Incentivizing Development

New Yorkers should be closely watching the negotiations in Albany for the replacement of the current 421-a tax abatement program. The city still desperately needs housing and depending on the levels of affordability required could determine how many units will actually get built.

The current Affordable New York plan expires on June 15th. 485-w, which has been proposed by our governor to replace it, has received initial praise from the real estate industry. One of the features of the proposal that would remain is the valuable 35-year tax abatement. Without it, the real estate tax burden would be too much to bear to allow new development.

In some cases, real estate taxes now account for a third of the gross revenue of an apartment building. By using simple math, if a new building in the outer boroughs can obtain gross rents of $60/SF, the real estate taxes are $20/SF and operating expenses are $10/SF, the net operating income would be $30/SF. At a capitalization rate of 5%, that building would be worth $600/SF. If land prices are $200/BSF and construction costs are $400/SF, that would represent a break-even project at best. Cleary, not an incentive for the developer to take the risk to build. That being said, if the majority of taxes are abated, that allows for some cash flow in the earlier years until rent growth can hopefully catch up with the real estate tax phase in.

The Affordable New York program was a very successful program because it incentivized developers to build.  It required, 25-30% of the units to affordable units and gave multiple options for levels of affordability.  Option C in the Outer Boroughs became one of the most popular options as it allowed the developer to include 30% of the units at 130% of Annual Median Income (“AMI”). This equated to roughly a $52/SF rent, which allowed for the blended rent of $60/BSF that I referenced above.

Critics of Option C said that it didn’t provide truly affordable units, which are needed at 60% AMI or below. While I don’t disagree with this statement, if you’ve read my past whitepapers on the subject, I believe that the way to create more affordable housing for all New Yorkers is to build more housing of all types. For deeply affordable housing, tax abatements alone won’t make them feasible to build. Fully affordable projects rely on tax exempt bonds to build where the developer has little or no equity in the transaction and is thus a fee developer. That land suitable for this typically trades in the $50-100/BSF range further out in the Boroughs.

The current 485-w program eliminates Option C and replaces it with Option B for buildings with 30 units or more. The levels of affordability required would be 10% at 40% AMI, 10% at 60% AMI, and 5% at 80% AMI. Based on our calculations, this would produce a blended rent of $42/SF when factoring in the remaining 70% market rate unit.

Based on our analysis below for a project that we sold in East Harlem, to achieve the same return a developer would have to pay 32% less for the land or $136/SF. We highly doubt this landowner would’ve sold if his value took this much of a hit.

Land sales have already plummeted with the expiration of Affordable New York. With it will be a big decline in housing units built in the next few years.  In a recent report by Bisnow, the number of permits for New York City in 2021 were only 19,923 compared to Philadelphia’s 26,116, a city with a population of less than 20% of ours.

As you’ll see by our historical analysis below, land sales in Manhattan have been at a steep decline to years past. I would assume the boroughs would be even more pronounced.

*Disclaimer: For reference only, investors should conduct their own due diligence on this matter.

My fear is that if land values previously suited for market rate development come down by such a large margin, owners will simply elect not to sell and wait things in hopes for a more favorable program in the future. Then the only segment of land that will be sold will either be priced for fully affordable or luxury condos – the barbell effect. The most needed housing in the middle will take on even more pressure since the passing of the Housing Stability Tenant Protection Act that made rent stabilized units permanent freezing those tenants in place.

Lastly, I would be remiss if I didn’t mention the other major consideration, which is the ability to decontrol these units on expiration of the tax abatement. Our governor is proposing that affordable units will remain affordable in perpetuity. Whereas the market rate units face the risk of being subject to regulation as well, if Good Cause Eviction passes.  In all, this doesn’t seem like a great proposition unless land can be acquired at steep discounts. I don’t see that happening anytime soon. Thus, I believe Albany needs to offer higher levels of AMI or be prepared to offer much greater tax subsidies.