Over-regulation and the systemic lack of new housing in New York City have created an opportunity for investors in free-market multifamily assets. In this article, we review emerging investment trends, underlying fundamentals and drivers. We also have some recommendations for smaller investors.

Investor’s Shift: Regulation Effect #1

Market rate apartments, which make up 45% of the City's 2.27 million rental units, consistently account for the majority of sales in the multifamily market. Our research shows that of the $2.11 billion multifamily sales recorded in Q1 2023 in New York City, 78% of the dollar volume was for buildings with predominantly market rate units, signaling continued investor confidence in free market multifamily. In contrast, regulated rent stabilized assets, which make up 44% of NYC’s rental units, accounted for only 14% of the dollar volume in the first quarter.

The Drivers: Regulation Effect #2

There are multiple factors driving investment in New York City’s free market apartment buildings. Demand for housing is stronger than ever but unlike many other parts of the country, supply isn’t keeping up. New residents flock here as students to attend one of the City’s colleges and universities or to work in industries such as FIRE (finance, insurance and real estate), technology or the arts. Higher interest rates have discouraged many renters from buying, which is also putting additional pressure on the rental supply. Therefore, the City’s housing crunch is expected to persist as economic indicators continue to improve, including the following:

• The fastest population growth since the 1930’s. New York City’s population increased by 6.8 percent between 2010 and 2020 or by 562,000 people totaling 8,804,000. After losing residents during the pandemic, economists forecast that net migration will increase again this year.
• Jobs grew by 163,200 in the past 12 months. The total jobs number is 4,683,100 pushing NYC above the 4,668,000 level last seen in February 2020.
• NYC is a college town. Over 550,000 students have resumed in-person learning at the City’s 110 universities and colleges.

Tourism is on the rebound. The City is expecting 61 million visitors in 2023, up from 56 million in 2022 and on track to reach the record level of 66.6 million visitors set in 2019.

Subway ridership has risen. There were 4,002,961 riders on April 20 (73% of pre-pandemic levels), the first time ridership surpassed 4 million since March 12, 2020.

Rental growth. In May, increased demand pushed up median Manhattan rents to $4,360, up 10.6% from the previous year; Brooklyn rents rose 9.7% year-over-year to $3,517; and rents in Northwest Queens rose 16.2% to $3,368 over the same period, according to the Elliman Report.

Manhattan, Brooklyn and Northwest Queens have seen rent increases in the last year.

Inflation hedge. Rents can be raised to offset rising expenses such as utilities, salaries, repairs and maintenance, property taxes and the rising cost of debt resulting from interest rate hikes.

Public policies are choking new construction, a topic I examined in a recent Forbes article.

• The Housing Stability and Tenant Protection Act (HSTPA) of 2019 removed incentives to rehabilitate rent stabilized units when they are vacated by long-term tenants because the law doesn’t allow for adequate rent increases to cover the cost of renovations. The result is, tens of thousands of units are kept vacant.
• There has been minimal rental construction. The expiration of the 421a tax program in June 2022 eliminated incentives to build middle income and affordable rental housing versus condominiums. Lawmakers argued that the 421a program, which produced 68% of the City’s multifamily apartments (117,042 rental units) between 2010 and 2020, was a “giveaway” to developers. However, 421a is a win-win because it generates housing and eventually tax revenue for the City while motivating developers to invest. Since New York City’s construction costs and taxes are higher than other cities, we are now seeing that if projects don’t make economic sense, developers will simply leave and build housing in more hospitable states.

Although the City will need 560,000 additional housing units by 2030, we can expect that the elimination of the 421a tax incentive will contribute to the continued housing shortage. New construction starts in NYC fell to only 12,005 housing units in the second half of 2022 and only 2,639 units in the first four months of 2023, compared to filings for 31,750 units in the first half last year when 421a was still in effect, according to a Real Estate Board of New York (REBNY) analysis.

Strong Fundamentals: Regulation Effect #3

Pre-2019, institutional investors looked favorably on rent stabilized housing as any vacancy presented a rehabilitation opportunity and, as a result, an increase in rent and value. This business plan brought a tremendous amount of capital to the City, benefited older buildings and enabled existing rent-stabilized tenants to enjoy great housing with low rents because those apartments were subsidized by the higher rent units. However, HSTPA changed that. Since then, institutional investors have shied away from regulated multifamily and invested heavily in free market buildings and affordable housing with a Capital A (as noted in my previous Forbes article).

For institutional investors in New York City, free market housing has presented a great opportunity, especially in the current inflationary environment. Some of the significant transactions in the last 18 months include:

• Blackstone Group purchased 8 Spruce Street from Brookfield Properties for $930 million.
• GO Partners acquired three Upper East Side multifamily properties for $825 million, and the American Copper Buildings, a pair of Murray Hill luxury apartment towers at 626 First Avenue, for $850 million.
• Ponte Gadea Group purchased 114 Fulton Street in the Financial District for $487.5 million.
• A&E Real Estate acquired 160 Riverside Boulevard on the Upper West Side for $415 million.
• Avanath Capital Management acquired 38 6th Avenue & 535 Carlton Avenue in Brooklyn for $314.5 million, which was the California-based investment firm’s first purchase in New York City.
• KKR has invested over $792 million in four New York City multifamily properties since 2020 including the $190 million acquisition of 80 Dekalb Avenue in Fort Greene, Brooklyn.
• Stonehenge partnered with the Carlyle Group to acquire a 32-story, 196-apartment rental tower on the Upper East Side of Manhattan for $114 million. Last year, the firm teamed up with San Francisco-based investor Stockbridge Capital Group to buy a 22-story, 163-unit market rate building at 354 East 91st for $128 million, and, in a separate transaction, closed on a six-story, 70,000 square foot apartment building at 780 Greenwich Street in the West Village for $80.4 million.
• The Carlyle Group has acquired 56 multifamily properties valued at $483 million since 2020, of which 44 valued at $190 million were for buildings with less than 10 units. In addition to joining Stonehenge in its acquisition of the 196-unit Upper East Side rental, Carlyle invested over $140 million in three rental developments with 421a tax abatements–two in Gowanus and one in Long Island City.

Smaller Buildings, Free Market, Tax Protected, Boosted by Over-Regulation

Smaller investors should follow Blackstone, KKR and especially Carlyle, which has invested heavily in small, class A and class B predominantly free market rental buildings that are, in many cases, tax sheltered. The waves of young adults and newcomers will continue unabated while the supply of housing in the current political environment will continue to diminish, thereby guaranteeing that the fundamentals will stay strong even during a recession or a down market.

Public Policies Fuel the Perpetual Growth of Free Market Rents

Rent growth could be mitigated by encouraging developers to build. New York Gov. Kathy Hochul tried to jumpstart the development market this year by introducing an expansive affordable housing program that included a successor to the 421a property tax abatement program and extending the deadline required to complete existing 421a projects from 2026 to 2030, among other initiatives.

However, the State Legislature didn’t approve the governor’s proposals to increase housing inventory, but passed more restrictive regulations for her to sign. One bill would disallow a rent increase as a result of the combination of rent-stabilized units, discouraging the rehabilitation of vacant units and reducing supply further. Another bill encourages tenants to sue their landlords for fraud, making it an administrative nightmare to run and own and rent-stabilized buildings.

In closing, the multifamily fundamentals in New York City are strong, pushed by too much regulation, lack of new housing and the misalignment of interests between the regulators and the overall real estate market. However, this has created an opportunity for investors who understand that any asset allowing for considerable rent growth will benefit.