Political risk in NYC real estate is the threat of new legislation being enacted after you buy which increases risk and limits long-term limits long term appreciation, yield and total return potential.
Political risk for property owners is an omnipresent and increasing threat in modern-day NYC. We’ll go over a few recent examples of political risk in NYC real estate and how unexpected changes have already impacted or may impact landlords in the future.
This article is geared towards free-market properties, which excludes rent-stabilized and rent-regulated properties. The latter two categories are so fraught with political risk that we strongly discourage you from buying them unless you’re a well capitalized, quasi-institutional investor or other seasoned professional with considerable experience.
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New York legislators capped security deposits at one month of rent as part of the Housing Stability and Tenant Protection Act of 2019. This was a devastating development for small, non-corporate landlords in NYC.
Here’s a good example which illustrates the political risk associated with the legislation:
Let’s say you love real estate and your dream was always to save enough money to buy an investment property in Manhattan. In 2018, that dream became a reality when you were able to stretch your finances as much as possible to purchase a small loft in the East Village.
The main selling points of the apartment were the tall ceilings and large (albeit old) windows.
You ended up spending $5,000 per window for a total of $45,000 to replace all of your apartment’s windows in order to maximize rentability.
Once the windows were replaced, you expected to achieve a rent of at least $5,000 per month.
You felt comfortable making this large investment because you assumed that it would still be legal to ask for a two month security deposit. But with the passage of this new law, you’re left with virtually no protection in the event a tenant decides to be reckless.
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If just one window is damaged, the entire legally capped security deposit of one-month is instantly depleted. This leaves zero protection for any additional and inevitable damage which would be caused by a rogue tenant, such as damaging more than one window, breaking bathroom tiles or wrecking fixtures.
Had security deposits in NYC been capped at one month originally, you might have decided to buy an apartment in another region or perhaps invest in another asset class altogether.
The Housing Stability and Tenant Protection Act of 2019 made it even more time-consuming, difficult and expensive to collect unpaid rent and ultimately evict non-paying tenants in NYC.
Here’s a great example of the additional red tape which has been imposed on landlords when it comes to collecting unpaid rent:
If there were this many pedantic steps to collecting unpaid rent before you purchased an investment property in NYC, you might have simply decided to buy real estate in another state/jurisdiction or simply invest in a completely passive asset like a S&P 500 ETF.
According to one NYC real estate attorney we spoke with, it can cost up to $20,000 and take 18 to 24 months to evict a non-paying tenant.
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With all this in mind, it begs the question: what’s the point of subjecting yourself to increasingly onerous and costly regulations by purchasing NYC real estate?
Whatever incremental return NYC real estate offers (if any) compared to a more passive investment like an index fund (or real estate in a less-regulated jurisdiction) can be instantly eviscerated if you have to hire a lawyer and spend tens of thousands of dollars to deal with a non-paying or nuisance tenant who refuses to move-out for months or years.
In other words, why invest in an asset class when it appears that the very rules of the game are being increasingly stacked against you? Moreover, it doesn’t appear that the pendulum will swing in the other direction anytime soon.
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Another political risk of buying real estate in NYC is that your property taxes may go up significantly as part of any future overhaul of the NYC property tax system.
This risk is particularly acute for townhouses in Brownstone Brooklyn as well as apartments in certain tax classes, as we’ll explain shortly.
Under the current NYC property tax system which was enacted in 1981, 1-3 family homes receive much more favorable tax treatment compared to condos and co-ops. While the current Cooperative and Condominium Property Tax Abatement helps mitigate the difference, it’s far from a comprehensive solution.
The current system also prevents large annual increases in property taxes by limiting assessment increase changes to 20% over any five year period. Moreover, the current system does not re-assess properties to market value at the time of a resale. This means that property taxes don’t automatically skyrocket upon a resale as is the case in other jurisdictions like California.
Discussions about overhauling the property tax system in NYC reached a fever pitch in early 2022, shortly after the New York City Advisory Commission on Property Tax Reform released its final report on December 29, 2021.
The Commission’s report all but guarantees that 1-3 family homes will face a significant increase in taxation under any future system, as indicated by its first recommendation:
Here’s some additional language from the Commission’s final report which makes it abundantly clear that property taxes will go up for 1-3 family homes:
Here’s an example of how the property taxes will increase on a typical brownstone in Stuyvesant Heights (307 Halsey Street) under the Commission’s proposed system:
In this example, annual property taxes will go up by 224% under the Commission’s proposal. This represents an additional $507/month outlay in carrying costs.
Unfortunately, Brooklyn brownstones aren’t the only types of properties which may be saddled with higher property taxes in the future. We’ve also observed that units in smaller buildings with 10 or fewer apartments may face significant increases. The apartments at risk are those which are in “Tax class 2C – Coop Or Condo 2-10 Res Units” under the current system.
Here’s an example of how a unit in a small Carroll Gardens condo building with just 5 apartments will be impacted by the Commission’s proposed property tax overhaul:
In this example, annual property taxes will go up by 415% under the Commission’s proposed system. This represents an additional $716/month outlay in carrying costs.
As we hinted earlier, the Commission also “recommends eliminating current assessed value growth caps for the new residential class and instituting five-year transitional treatment for market value growth, whereby year-on-year changes in market values are phased-in over five years at 20 percent per year.”
This means that property taxes for all homes will go up considerably faster than they otherwise would have under the current system.
On the flip side, most analysts believe that the proposed overhaul of NYC’s property tax system will reduce property taxes for properties in Staten Island, South Brooklyn neighborhoods such as Bay Ridge and parts of Queens.
Now let’s imagine that you buy a brownstone in Bed-Stuy. Suddenly, your property taxes double because the city implements the Commission’s proposed reforms. Shortly thereafter, New York passes good cause eviction legislation (see next section) which prohibits you from raising rent more than 3% a year. You’re now faced with a nightmare scenario of ballooning carrying costs and rent which cannot legally be raised sufficiently to cover the additional costs. Good luck selling this property for anything near what you paid for it!
In recent years, New York’s politicians have become increasingly flirtatious with the idea of passing Good Cause Eviction legislation. The most recent iteration of this proposal (Senate Bill S2892B) would prohibit landlords from raising rents by more than 3% or 1.5x the annual increase in the regional Consumer Price Index. In addition, tenants would have the automatic right to renew a lease indefinitely with few exceptions.
While this legislation would obviously kill much of the thesis behind buying and investing in NYC real estate going forward, it would be a calamity for existing owners of real estate in the city.
The risk of good cause legislation is particularly acute for working class, small-time landlords, of which there are thousands in NYC.
Just imagine if you worked for over a decade to save $200k to make a down payment on a $1m investment property in NYC. Buying a rental property was the centerpiece of your retirement strategy.
Unfortunately, you happened to buy right before the pandemic. By the time you closed, completed touch-ups and finally listed the apartment, rents in NYC had fallen 30%.
As we’ll demonstrate below, it could take 5 or more years to legally return to pre-pandemic rents under the proposed legislation, regardless of how quickly actual free market rents recover:
Pre-Pandemic Rent [March 2019]: $5,500
Pandemic Year 1 Rent [March 2020]: $3,850 (-30%)
In March 2021 (year one renewal), the regional CPI was 2%. Your allowable rent increase would be the greater of 3% (per statute) or 2% (CPI reading). Your renewal rent in March 2021 is therefore $3,965:
In March 2022 (year two renewal), the regional CPI was 6.1%. Your allowable rent increase would be the greater of 3% (per statute) or 6.1% (CPI reading). Your renewal rent in March 2022 is therefore $4,207:
As you can see, nearly two years after the start of the pandemic and despite NYC rents having risen to all-time highs by March 2022, your rent of $4,207 is still 24% below the pre-pandemic rental rate of $5,500 because of good cause eviction legislation.
As you can see, the political risk associated with possible good cause eviction legislation goes far beyond a minor speed bump. It’s a potential terminal insolvency risk for thousands of small-time real estate investors in NYC with wide ranging ramifications for property values in NYC.
