The 'Impossible Dream' of Rental Development

Real estate experts say the development of residential rental apartment buildings is grinding to a halt in New York City. Limited availability of financing, high land and construction costs, the elimination of the 421-a program, and limitations on tax exemption financing has led to conditions that make building unprofitable for developers, even as the demand for new rentals is greater than ever.

"Developing rentals is the impossible dream," the chairman of Douglaston Development, Jeffrey Levine, said. "The ongoing strength of the condominium market has absorbed land suitable for residential development. That, in concert with the virtual elimination of tax bond allocations, and the lack of liquidity in the capital market, has made it virtually impossible to create residential rental apartment buildings."

Nevertheless, Mr. Levine and other developers have rental buildings in various phases of construction around the five boroughs. His company is developing a 34-story rental apartment building at 316 Eleventh Ave. near 30th Street with a total of 368 apartments. The building is situated within the Special West Chelsea District, High Line Transfer Corridor and will have 4,000 square feet of retail space and 28,000 square feet of parking.

On the corner of Eighth Avenue and West 31st Street, Savanna Real Estate Fund I LP is planning to develop a residential rental building with 90 luxury rental units, retail space on the lower level and the ground and second floors, and corner frontage on Eighth Avenue and 31st Street.

The largest rental development in Lower Manhattan, the 74-story mixed-use tower at 8 Spruce St. near City Hall and the Brooklyn Bridge, is being developed by Forest City Ratner Cos. The project, designed by architect Frank Gehry, would have about 850 rental units, with rents projected at about $85 a square foot.

"There is no question that we have a shortage in rental housing, yet it has become increasingly difficult, if not cost-prohibitive, to add quality housing stock to our already depleted supply," the chairman of national real estate practice at Greenberg Traurig, Robert Ivanhoe, said. "Though the real estate market has taken a respite from its 10-year boom, prices for land have not softened appreciably."

He continued: "Add to that ever-increasing construction costs, the prospect of even higher prices for raw materials and the weak dollar, the expiration of the 421-a program later this year in Manhattan, lack of availability of 80/20 tax exempt low floater bonds to finance large rental projects, and the credit crunch, prospects for new rental projects in Manhattan seems rather bleak, particularly after completion of those projects that were commenced prior to the expiration of the 421-a program. The result of this confluence of events in a supply-constrained market will be to drive up rental rates even higher. It will take a change in the underlying fundamentals of the production of rental housing or governmental action of some sort to create the incentive for developers to produce financially viable multifamily rental housing in Manhattan or in the boroughs." The chairman of the Brody Group, Eric Brody, said it is "nearly impossible to make a residential rental deal make sense unless you purchased the land a number of years ago. There is only one way that I am seeing that rental projects make sense. They are mixed-use projects with retail and residential rental. Strictly residential rental projects are close to impossible, but if you can incorporate retail into the project, you have a shot of getting the deal done. It's still a long shot but retail income can cover a lot of debt."

In the meatpacking district, a joint venture of Taconic Investment Partners and the Related Cos. is building a hybrid of condominium, market-rent, and "affordable" rental apartments. The co-founder and principal at Taconic Investment Partners, Charles Bendit, said it has become "increasingly difficult to build rentals in the boroughs without government subsidies, due in large part of the cost of building. A new building will cost between $300 to $500 per square foot for hard and soft costs, with the low end of the price range being low-rise wood frame or block and plank construction. This does not include the cost of the land. After a loss factor for common areas, the cost per net rentable square foot is between $350 and $600 per square foot. Rent for a property in the boroughs range from as low as a gross rental of $20 per square foot to a high range of $45 per square foot. With the high costs of operating a rental building, one can see that building a rental building is not justifiable."

Mr. Bendit added: "In Manhattan, where rents can be as high as $75 to $90 per square foot, one could justify building rentals, except the fact that land costs won't allow for rental property development. Our company is in partnership with the Related Companies in the recently completed Caledonia on Tenth Avenue and 16th Street, where we have 288 rental apartments plus 190 condominiums. The condominiums were all sold within a short period of time and the rentals are just coming to the market. The market is very strong for the rentals, and it would not surprise us to see market rents will be in the range of $85 to $90 per square foot. What enabled us to build rentals, however, was an historic land basis. Today it is more difficult to justify building a rental, including land is in excess of $1,000 per square foot, which makes it economically unfeasible to develop a rental."

Individuals have until March 15 to submit an application to qualify for one of the 59 "affordable" housing rental apartments that are under construction in the Caledonia. Apartments range in size from studio to two bedrooms, with rent ranging between $461 and $738 a month.

"A survey of the core Manhattan housing market indicates over 20,000 housing units from about 90 sites are scheduled to enter the market over the next three years," the president of Metropolitan Valuation, Steven Schleider, said. "Of the scheduled housing units, the split between rental and condominium units is relatively even. The largest concentration of new development is focused in Lower Manhattan and Midtown West. Within Lower Manhattan, almost 60% of the proposed new units are slated to be condominium apartments, with large-scale development scheduled for Battery Park City."

Mr. Schleider added: "In Midtown West, recent zoning changes in the Hudson Yards area has prompted a large number of residential development plans, with the majority focused on rental development. Of the 6,645 units planned, over 80% are scheduled for rental development, with Silverstein's River Place II representing the largest scheduled development at 1,359 apartments, of which approximately 20% will be set aside for low-income households.

"Pricing pressure on well-located, full-service rental buildings in top condition is maintaining annualized rentals in excess of $70 per square foot, with some leases piercing well into the $80s per square foot," he said.

The senior managing director at Rose Associates, James Hedden, said the good news is "that the residential rental market in all five boroughs is strong with low vacancies and healthy rents. This really is a testament to the healthy New York City economy, and the successful economic policies of the city and state. Unfortunately, as a result of this vibrancy, the cost of land, coupled with increasing construction costs, has made it extremely challenging to provide rental housing."

At least 4,000 rental apartments are in various stages of planning and construction in downtown Brooklyn. Developers include Avalon Bay Communities, the Clarett Group, Stahl Real Estate, and developer John Catsimatidis.

A joint venture of Rose Associates and MacFarlane Partners is planning the residential component of the new 65-story building with a total of 916 rental apartments on the former site of the Albee Square Mall. The development, known as CityPoint, is a joint venture of Acadia Realty Trust and PA Associates, which plans to build 500,000 square feet of retail, with enclosed parking, and 125,000 square feet of office space on the lower floors. This project would be the largest new development in Brooklyn in more than a decade.

A managing director at Prudential Douglas Elliman, Andrew Gerringer, said he believes "that we will be seeing more rentals coming on line that were originally planned as condominiums. I know of a 300,000 square foot building in Long Island City that was planning to go condominium; then the lender said they would only lend if it was built as a hybrid rental with a condominium component. Now they changed their mind again and will only lend if it makes sense as a full residential rental. This is a scenario that I believe we will be seeing a lot more of going forward for some time."

The principal of W Financial, Gregg Winter, said that in most cases, "rentals can only be built where land has been held by the developer for years, or in other cases land held for decades for another business purpose, like a parking lot or garage, is developed by the longtime owner, often with a joint venture partner who is a professional developer. If that same parcel were to be sold at market rate, the economics would be unlikely to work as a rental. The sunset of the 421-a program strikes an additional, possibly fatal, blow to the economic viability of developing residential rentals or mixed-use projects in New York City."

"High rental rates and low vacancies, high demand have made it very attractive to developers to plan and build residential rentals," the president of Citi Habitats, Gary Malin, said. "Average rents increased 10.4% from 2005 to 2006 and 5.5% from 2006 to 2007. Vacancy rates for Manhattan averaged at or below 1% for 2007, primarily due to the lack of rental inventory."

Mr. Malin continued: "Given the current credit situation, it is uncertain how many additional rental developments will come to market, but clearly, since New York is a renter-centric city, rental investments should continue to perform in the face of economic uncertainty."

A principal at Rock a Bill Advisors, Tim Henzy, said: "One of the major obstacles to the development of rental housing in Manhattan and more importantly the outer boroughs is the cost of construction. Contractors are used to being paid to build condominiums, particularly high-end; they are therefore not in the mode to bid or build rentals.

"Lenders are highly apprehensive to take on market rental deals in the boroughs until the condo market shakes out. In many instances certain unsold condominium units will become rentals," he said.

A principal at Singer and Bassuk Organization, Scott Singer, said the supply of construction financing available in the market "has been reduced by two main factors, the second being the more significant: First, a few lenders have pulled out of the market entirely, and second, virtually every lender has reduced the maximum loan size exposure they are willing to take on any one transaction."

Mr. Singer added: "However, among the remaining construction loan liquidity in the market, I would expect virtually every lender to say that rental apartments in New York City would be at the very top of their list of preferred projects. The developers who will be able to exploit this dynamic to their greatest advantage are some of the major families who have former garages, parking lots, and industrial facilities that are or can be zoned for residential — where their land cost is effectively zero and therefore the economics of rental development feel attractive. Furthermore, construction lenders will still give these long-term holders credit for the equity value in their land, allowing them to finance 100% of the new development costs with low-cost first mortgage financing in some cases."

Even in these troubling credit-crunch times, expect that established developers of residential buildings will be resourceful in continuing the development of rental buildings to meet the housing needs of the thousands of individuals flocking to reside in New York City.

Mr. Stoler, a contributing editor to The New York Sun, is a television and radio broadcaster and a senior principal at a real estate investment fund. He can be reached at mstoler@newyorkrealestatetv.com.