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A Cautionary Tale for Affordable Housing Regimes

January 5th, 2024 | Article By Investment Team

Approximately 2.4 million NYC residents currently live in rent-stabilized apartments, accounting for 45% of the city’s rental units supply. New York’s rent stabilization program is by far the largest and most impactful rent control regime in the United States.


What was once the crown jewel of New York City’s real estate scene, is now a hot potato that no one dares to touch besides a few nonprofits, which are exempted from taxes and restrictions placed by Rent Stabilization Laws, and a handful of conglomerates such as Blackstone. NYC’s rent stabilization regime is in serious trouble.


Today an investor can buy a fully tenanted, five-story rent-stabilized Brooklyn apartment for less than the price of most penthouse units in luxury condos and far less than even just the value of the land itself –but even at such low price points, taking on such portfolio may still not be a good idea.

Rent-stabilized apartments are commonly found in buildings constructed before 1974. (StreetEasy/Getty Images)

Rent-stabilized apartments are commonly found in buildings constructed before 1974. (StreetEasy/Getty Images)

So how did NYC’s rent-stabilized apartment buildings fall from its grace?


The Appeal of Rent-Stabilized Properties in NYC Before 2019


The law was introduced in 1974 to address the housing crisis at the time. It was devised to keep rental units affordable by capping rent increases at a rate slower than the typical wage growth. Initially, many multifamily buildings with six or more units were fully rent-stabilized, but over time, as tenants moved out or passed away without transferring their leases, a portion of these units transitioned to deregulated status. Today, NYC's rent-stabilized portfolios are a mix of entirely rent-stabilized buildings and those partially stabilized.


The defining feature of these rent-stabilized apartments is that their rent increases are capped at 2-3%, as determined bi-annually by the DHCR. This rate is notably lower than the average GDP and wage growth in the US, particularly in NYC. While this arrangement benefits tenants, it poses a challenge for landlords, as the limited potential for rent increases is often outpaced by heavily inflation-dependent operational expenses.

788 Riverside Drive, a 62-unit rent stabilized building pictured here, recently sold for $10.2 million ($126 psf), or 80% below replacement cost.

This should theoretically lead to a constant shrinking of the valuation of these buildings if one uses the rent roll to calculate the building's worth, as their Net Operating Incomes slowly decrease over time. But that did not happen for NYC’s rent-stabilized apartments.

How was that possible?

The real allure for landlords and investors lies in its potential for deregulation. The focus was not on the immediate returns from stabilized rents but on the opportunity to convert these units back to market rates.

Before the HSTPA of 2019, strategies such as conducting Individual Apartment Improvements (IAIs) or Major Capital Improvements (MCIs), as well as undertaking Substantial Rehabilitation (Sub Rehab), were employed to navigate around rent increase limitations.

Successfully deregulating apartments from the capped annual rent increase to market rate could significantly elevate a property's valuation. The potential to liberate these units from rent stabilization laws and introduce them to the free market, where they could command higher rents, was a key driver of investment appeal.

The market dynamics prior to the HSTPA of 2019 also fostered a unique phenomenon where properties with higher vacancy rates were more valuable than those with lower vacancy rates. The rationale was that buildings closer to destabilization, particularly those nearing the 80% vacancy threshold, were prime candidates for substantial rehabilitation. Completing such rehabilitation works allowed landlords to convert the entire building to market rate, thus enhancing its overall value. This period saw high returns for investors adept at leveraging the opportunities.

The Turning Point: Housing Stability & Tenant Protection Act of 2019

In 2019, the New York City rent-stabilized landscape underwent a seismic shift with the introduction of the Housing Stability & Tenant Protection Act of 2019 (HSTPA 2019). This landmark legislation redefined the rules governing rent-stabilized apartments, marking a decisive turn from the previous regulatory framework crushing the rent-stabilized asset class’s classwide valuation to go down by (30-60%) with many high-profile RS owners to hand back keys upon foreclosure..


The HSTPA 2019 aimed to bolster tenant protections and address the growing housing affordability crisis, but it also brought profound changes to the financial dynamics of rent-stabilized property investments.

Key aspects of the law, such as individual Apartment Improvements (IAIs), Major Capital Improvements (MCIs), and vacancy-related increases, underwent significant revisions. These changes not only altered the strategies used by most rent-stabilized operators for increasing rental income but also increased the operational and legal complexities for landlords. The following chart encapsulates the four most pivotal changes introduced by the HSTPA 2019:

As the rent increases become significantly more restricted, the returns horizon for the renovation costs is extended from what was 3-4 years to 14-15 years, effectively wiping out any incentive the landlords might have to renovate the buildings and individual units up to market standards. Because…it is simply not good business to only be able to recoup the costs of renovating an apartment in over ten years.


However, not all loopholes surrounding rent-stabilized buildings were addressed with HSTPA 2019, there were still two last resorts the landlords could use to significantly raise the rental income of their rent-stabilized assets.

The Last Two Avenues to Free Market Rate

Immediately after the introduction of HSTPA 2019, the valuation for rent-stabilized buildings started to crumble. But not all hopes of deregulation were crushed, those few who knew their ways around the rent stabilization laws still had two tricks under their sleeves. So the initial collapse of rent stabilization properties’ valuation was slow and gradual.

The First Trick – Substantial Rehabilitation

In a post-2019 HSTPA world, the best way to escape the specter of rent stabilization and shoot for lofty rents was to have an empty, or near empty, building and renovate it thoroughly – HVAC, plumbing, electricals the whole nine yards. The reward for doing the renovation is a sparkling new building with rents far higher than what rent stabilization would otherwise allow for. Completing a good reno and leasing the units up can oftentimes double the value of the property.


Substantial Rehabilitation’s exemption from Rent Stabilization Laws was put in place to help and incentivize owners to address and fix buildings with substantially hazardous conditions. But as it became one of the only remaining avenues for meaningful rent increases, it became widely abused, more specifically through its 80% vacancy presumption that automatically registers a building as “seriously deteriorated” upon reaching 80% vacancy.

As what was considered a suboptimal method to deregulation, in comparison to MCIs and IAIs, now becomes one of the only two methods to deregulate apartments, this pushed further the above-mentioned strange phenomenon that rent-stabilized apartment buildings with much higher vacancy rates(closer to the 80% threshold) trades at significantly higher prices than their tenant-occupied counterparts. This phenomenon exacerbated the landlords’ incentives to keep

apartments vacant because if their vacancy becomes high enough, they can file for Substantial Rehabilitation, rather than fixing each apartment and recouping the costs of doing so on a 14-15 years timeline…

The Second Tricks – Frankenstein’s Apartments


Another classic dance many rent-stabilized owners performed was that of “Frankenstein-ing”, or the combination of two or more apartment units for a higher rent than the sum of the previous rents. The owners are allowed to set “first rent” on the newly combined apartments according to market comps, effectively deregulating those newly combined apartments back-to-market rates.

This deregulation method was often employed on half-vacant apartment buildings that were still too far away from reaching the 80% threshold required for Substantial Rehabilitation. Investors would begrudgingly take on partially occupied buildings and hope for Frankenstein units or to work other angles. The returns on such projects were not nearly as lucrative as those involved in Substantial Rehabilitation where it was common for operators to see 2x value upon completion.

Unlike the buildings that underwent Substantial Rehabilitation, the units created using this method usually take longer to lease and usually do not achieve rental prices as a normal apartment because they often feature harder-to-lease units laid out upwards of 3-4 bedrooms. You are simply not going to be able to get 2x the rent of a 2-bedroom apartment from a 4-bedroom apartment. Although a less optimal deregulation method, in comparison to Sub Rehabs, and the previous version of IAIs and MCIs, it remained a viable avenue for landlords to use to get out of RSL.


The Unsuccessful Landlords’ Advocacy Attempts


The landlords have continually attempted to seek relief through the judicial system, where iconic landlord advocacy groups like CHIP and RSA have been trying to “facially challenge” RSL through the New York State Court, the Second Circuit Courts, and ultimately the Supreme Court. Their challenge has been dismissed by all lower courts, and this regulatory effort is marked unsuccessful upon SCOTUS’s rejection to hear their case at the Supreme Court, where Chief Justice Roberts argued that RSL does not constitute takings of private properties when landlords have an array of methods to 1. Claim units for self-use 2. Legally evict tenants who are not paying. And that they bought into such properties knowing they are subject to future regulatory changes in the space. So the current Rent Stabilization Laws although does put serious

limits on the profitability of those landlords’ assets, they are not enough to constitute a violation of the Fifth Amendment that protects the takings of private properties.


One of the only statutory wins on the landlords’ side was heralded by the rent overcharge case of Regina Metropolitan Co. v. New York State Division of Housing & Community (Regina Metro) where the property management company Regina Metropolitan Co. argued that the extension of the statute of limitation on rent roll records (used to determine in court illegal rent raising schemes) from 4 years to 6 years, as outline in HSTPA 2019, would constitute retroactively punishing owners who were following the law at the time, that is they only had to keep records for 4 years, any record beyond that time frame was most likely destroyed, as advised by their attorneys.


This portion of the look-back time period provision was reverted back to what it was pre-HSTPA 2019. This case marks one of the only successful pushbacks from the landlord’s side so far. This win in 2020 bolstered the landlords’ determination to continue fighting the Rent Stabilization Law but was itself quite fruitless because it was not able to revert any of the other more substantial changes that limit the specific rent increases, as those were the provisions that truly limited the rent-stabilized properties’ future profitability.


End of the De-Regulation Era


Just as the Rent Stabilized owners were slowly coming to realize that their effort to seek relief through the judicial system proved fruitless, bad news just kept coming.


In the DHCR’s newest version of the Rent Stabilization Code published on November 8th, 2023, they introduced a de facto ban on Frankenstein’s apartments and significantly raised the restrictions on which buildings can file for Substantial Rehabilitation.


With the last two loopholes amended, gone is the Wild West era of trading Rent-Stabilized portfolios and deregulating them to make 2x profits…And those who are caught still holding such assets in the hope of deregulation will soon see their judgment day.


The De Facto Ban on Frankenstein’s Apartment


Combining two or more rent-stabilized apartments is now still possible, but doing so will be devoid of any economic incentive, constituting a de facto ban on such combinations. The key changes are as follows:


  1. When two rent-stabilized apartments are combined, the new legal rent is the combined legal rent of the two apartments, plus applicable increases.

  2. When a rent-stabilized apartment is combined with a non-regulated apartment, the combined unit is now rent-regulated.

  3. Where the space of a non-regulated apartment is increased by adding space from a regulated apartment, both apartments are rent-regulated;

  4. When the space of a regulated vacant apartment is increased, the rent for the new space shall be the prior legal rent, plus an increase equal to the percentage increase of the space, as well as other applicable increases; and

  5. When the space of a regulated vacant apartment is decreased, the rent for the new space shall be the prior legal rent, plus a decrease equal to the percentage decrease of the space, as well as other applicable increases.



Changes Made to Substantial Rehabilitation


Similarly, with the Sub Rehab, the DHCR did not outright ban such practices because there are definitively genuine cases of buildings that are undergoing actual hardship, and need such incentives to justify any building-wide improvements.



The DHCR has:


  1. Removed the presumption that a building that is at least 80 percent vacant is in significantly deteriorated condition and

  2. Removed exceptions to the otherwise required replacement of building-wide systems where those systems were recently installed or structurally sound.

Now each building that files for Substantial Rehabilitation will be subject to DHCR’s review, and DHCR holds the discretion to determine whether a building is in fact in a “significantly deteriorated condition.”


The vast majority of the past Substantially Rehabilitated projects relied solely on the 80% vacancy presumption, meaning that the building itself did not in fact reach such “significantly deteriorated condition.” However, with the newly implemented change, such projects will no longer receive approval from the DHCR.


With these two new amendments in place, there is now little room for future deregulation schemes unless the buildings are in genuinely deteriorated conditions, and not too many buildings in NYC currently are eligible for this criteria.



Negligence and Cost Cutting Persists Despite New Regulations


With the possibility of deregulating rent-stabilized apartments out of the picture, are the rent-stabilized owners going to squash their pipe dreams of one day deregulating their building and start leasing out the vacant apartments?

The answer, unfortunately, remains a no…As discussed in the MCIs and IAIs portion of the article, many of these apartments are sitting vacant because they are missing the necessary renovation and upgrades to make them habitable once again. The owners remain not incentivized to do so, as exemplified by the recently partially collapsed Bronx building. The landlord of this building, Jacob Zanger, has been on NYC’s Worst Landlords List many consecutive years and was ranked 50th “worst landlord” in NYC given the 623 violations among his 4 rent-stabilized buildings.


It is quite obvious that these rent-stabilized operators have been well aware of the hazardous conditions inside the property that led to its recent collapse. They would rather sit and watch the buildings crumble so that they can file for Substantial Rehabilitation based on the building’s actually hazardous conditions.


On top of the lack of incentives, as the landlord’s operating costs catch up, their focus will inevitably shift more and more towards cost-cutting measures. Many will turn to deferring necessary repairs and capex to the detriment of tenants and the building's long-term value.


The struggle between rent-stabilized landlords and tenants is far from over, but the current stage is one that clearly favors the tenants while leaving the rent-stabilized operators in limbo. The owners protest such regulations by simply neglecting the properties rather than continuing to spend money on the property only to make them back in 15 years.



How Will the City Solve Its Housing Affordability Crisis?


Although the US national wage growth in recent months has shown signs of outpacing rent growth, New York City’s market rent prices remain extremely expensive for most of its residents. And there simply isn’t enough affordable housing for everybody, especially when the 421a Tax Abatement program (an affordable housing plan that offered tax breaks for new constructions) was discontinued in 2022. Combined with the influx of migrant workers in NYC, the city is facing an emergent housing crisis.


Realistically, the only way to solve NYC’s housing crisis is to build more affordable housing. But with the discontinued tax abatement program, there also lacks any incentives for developers

to include an affordable housing portion in their new constructions. With Mayor Eric Adams announcing his version of NYC’s affordable housing plan, many believe 2024 will be the year we see new legislation providing incentives for developers to build affordable housing once again.

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