The Brooklyn development market slowed considerably in the first quarter, a continuation of 2016’s trend, as the expiration of the popular 421-a tax incentive program kept investors sidelined. Now that the program has been reinstated in the form of “Affordable New York,” neighborhoods that saw a lull in activity, such as Flatbush, are now primed for a significant pickup in demand.

(From left to right) Alexander McGee, Director - Investment Sales and Brett Campbell, Senior Analyst

It is no secret that the expiration of the 421-a tax exemption a year and a half ago severely dampened new development projects throughout New York City, with the downturn in Brooklyn particularly pronounced.

New York City’s biggest borough saw total development dollar volume in the first quarter at just over $331 million, an astonishing 45% drop from the $619 million tallied during the period in 2016, according to Ariel Property Advisors research. Only 54 transactions were recorded in the first quarter, a remarkable 40% and 32% below the same quarters in 2015 and 2016, respectively.

In 2016, the Brooklyn development market saw $3.136 billion in dollar volume for the year, down from $3.56 billion the year prior. Despite the drop, prices edged higher in Brooklyn year-over-year, with the average buildable square foot rising by 6% to $262, according to Ariel Property Advisors’ “Brooklyn 2016 Year-End Sales Report.”

The 421-a tax exemption was highly enticing before it expired, offering developers of residential properties in certain areas a 25-year tax break in exchange for the creation of low- to middle-income housing. As developers, affordable housing activists, trade unions and politicians, including New York’s Governor Cuomo, debated the program’s destiny for well over a year, new development throughout most of New York City dramatically slowed.

However, in April, New York State lawmakers revived 421-a as part of the state’s $163 billion budget. The new program, called “Affordable New York,” offers full property-tax exemption for as long as 35 years. The new program comes with some cost to developers as it implements new standards for construction wages, but most contend the tax advantage far outweighs this added expense.

Flatbush: The Next Development Frontier

From a development perspective, the up-and-coming Brooklyn neighborhoods of Flatbush and East Flatbush have fared significantly better than Brooklyn as whole. While there was a slight downturn in dollar volume in 2016, at $50 million versus 2015’s $56 million, transactions in the area held steady. Moreover, if the dollar volume of $18 million in the first quarter keeps pace for the remainder of the year, 2017 will surpass 2016’s tally of $50 million for those areas.

Flatbush’s popularity amongst investors is a relatively new phenomenon, which is starkly evident when looking at pricing, with the average price per buildable square foot at $119 in the first quarter, an astounding 43% higher than 2014’s average of $74.

There is currently substantial value in developing rental buildings in Central Brooklyn, due largely to the “affordable” component of the Affordable New York legislation. In Manhattan, the affordable rental rate is considerably lower than the market rental rate. Therefore, the owner will see a steep difference in rent between the required “affordable portion” of the building and the free market dwellings.

Meanwhile, in the outer boroughs, namely Central Brooklyn, the affordable rents are extremely close to the market rents. In Flatbush, the “affordable” two-bedroom at 130% of area median income is $2,652, while the free market rent for the same unit in the same location is $2,600. The law, therefore, provides a clear path for developers to capture the whole rental market and fair market rents across the board in budgeting rental communities.

Flatbush’s extreme value and substantial upside likely has developers experiencing a bout of déjà vu. That is because the neighborhood looks a lot like Bedford-Stuyvesant did just a few years ago before rampant development activity sent prices sharply higher, with the price per buildable square foot reaching $252 in the first quarter, more than double 2014’s average of $127.

With pricing more than half that of Bedford-Stuyvesant, Flatbush offers developers the opportunity to build in a solid neighborhood with much less capital. Unlike Flatbush’s modest decline in 2016, dollar volume for development sites in Bedford-Stuyvesant decreased to $95 million in 2016, down a remarkable 55% from 2015.

Flatbush’s relative affordability has not fallen on deaf ears and in the northern part of Flatbush, institutional investors who have long focused on core markets are now planting their flags in the neighborhood. For example, Hudson Companies is developing a 170-unit market-rate building at 310 Clackson Avenue. The company is in the second phase of a large development at 350 Clarkson Avenue that will have 248 residential units and 6,000 square feet of retail space.

Looking ahead, interest rates are positioned to move higher, but they remain historically low, which should bode well for the financing of development projects throughout New York City. While Affordable New York is undoubtedly positive for Brooklyn development, it will be a significant boon for Flatbush, where the tax incentive will fan the flames of an already sizzling development market.