been added to the account. Additionally, many systems now allow for owners portals, so the building owner can independently check their cash balance, open vendor invoices, and rent receipts. Quality of Document Management Property management can be a very paper intensive proposition. In many older management companies, filing cabinets can start to compete for space with employees. Furthermore, a physical filing system means that if one person has a tenant’s file on their desk, or a lease that isn’t filed, no one else can readily find it. We’ve opted now to scan everything that comes into our offices. Physical signed leases are still maintained as original hard copy for legal reasons, but everything can now be readily accessed by anyone from anywhere (so long as they have an internet connection). And, in fact, once my laptop is sync’d with our cloud-based repository, I can find any document even when not connected to the Internet. We scan every invoice, every check that we cut, every insurance notification, every city filing, every boiler registration, every DHCR rent registration, every SCRIE/DRIE notice, every security account deposit, etc. We also have the ability to forward email correspondences to our cloud repository to be properly filed. An admin in our office tags every document based on building, apartment, month and year, creating a virtual filing cabinet. Anyone can pull up a full display of everything in a tenant’s file. Furthermore, OCR (optical character recognition) is automatically run on everything that is scanned so that all documents are searchable. So, if there is a need to see all the invoices last year from ABC Exterminating, across multiple buildings, you can find every one in a matter of seconds. It’s very cool! Quality of Reporting Though most property management companies will have a standard set of financial reports that they send out monthly, owners should have the ability to tailor what they get and even ask for custom reports that better suit their needs. We have one client who wants us to send a pared down set of reports to her, but a more complete set to her accountant, so we accommodate. For another owner, we developed a custom month-to-month cash flow report specifically to fit his needs. We have a goal of getting the prior month’s report out to owners by the 10th of the current month, something that we always do. And because of our scanning system, we are able to combine the financials with images of every invoice and check that relates to those financials, all tied together in a single PDF document. If the owner ever misplaces this composite report, we can get them another copy in minutes. You should also find out who you will be communicating with when you have questions about the financials. In larger companies, the agents are often not really qualified to answer accounting questions, particularly about things like payroll reporting, the handling of security deposits and prepaid rents. Also, find out who your accountant will be dealing with when gathering tax information at the end of the year and make sure that he/she will be able to get what they want with reasonable turnaround. Registration and Compliance Procedures If asked, a prospective property management company should be able to tell you their process for complying with the multitude of filing and compliance activities required by New York City and New York State and spell out which will or will not incur additional charges. How are they handling annual fire safety notices, window guard notices, and lead paint notice requirements? How do they handle DHCR rent registrations? Boiler inspections? Fuel storage registrations? Elevator inspections? Local law requirements? Bench marking or energy audit requirements? Will they file property tax appeals on your behalf? Will they file your annual RPIEs? Do they use a subscription service to track violations, registration anniversaries, and other compliance requirements? This is all the minutia that you don’t want to do and a primary reason for hiring an outside company. You need to know that this will be done right without your having to babysit it. How Are They Going to Work Your Building? Given the lofty values in the New York multifamily market these days, your asset is going to require some active management if you want to see it’s value continue to grow faster than alternative investments. You should walk your building with any prospective management company and ask them what they are going to do to increase your value? How much time will the put into getting to know your tenancy? What’s their game plan for ferreting out any illegal tenants/sublets? See if they are savvy enough to bring up things like MCIs and MBRs without prompting, assuming you have a number of below market stabilized or rent controlled apartments. How adept are they at carrying out those major capital improvements, both in terms of getting the physical work done and the subsequent DHCR filings? Do they have the chops to pull off individual apartment improvement renovations that will really maximize the rent bump you get from your expenditures? Ask to see some before any after photos of renovations they’ve overseen so you have a sense of the level of contractor they employ and the aesthetic of the design. If a company principal is going to be your managing agent, they have an incentive to increase your rent roll, since their fee increases as a percentage of that rent roll. However, with larger management companies, where you will have an employee as an agent, ask what incentive they have to recapture below market units. If they are not getting some compensation for going that extra mile to get you an apartment back, how much effort will they really put into it? Without a proactive agent, you will not see the return you are expecting on your building. Tenant Relations Some tenants can really be a pain, but we also really love many of our tenants and have a great relationship with them. And having such relationships can be invaluable in terms of discovering questionable activities in a building or making sure that you get the first call when a problem occurs, rather than that call going to 311. Ask to speak to a number of older and newer tenants (stabilized and market rate tenants will likely have different perspectives) in a couple of buildings being managed by the prospective management company. I think it’s okay to let the management company select the tenants, since a random selection could easily get you the crazy tenant that never will like anyone that manages their building. Such conversations may prove eye opening. You’ll find out how responsive management is, whether agents are respectful, whether they feel the building is cared for, their experience with the initial lease and renewal lease process, etc. Though tenant perceptions of the management company should not be your primary determinant, you will be well served by having it become part of your decision making process. Choosing the right New York City property management company is critical to the financial performance of your building investment. Given all the due diligence that goes into buying a multifamily rental building these days, it’s imprudent not to put similar effort into selecting a company to manage the property. If you are an owner, we’d appreciate the opportunity to sit down with you and see if we can be of service. If you are a broker, we’d be thankful for any referrals to clients who really could use a company that will property look after their interests. Michael Vinocur mvinocur@bemnyc.com 212-503-7953 212-380-7953 (c)

More New York City Multifamily Market Info…This Time from Recent CHIP Seminar

Last week I made my annual trek to the NY Buildings show over at the Javits Center. My business partner and I walked the show floor for an hour or so, with particular focus on various building electronic key and finger print recognition entry systems. Our goal is to find a way to make sure that only tenants of record and their families  can gain access to the building. Most landlords with rent stabilized units know that there is illegal subletting going on. We’re going to explore integrating such a system with our security cameras and will advise in the future as to how well the technology works for us.

Robert Shapiro presents a look at the 2012 market.

After the show, we ventured to a panel discussion hosted by CHIP, Community Housing Improvement Program, a trade association representing more than 2,500 apartment-building owners in New York City’s five boroughs. Robert Shapiro of Massey Knakal opened with a review of the 2012 market and Peter Von Der Ahe of Marcus & Millichap offered his perspective on the near future. Much of what these two well-known brokers reported echoed things I’ve reported in past blogs, namely the extent of the year-end capital gains law triggered transaction frenzy, the crazy current values, lack of inventory, amount of money chasing deals, etc.

I found myself shaking my head at some of the recent deals that Peter reported on. He noted that 111 Kent Avenue in Williamsburg has sold to West Coast-based American Realty Advisors for $56,000,000 or $913 per sq. ft. He reported that the cap rate on the deal was 3%. Granted, this is a well designed new rental building, but it’s priced with every unit already at market rate. He also pointed to a 14 unit rental building on Irving Place and 19th Street that is in contract for 1000 per sq. ft. Assuming you could get 100 per sq. ft. for the apartments (which I imagine would require a considerable investment in unit upgrades), by the time you look at gross vs. net square feet, the likely tax rate, and other operating costs, is there room for more than a couple percent cap rate? Maybe this is a conversion play, but seems like a lot of risk to me.

Andrew Barrocas, CEO of MNS, Real Impact Real Estate continued with the bullish market prognostications. With a focus on Brooklyn, Barracas painted a picture of a market that could only go up. He made it sound like there is unlimited demand for people willing to spend $2000 per sq. ft. for apartments and claimed that the Irving Place deal referenced above was “cheap.” I’m sorry, but when I hear such unbridled bullishness, I get nervous.

Andrew Hoffman offers buyer’s perspective.

The talk that I most identified with was given by Andrew Hoffman, COO of Stonehenge Partners, which manages a portfolio of mostly Manhattan multifamily assets worth approximately $1.5 billion. Hoffman come right out and said, “It’s a hard decision to buy” in today’s market. The biggest problem his firm faces is in sourcing properties and he hesitantly stated that once properties get into the hands of the major brokers, they get shopped around to the point where the pricing makes no sense to Stonehenge. It sounds like any deals they are likely to do these days will originate from internal cold calling to other owners in hopes of uncovering a reasonable seller.

However, Hoffman contends that there are still plenty of buildings that haven’t been properly worked (though maybe not that many in the core Manhattan market where Stonehenge tends to play). “The first thing I like to see is a really dirty boiler room,” states Hoffman, a sign that there is lots of opportunity to make the building better and thus increase value. Though I’m a relatively small player without decades of experience in multifamily, it was reassuring to see that Stonehenge’s strategy for unleashing value in regulated buildings is effectively no different than mine. They look at whether all the tenants are legal. Can they do any buyouts? Where are opportunities to do capital improvements and perhaps file for MCIs? He also pointed to the potential for retail buyouts, something I never considered. Clearly in the right neighborhood, where a major upgrade in a building’s retail could drive its value, this could be an effective strategy.

The final speaker was Jeff Farkas of Farkas Management, who, after successfully growing a small family multifamily portfolio into a fairly substantial one, sold off much of his Washington Heights interests in 2005 in order to diversify into municipal bonds and more core Manhattan holdings. His task on the panel was to present the perspective of “the seller” in today’s market and he made a fairly compelling argument for why one might want to let go of some property in the current environment. He cited data about how his portfolio grew 800% from 1986 until 2005, but only 50% more in the next eight years, after he sold. What was most interesting was that while the rent roll over those last eight years grew by that same 50%, the NOI in the buildings was unchanged–primarily due to increases in taxes and water and sewage charges. Thus, Farkas contended that most of the post-sale increase in value was due the decrease in interest rates and compression of cap rates. As a result, today’s values are extremely vulnerable to a spike in interest rates–something that eventually will come our way.

At the end of the panel, my partner turned to me and said, “I’m afraid that last guy made the most sense of anyone that we heard speak.” Though I tended to agree with him, we both are still looking at potential new acquisitions. However, as suggested by one of the panelists, for it to make any sense, it will likely have to be a quiet deal that has not been shopped all over the market.

 

 

A Brief Report on Massey Knakal CRE Investment Summitt 2013

Photo courtesy of GreenPearl Events

First of all, I apologize to my readers for the long gap since my last blog post, but business has been very busy as of late and the blog has fallen by the wayside. Additionally, I’ve been waiting for something worth reporting on. Last week I attended the Massay Knakal CRE Investment Summit t the Hilton. Though I didn’t stick around for the full day, as the focus was more on retail and office than on multifamily, I did listen to the keynote talk given by Bob Knakal, Chairman and Founding Partner of the firm that bears his name. As always, Bob’s talk was filled with data gathered by his firm and offered a solid assessment of the state of the NYC commercial market.

In his overview, Knakal presented data that shows that building turnover has contracted from last year’s uptick and now suggests that the average hold period for a building in New York City is over 40 years. As widely reported, last year showed quite a transactional volume uptick due to anticipated changes in the capital gains tax rate, and thus Knackal is looking or a 20-25% decline in number of deals in 2013. He does, however, see potential for a slight increase in dollar volume due to the recovery in large office building transactions. The feeling is that rents will increase over the next year in all sectors with greatest strength in retail, followed by residential, followed by office. As an example of some of the startling changes in retail, it was reported that rents in Bushwick have doubled in the last nine months.

Knakal outlined five things to look out for in 2013:

1) Supply: Will be healthy this year as evidenced by the recent growth in Massey Knakal net exclusive listings during Q1 from 114 to 168.

2) Demand: Will continue to exceed supply. This is being fueled by:

• High net worth individuals who are chasing yields in this 0% interest rate environment
• Real estate families, who are, always looking to expand their portfolios
• Institutional investors, ripe with cash and again comfortable with the market
• Foreign sector investors, who see NYC as a safe haven to move cash to

Photo courtesy of GreenPearl Events

3) Interest Rates: This has been the rocket fuel that has driven the market. Knakal noted, though, that however artificial these low rates, investors seem not to be properly factoring the risk of what happens when rates do rise. He went on to suggest that rates could rise faster and sooner than people think. However, in a later “Borrower’s Brawl” session, a panel seemed less willing to guess when rates would go up. All felt it would eventually happen, and that it is a major risk, but no one would venture as to timing.

4) Jobs: This is the factor that can have the biggest impact on commercial real estate since it impacts all three segments–office, retail, and residential. Knackal noted that the current job market has the lowest percentage participation since 1979 and that nationally we are still 12 million jobs short of what is needed to “feel good” again. Given the Federal Reserve’s posture towards trying to promote job growth, I would conjecture that rates are safe until we start to see some convincing job growth.

5) Mayoral Race: New York City has been propped up by having had two consecutive pro business Mayors over the course of 5 terms. So, clearly there is a fear of having a less accommodating  more liberal next mayor. Beyond the mayoral race, Knakal pointed to importance of maintaining state and local tax deductibility. His fear is that if this is pulled, it will sink the area, as people choose to work elsewhere in order to avoid the onerous resulting income tax disparity.

Look for my next blog to post within about a week. The NY Building Show is coming up this week and I plan to attend a special CHIP panel entitled, “Buy, Sell or Hold.” I’ll report on what the pundits have to say if this proves an informative panel.

NYC Multifamily Owners – Beware the TPU!

I’ve been to quite a number of industry meetings the last several months, notably those hosted by RSA and CHIP, where there have been warnings about the new Tenant Protection Unit or TPU. This is a new group within the New York State Homes and Community Renewal agency (formerly DHCR), created last year by Governor Andrew Cuomo to proactively increase and enforce compliance with the New York State Rent Stabilization Law.

New kitchen

I had heard that the initial focus of the unit was on looking for owners who hadn’t properly registered regulated units over the past four years. At least, as an owner, if you know you’ve properly registered all your regulated apartments consistently, you should be free of any harassment on this front. The other area of focus has been on individual apartment improvements (IAIs). As many of my readers will know, one can gain rent increases by making certain improvements to an apartment. The allowable increase is equal to 1/40th of what was spent on the improvement if your building has 35 or fewer units and 1/60th for those buildings larger than 35 units. This lesser benefit for larger buildings was a new twist passed last year. If someone is living in an apartment, he/she has to preapprove such an improvement and the resulting rent hike in advance. Since most tenants will never agree to any improvement that is going to increase rent, most IAIs happen when there is a vacancy, at which point the landlord can do whatever he/she wants in terms of upgrades.

Kitchen “Before”

In 2011 we got back a low rent apartment after a bit of a battle. The tenant of record had moved to Florida, which we could prove, but her estranged husband then tried to argue that he had rights to the apartment and could allow it to be used by an unrelated female acquaintance and her thug boyfriend. Eventually we got an eviction and proceeded to fully renovate the apartment. Before and after photos punctuate this blog post. The legal rent went from below $900 to around $2300, which I guess made us a ripe target for the algorithm that is triggering a TPU audit, since the rent went up by much more than the typical 20% vacancy increase.

I first got a letter dated 3/19/13 stating that I had to comply with the TPU audit requirements. I had been told by the folks at RSA that the key thing is to just respond quickly with as much information as possible, so I started working diligently on it, having my assistant gather information as well. A couple of days later, I got another letter from TPU stating that I was still being audited, but they had referenced the wrong rent registration years in their first letter. That same day, I got yet another letter that read exactly the same as the one I got on 3/19. So, this unit has now contacted me three times about the same IAI. Efficient government at work!

New Open Layout

The core of what one has to do to comply is as follows:

Please submit all supporting documents that justify the cost of the IAI. This would include, but not be limited to: leases, bills, cancelled checks, receipts, contracts and invoices from contractors. In addition, please include the date the work was completed and the calculation of the new legal regulated rent (including the prior tenant’s last rent, the vacancy allowance, any longevity allowance, and the increase due to the IAI). If you do not have a contractor’s itemized breakdown of costs, you must submit a notarized Owner’s Affidavit which must contain the following information: (1) a detailed description/explanation of the work performed; (2) the installation dates of the work; (3) the identity of the coutractors/subcontractors; and (4) a breakdown of the cost of the work. Please note that all costs claimed for the IAI need to be broken down and itemized. Many renovations include non-allowable costs which our staff will be unable to segregate if a complete breakdown is not submitted. If the TPU cannot determine which items are allowable, it could result in the entire IAI being found unacceptable, which, in turn, may lead to a finding that the rent is too high and further administrative or legal remedies. Please mail all documents back to the Tenant Protection Unit with a copy of this letter and a cover letter, at the address indicated above. You may also submit these documents to us electronically at the following email address: tpuiairesponse@nyshcr.org.

Luckily I keep very good records and had copies of everything. Additionally, because we also have a design/build business, I have accounting software that allows me to accurately track job costing. So, at least I was able to run a single report and see every cost that was applied to this renovation, grab check numbers, vendors, etc. Still, organizing everything for TPU was quite a pain and consumed many hours on the part of my assistant and me. We scanned every contract, bill, and credit card statement we had that pertained to the job. Then, since no one gets back cancelled checks per se, we create PDFs of all the bank statements that pertained to any checks that had been written and cross referenced them to a spreadsheet listing each expense. Though not requested, I sent some before and after photos as visual proof of the work done. I also had to write an affidavit giving a “detailed cost breakdown,” a list of all our contractors, etc. and get it notarized. The alternative to this is having your GC breakdown all the costs, but who is to say that he’d be able to do that in a manner that would be satisfying to TPU. Given that there are no real guidelines as to what’s expected in an itemized cost breakdown, it feels a bit like they are making this all up as they go along.

New bedroom finishes

That said, there certainly are some less than reputable characters out there in the multifamily ownership world who I’m sure are playing a little loose with the IAI increase rules. So, I understand the motivation behind what TPU is doing. However, I’m sure that such individuals would have little trouble creating a paper trail sufficient to get whatever legal rent they needed to get to. For people like us, who are doing the right thing, by the books, these audits are just one more regulatory burden to be subject to, one that doesn’t even prove that the actual work done matches the claimed dollars spent.

 

 

State of New York City Multifamily 2013 — Couldn’t Be Much Better

This week I ventured early one morning to check out the Bisnow Multifamily held over at the Hilton. As I mentioned in a previous blog, I feel it’s good to try to get out of the office with some frequency to network with others in the industry and to be able to take the temperature of the industry. Even though such meetings feature speakers doing business far beyond what we do, real estate is real estate, and much of what the biggest players in our market have to say translates down to the most basic New York City multifamily building.

James Nelson and Giacomo Barbieri

The opening presentation featured James Nelson, a partner at Massey Knakal, interviewing Giacomo Barbieri, who heads up Northeast acquistions for TIAA-CREF, the financial services company that manages over 1/2 trillion in assets. Barbieri’s firm has exposure to about $60 billion of real estate, about half of which is in the private sector. The firm has been historically underweighted in multifamily due to an inability to compete with the competition from the condo market in the past, but since the post Lehman collapse, they’ve been looking to increase exposure to this sector.

Nelson questioned whether they were still attracted to buying NYC multifamily, given today’s less than 4% cap rates. Barbieri suggested that this was no lower than other major key U.S. city and that New York is still very attractive due to its consistently solid rents. He also noted that they days of double digit returns on multifamily investment is firmly a thing of the past and that returns are going to migrate to 4%-6% over treasuries. This was comforting for me to hear as I’m often in disbelief when syndication types claim they can give returns to investors that are in the “teens.” Those claims just don’t jive with today’s cap rates on sales. Barbieri argued that there is a lot of core capital out there these days chasing deals from investors who are willing to run a “marathon” and hold indefinitely. After the Q4 selling furry, driven by the change capital gains law, there is very little inventory and he’s been outbid on 3 or 4 deals already this year. His advice–Be patient!

The opening session was follow ed by a panel featuring Shimon Skury, President of Ariel Property Advisors, David Dishy,
President, New York Affordable Housing Preservation Fund; Alan Miller, Executive Managing Director, Eastern Consolidated; Ralph Herzka, President & CEO, Meridian Capital Group; Steve Cox, Director, Centerline Capital Group; Bassen, Director-Acquisitions, Invesco Real Estate.

This was a solid group of panelists that offered a smattering of facts and quips, many of which bear repeating.

2012 was noted for $8 billion in multifamily sales in NYC, driven largely by the election and changes in the tax code. Though there was very little for sale in early 2013, Shkury reports that inventory has just started to pick up this year. Cox said that, on

Shimon Shkury of Ariel Property Advisors

the financing side of the equation, Fannie Mae and Freddie Mac have been pushing private lenders to be more competitive. Herzog noted that NYC multifamily is an asset class that had almost 0% losses during the last several years and is more or less recession proof. Plus, he noted, “Everyone wants to live in New York City!” He comically quoted a landlord who said, “Every day I have 6000 people going out to work to pay my rent. And if they can’t, they just get another roommate.” Invesco’s Bassen went on to comment that the NYC has the best fundamentals for multifamily of any major U.S. city and that given the current new construction economics, with a great bias to condo construction, there will be a shortage of new rental construction.

Ralph Herzka of Meridian Capital

In looking at multifamily as an attractive investment, still, Bassen noted the comfort he gets from being able to buy buildings at less than their replacement cost. Dishy cautioned, however, that you still could find that you overpaid if you have a shorter investment time frame and exit cap rates move the wrong away on you. Still, Herzog notes that clients of his would still rather “buy bricks” with some current return and upside than sit with money in the bank at near 0% interest.

On a different note, Dishy commented that, “Now, in the culture, there is a respect for design that didn’t used to exist in the rental market.” Thus, there was quite a bit of discussion about the success of projects like MiMa, Mercedes House, and New York by Gehry, all catering to the luxury rental market. Though people do see the “micro apartment” as something we also may see more of, Bassen pointed out, “Cows and horses can sleep standing up, but people still need a bed.”

The follow up panel was positioned as the “developer panel” and included Ofer Yardeni, Co-Chairman & CEO, Stonehenge Partners; Jenifer Steig, Partner, The Cheshire Group; Kenneth Horn, President, Alchemy Properties; and Jonathan Rose, president, Jonathan Rose Companies.

Rose’s opening comments included his proclaiming that the affordable industry is running out of money. So, in addition to the shortage of new rental construction on the high end, it looks like there is going to be less building on the low end as well. Always

Ofer Yardeni of Stonehenge Partner, with mic.

outspoken Ofer Yardeni noted that in 20 years in the business, he’s never experienced a market like this. He’s seeing Greenwich Village rentals routinely hitting $85-$95 per square foot. The depth of the market continues to surprise him and 55% of his tenants are coming from out of town. In a bold statement, he projected that “For the next three years I expect that prices for multifamily will increase by 8% per year,” though he did qualify that this assumed that the 421 tax abatement program was not revived causing and increase in new construction.

Both Jenifer Seig and Ken Horn talked of a booming condo market, though Seig pointed to a lag in outer borough co-op appreciation. Horn’s firm turned buyers in 2009/10 as they witnessed an 85% drop in the number of building permits being issued. The strength of their business is best evidenced by their ability to sell out off of floor plans now, due to the dearth of product on the market.

Overall, the mood was so bullish that it makes me take pause. As an owner of rental assets, I loved hearing this message, but given the cyclical nature of this business, I think buyers should be cautious and not get sucked into overly optimistic assumptions in order to rationalize new purchases.

 

Major Capital Improvements (MCI’s) – A Real Incentive for NYC Landlords with Regulated Units

  

Say you have a building in upper Manhattan that has a majority of apartments that are renting for well below market due to rent regulation. Your rents are so low that  no one ever moves. After all, where could they possibly get a comparable deal? Year after year you see your tax, water/sewer, and heating bills go up, often by double digit annual percentages. Yet, when the Rent Guideline Board comes out with their annual determination, the “evil landlords” are rewarded with a 2% rent increase on one-year leases and a 4% increase on two-year leases. Wow! You’ll be lucky if that increase covers half of your increase in expenses.

One of the few tools that landlords have to combat what might otherwise be an ever declining net operating income is the Major Capital Improvement (MCI) law. Some time ago, DHCR saw that there was no incentive for financially pressured landlords to reinvest in a building’s infrastructure. Yes, sometimes having to buy a new boiler or a new roof is unavoidable, but given that landlord’s were effectively getting a 0% return on MCI investments, there was a tendency to let many rent regulated buildings decay. The MCI law changed that.

Under the law, certain capital improvements can allow a building owner to garner rent increases that are in addition to the often minuscule RGB annual increases. Specifically, so long as an item being replaced has reached it’s “useful life,” you are allowed to effectively recoup your investment over a seven year period, i.e. 84 months. DHCR has determined what improvements qualify and has assigned useful lives to all the items. (qualifying MCIs and useful life). Yes, the application process is a bit bureaucratic and DHCR has been taking forever to process MCI applications these days ( due to personnel cutbacks, it now generally takes a  year or more vs. what used to be as little as 3 months), but where else can you get as high as a 14.28% annual return on your investment these days, with minimal risk?

How do you get that return? Well, assuming you do a qualifying MCI, say a new roof, and DHCR approves your application, you get to take the cost of the improvement, divided by 84 (the number of months in seven years), and increase your aggregate monthly rent by the resulting amount. Thus, if you spend $84,000 on new windows throughout your building, you get to pass $1000 per month in added rents onto your tenants (assuming they are all regulated units). The actual allocation of that $1000 is proportionate to the number of rooms in each apartment. In other words, if there are 100 rooms in the building, a 5-room apartment would get 1/20th of the total monthly MCI increase assigned to it.

The 14.28% return will get trimmed back if you have commercial space in your building as DHCR can view stores as “benefiting” from the MCI. Thus, a portion of your spend doesn’t get to pass through to your residential tenants. Also, if you have unregulated apartments, you can’t pass on an increase to them. Furthermore, if you have any regulated apartments that are effectively already at market, perhaps with preferential rents, it might not be prudent to hit the tenants with an MCI increase if it could cause them to move out. Furthermore, there is the time between when you invest in the MCI and when you receive a DHCR order that grants you a rent increase. However, note that DHCR also grants something called a “temporary MCI increase” which effectively allows the landlord to recoup the lost increase from the time the application is docketed until when the order is granted. Docketing usually seems to take place within a couple of months of receipt of the application by DHCR.

Another nuance is that you can’t increase a rent stabilized tenant’s rent more than 6% a year from MCIs (15% for rent controlled units). This 6% includes both pass through of permanent and temporary MCI increases. If you hit that cap, you don’t lose the benefit, you just have to consume it the balance over 6% in the subsequent year(s). This is another factor that can whittle a bit more away from my 14.28% number.  So, if an MCI is going to cause a $100 rent increase to a $1000 apartment, you can only take $60 of the increase this year and the other $40 gets added a year later. If you start hitting the cap and find yourself with multiple overlapping MCIs, and multiple temporary MCIs, you’ll need a strong spreadsheet guru in house to properly manage and calculate increases on a unit by unit basis. The whole thing gets further complicated by the fact that the “legal rent” that is used for all future renewal rent calculations goes up by the whole MCI the moment it is approved, even if the 6% cap will take 3-4 years to consume.

This last nuance is something almost no one I’ve meet in our business, even specialized consultants, understands. It doesn’t make that big a difference, but it can add a few dollars per month across all your apartments, which only gets further compounded over time. I only learned about this fine point by visiting DHCR some time back and asking questions of a really responsive supervisor at their Queens offices. At that meeting I was handed an opinion letter which is linked here and answered all sorts of complicated questions that come up that most people in our business can’t properly answer. I’m willing to bet that no one reading this blog has seen this letter before, but that many of you will know someone that can benefit from it.

Though I’ve pointed to a number of things that can reduce your effective return from your MCIs—delayed approval by DHCR, 6% caps per year, the negative effect of commercial space, and the impact of market rate units, don’t forget that the gains you get awarded are then compounded every year that you do a renewal lease (since the MCI becomes part of the base rent). Thus, over time, the real return can conceivably exceed 14.28%. Furthermore, if you figure that a well maintained building in upper Manhattan can now fetch 10X gross rent roll, then a $70,000 MCI, which can increase rents by $10,000 a year (1/7th), would have the impact of increasing the building’s value by $100,000 ($10K x 10). In the case of a building where a buyer is focused on the cap rate, the value from that $70,000 investment might be even greater. So you get added cash flow now and a kicker if/when you sell the building.

The bottom line is, if you have the cash, have predominantly below market regulated rents, and have items that in your building that are at their useful life, you MUST do MCI’s. And if you’re in a position to refinance at today’s crazy low rates, try to pull out some extra principal that you can plow back into your building via MCIs. If you can borrow at 3% and get a 10%+ return on that money, wouldn’t you do that all day long?

If you have any questions on MCIs, would like to simply talk shop, or are looking for a knowledgeable, hands-on, tech-savvy property management company, I can be reached at 212-203-5613 or mvinocur@bemnyc.com.

Michael Vinocur
Building Equity Management LLC

CRE Industry Meetings — The Value of Getting Out of the Office

As a multifamily owner as well as a property manager for 3rd parties, it’s easy to get lost in the day to day chaos of our business and forget that there are others out that I can learn from. I didn’t grow up in the real estate business. In my former life, I was a principal in a successful publishing and conference company. My conference business was based on the proposition that meeting face to face with your peers in the industry was invaluable. I maintain that that premise holds true in any business, including multifamily real estate.

Yesterday I attended a seminar sponsored by CHIP (Community Housing Improvement Program) in conjunction with the NYCLA (New York County Lawyers’ Association). If you are not familiar with CHIP, it’s a trade association targeting owners of rental housing in New York City, with a Board of Directors that includes some very major players in the business. The group runs a number of annual educational and social events, publishes a very useful monthly newsletter, and does significant lobbying for the industry. Attending this event (which, if I was a lawyer, would have also netted me continuing education credits as well), cost me merely $35.

I find that meetings like this are a valuable way of both benchmarking what I do know and invariably supplementing that knowledge with something that I hadn’t previously known. Yesterday’s seminar was entitled “Perceptions of a Multi-Family Real Estate Deal” and featured a panel that included two representatives of well established law firms, an institutional real estate investor, a commercial lender, and a title company representative. Given the focus of the talk, a good deal of time was spent talking about buyers’ due diligence prior to closing on a transaction. What I discovered was how poorly served I’ve been by the smaller one or two-person law firms I’ve used in the past on my own deals. While seemingly quite competent to negotiate my contract of sale, review loan documents, and make sure title was in order, I now realize that none of these smaller firms really had a thorough process or check list relating to due diligence. As a result, I definitely made mistakes in the past that I might not have made with proper council. On the other hand, I imagine the larger firms charge higher fees, so there’s always a trade off.

The attorney presentations outlined a broad array of information that they ideally would like their clients to obtain before closing on a purchase. Some of it was admittedly unrealistic, particularly in today’s sellers’ market, where a family-business seller is likely to move onto the “next buyer” if pushed too hard for information they think is overreaching. For instance, most sellers will decline a request of tax returns and perhaps bank statements as well. However, having a law firm there to make sure that things like petroleum bulk storage certificates or DEP registrations are all in order, to make sure that you get your insurance agent to obtain a loss run on the building you plan to buy to determine future insurability, and to obtain not just a DCHR rent registration report, but also information on all docketed items in DHCR’s records, is certainly comforting.

One of the speakers, Nicholas Kamillatos of Rosenberg & Estis, discussed how he looks at a deal from the seller’s perspective. He suggested that if you are a good operator who is purporting to be selling a “clean building,” then your behavior within the due diligence period needs to support this. That means readily producing documents and files that are clear and organized. Your financials should be consistent with the figures in the broker’s work-up. Be proactive and have DHCR rent registration printouts ready in advance. Make your own checklist of permits, licenses, and inspections that are required for your building and have supporting documentation lined up to show that everything is in good order. Have your tenant files compiled so that a prospective buyer can easily verify that your registered rents are actually legal rents.

The most interesting piece of information I gained from Kamillatos’ presentation relates to the idea of a termination clause vs. a time of the essence (TOE) clause in your contract of sale. As a buyer, I always was worried about a TOE clause and what would befall me if I wasn’t ready to close on time. However, as Kamillatos pointed out, to enforce a TOE clause, the seller must show the court that they have satisfied absolutely ever obligation that was represented by the seller in the contract of sale. As a result, a good buyer’s attorney can generally find some technicality to nullify the enforcement of the TOE clause. Thus, if you get a sophisticated buyer who is possibly looking to tie you up indefinitely, hoping really to just flip the deal, the TOE clause can come back to bite the seller. Kamillatos argued to opt for a termination clause instead, so that you have the option to terminate after a specific passage of time, thus voiding the contract so you can move onto the next prospective buyer. (Though not suggested in the seminar, I wonder if you could write a contact that included elements of both a TOE and a termination clause, so you could size up your buyer and then decide which route to go?)

Michael Soleimani of Westbrook Partners, a CHIP board member, offered his views as an institutional investor. Though his firm has the competitive advantage of being able to close a deal in seven to 10 days, without financing, I learned that they can’t be more competitive on all deals. Because of the profile of their investors, including insurance companies and pension funds, they have to do a much deeper level of due diligence than we have to and can’t necessarily compete on many deals that family-owned investors would consider. This includes buildings with a high percentage of regulated apartments. Westbrook is more likely drawn to deals where there is a good percentage of market rate units, particularly where a long term owner hasn’t maximized his rent roll because he is more focused on preserving a consistent cash flow than increasing the absolute return on investment.

In addition to further insights I gained from the presentations and Q & A session, there was the added benefit of networking with my fellow attendees. There were several people I’ve gotten to know around the industry, from bankers, to brokers, to attorneys, to other owners that I bumped into at the meeting. Not only does getting out of the office help to cement these relationships, but it also helps further one’s reputation as an engaged, knowledgeable player in this industry–something that over time will certainly lead to referrals and new business opportunities.

Rent Controlled vs. Rent Stabilized — Don’t Fear Rent Controlled Units

It’s funny. Those buying into the regulated multifamily market often fear rent controlled apartments as though they are dead units. A landlord might have a 30-unit building with a few rent controlled apartments, in many cases paying less than $250 per month, and treat those apartments as having a frozen rent until the passing of the typically elderly tenant. This is not true.

In one of my buildings in Washington Heights, the combined rent from our three rent controlled units, when we purchased the building, was approximately $750 per month. Incredible, huh? Now, about 10 years later, with the same tenants in place, our combined rent for these three units is over $2350. That’s equivalent to 12% annual rent growth without a vacancy. It also probably equates to a $200K increase in the value of the building.

How was this possible? Through a combination of MBRs and MCIs and fuel cost adjustments. For those not savvy with the acronyms of DHCR (Division of Housing and Community Renewal which I think has now been rebranded as HCR, Housing & Community Renewal), MBR stands for Maximum Base Rent and MCI stands for Major Capital Improvements. Underlying the MBR law is an understanding by New York State that a landlord can’t properly maintain a building/apartment if the rent never goes up. Under the law, there is a formula that establishes the maximum rent that can be charged on a rent controlled apartment as a result of the increases I’m about to describe (this is different from the actual rent being charged and generally much higher). And so, you can take advantage of MBRs and MCIs until you hit this maximum base rent. The dollar amount is specific to each particularly apartment and is determined by a rather convoluted process beyond the scope of this blog, however once established, it is registered with DHCR and continues to go up every year by a published adjustment (which is more inline with the annual rent control board increases well below the 7.5% figure described below). On our three units that I described earlier, our maximum base rents are all above $1100, so it will be years, if ever, before I ever risk hitting that ceiling.

MBR Increases
MBR increases are typically 7.5% per year. They are approved for a two-year cycle based on an application that must be submitted to DHCR. Many months after submitting your application, you get a Maximum Base Rent Order of Eligibility which gives you legal permission to charge the increases. We use an outside consulting firm to file for us as they have greater expertise than we do and their fee is well offset by my not having to do it myself. Plus, I only pay the fee once, a percentage of my rent increase in the year granted, but I get the benefit forever. The increase compounds over time, so using a firm to file ends up being a reasonable upfront cost. If your increase doesn’t get approved until after January of the first year of the two-year cycle (which is always the case since, like every NY/NYC agency, they are backed up), you can then charge the tenant retroactively for any missed increases. On year two of the cycle, you already have your approval in hand, so on January 1 of the 2nd year of the cycle you automatically can take your second 7.5% increase.

What else do you need to know? Your building has to be relatively clean, i.e. fairly free of HPD violations. In fact, you must be able to show that you’ve removed 100% of rent impairing violations (C violations) and at least 80% of the other prior year’s violations. You don’t, however, have to invite HPD in to inspect and clear them of record, though that is not a bad idea at some point. You can simply have a licensed architect write an affidavit that affirms that you have removed enough violations.

As an aside, I was at an RSA meeting this past week where I heard the horror story of a gentleman who had invested in regulated units within a co-op, where some tenants at time of conversion had remained as renters, which clearly was their right. This fellow owned at least one rent controlled unit in this co-op. However, he couldn’t get MBRs because the building had too many violations. He was in the unfortunate position of owning in a building with terrible management, who had no incentive to fix violations. As a result, the apartment owner’s rent was frozen, seemingly forever! I believe his monthly maintenance fee to the co-op now exceeds the rent he gets. I really felt for the guy. He’s in a terrible position. At least I learned the lesson to not own rent controlled units in a building that is controlled by someone else.

MCI Increases
State rent laws allow you to gain rent increases across all regulated apartments for a specific list of major capital improvements done to your building. These include new boiler, windows, doors, electrical, plumbing systems, roof, etc. I’ll leave the nuances of doing MCIs for a future blog, but the bottom line is that you are allowed to amortize your investment over 7 years, or 84 months. The expense gets spread across all your apartments based on the proportionate number of rooms in each apartment relative to the building. One restriction is that if you do a really big MCI you are restricted as to how much you can pass through as a rent increase in one single year in order to not slam the tenants to hard in a single year (though you can carry forward excess amounts and capture them in future years). On rent stabilized apartments that annual cap is 6% of the base rent of the unit. For rent controlled units, however, it is 15%! And realize that if you do a reasonably expensive improvement, and your rent controlled apartments have very low rents, it’s not that hard to reach this 15% level.

What does this mean? In those years where you have significant MCIs as well as file successfully for MBRs, you stand to get 22.5% increases on the rent in your rent controlled units. Not bad, huh?

You can add further to this by annually filing for Fuel Cost Adjustments. Unfortunately, these adjustments only look at increases going forward, so if you never filed before, you can’t get the benefit of all the cost increases in the last several years. Still, going forward, you at least know you will get a rent kick if your fuel costs go up. I’m not sure how effective this will be for us in the future, now that we are heating with gas, but with #2 oil, our fuel surcharges have been adding a good 15% to the rent of the tenants.

The bottom line is that, in many ways, a rent controlled unit in your multifamily building has better rent growth potential than a low priced rent stabilized unit. In fact, within a couple more years, in the building of ours I used as an example, we are going to see the rents in our rent controlled units exceed those of our lowest stabilized units. Though brokers will always pitch you about a building’s upside if rents are low, if they are too low, people never leave (unless they are open to an expensive buyout). Thus, if we look only at those units where the tenant is never going to leave, you stand to increase your rent roll faster with units that are rent controlled rather than with ones that are rent stabilized.