Over the summer New York City passed a law that focuses increased attention on protecting tenants in buildings that include a large percentage of rent-regulated apartments!
Specifically when that building changes hands at an inflated price, suggesting that an endgame of the new buyer might be to get these tenants to move out!
In New York City that faces a shortage of affordable housing, this formula by commercial real estate investors to make outsized returns through forced or coerced evictions can be described through popular culture as expressed in the short video below:
Now the NYC Department of Housing Preservation and Development proposes the Speculation Watch List that, according to a spokesman, ‘will serve as an important advocacy tool for the public that leverages data analysis to identify buildings at risk of tenant harassment or displacement’.
The methodology to be used is ‘simple’, identifying buildings where based on a buildings net operating income or NOI, the buyer appears to be willing to spend more than a building may logically be worth.
This idea in the commercial real estate world of ‘paying too much’ necessitates a quick examination of the traditional ways that a commercial building is valued…through net operating income and capitalization rate.
Quick Primer On The Valuation Of Commercial Real Estate
From the article, ‘What Is A Cap Rate?‘, a look at the traditional way in which a commercial property is valued.
Commercial Real Estate (CRE) 101
For valuing commercial real estate there are no premiums typically paid for curb appeal (although in actuality rents may be higher as a result potentially increasing the buildings gross income) or the number of bathrooms in the building.
Any premium a buyer is willing to pay for a given area will be reflected in the capitalization rate that is the return for an investor, used to determine value. The more desirable an area is considered, the lower the cap rate a potential buyer will be willing to accept.
Buyers of commercial real estate are investors concerned with one thing, the return expected on their investment dollars! In other words, the Net Operating Income (NOI) that a building throws off derived by subtracting building expenses from gross rents.
(Note: If two buildings in different locations have the same NOI, the one with the lower cap rate will have a greater value. To see for yourself divide a $100,000 NOI by .05 and .09 to see the difference.)
Back in 2014 in an article that asked whether prices for CRE may have gotten a bit too frothy (Cap Rates At Record Lows – Speculation or Prudent Investing?), the following explanation was provided…
‘In the world of commercial real estate, the way that an investor, or buyer of a property, will evaluate that potential investment is through the simple equation getting them to a capitalization rate.
Simply the capitalization rate, or cap rate as it is commonly known, is calculated by taking the Net Operating Income of a property (NOI) and dividing it by the price of the property.
Cap Rate = Net Operating Income/Price of the Property
As an example, if the NOI is $24,000 and the asking price or recent sales price is $300,000, then the Cap Rate is 24,000/300,000 which equals .08 or 8%.
If an investor were to buy this building given the criteria above his return would be 8% and, if financing were to be used, the rule of thumb would be that the cost of funds or mortgage rate would be below 8%.
The New York City Speculation Watch List
What is it that might signal to rent-regulated tenants in a building or advocacy groups that they could be exposed to harassment intended on getting them to move out so that a landlord can shift the apartment to a market rent?
Basically, a red flag might present itself when a buyer of a building with many rent-regulated apartments is willing to pay more than what the rent roll and areas cap rate would suggest that the building is actually worth.
This ‘overpayment’ would provide New York City with what can only be described as subjective and anecdotal evidence that the new buyer MAY seek to get the buildings rent-regulated tenants to move out.
From an article at Crain’s, ‘Buyers of market-rate buildings might believe that values in a particular neighborhood will go up, and thus pay more than what the current rental income suggests the building is worth. Hitting those higher rent numbers then becomes crucial to pay back acquisition loans.
When the same thing happens in buildings with large shares of rent-regulated apartments, however, it raises red flags. Rents are not supposed to rise dramatically in the protected units, so the only way for landlords to pay back their loans is to remove regulated tenants and convert the units to the market rate. Often, this happens through unscrupulous and illegal means.‘
According to a spokesman from NYC, ‘The Speculation Watch List will serve as an important advocacy tool for the public that leverages data analysis to identify buildings at risk of tenant harassment or displacement. This will be yet another resource at our disposal to protect tenants and preserve affordability throughout the city.’
Michael Haltman, President
Hallmark Abstract Service
Phone: (646) 741-6101