The Real Deal - article link

Within the spectacle that is the New York real estate market, rental units are pulling off a vanishing act.

Soaring land prices and construction costs are making the newly developed rental unit a nearly endangered species and some older rentals are disappearing due to conversion, say market observers.

"A lot of buildings are going from rental to condo," says Andrew Heiberger, who recently formed Buttonwood Real Estate, after leaving another company he founded, Citi Habitats, the city's biggest rental firm. "Between land prices and the huge cost of construction, rental buildings will not be built or planned or financed, because they can't be underwritten for a number of years."

Heiberger left his old company to start a development firm that has the freedom to focus on the condo market. Construction of new rental buildings has slowed for the moment, he says, though that may change.

"There couldn't even be enough supply of rental units," Heiberger says. "When I was at Citi Habitats in 2004, we charted how many big rental buildings of 50 units or more were built since 1995, and that was over 100 below 96th Street.

"Now, there's nothing even close to that going on for rental – it's more like five buildings."

Yet a representative with the city's Rent Guidelines Board says the lack of new rental development is just a drop in the bucket compared to overall rental inventory. The United States Census Bureau conducts a triennial housing survey for the city, and results from 2002, the most recent figures available, show the percentage of rental units to be 67.6, or about 2 million of the total New York City market of 3 million units.

The bureau is updating figures for 2005, and many in the real estate industry predict a shift of several percentage points in favor of for-sale housing.

"I've been saying for 12 months that the prices of the rental market are poised to rise rapidly," Heiberger says. "When the vacancy rate gets below 2 percent, which is basically a no-vacancy rate, supply dries up, which it has, and prices will rise."

The flat rental market dates back to 1999, but government incentives, such as the Liberty Bonds program, which spurred construction of rental housing Downtown, have disrupted typical market forces. The Liberty Bonds program still has about $200 million to be issued, enough to fund one large project. It should create 4,597 rental units, or about a third of the units built south of Canal Street since 2001.

But with government incentives expiring, the creation of rental housing may suffer a serious setback.

"If you look at the history of rental development over the past 15 years, you see that most of it was spawned by tax incentives," says Nancy Packes, president of the project marketing division at Brown Harris Stevens. "So government always has the ability to provide incentives for rental development."

While Packes maintains that the development of rental buildings has occurred without government help – there's the Anthem at 222 East 34th Street, 1 Sutton Place North, and many of the buildings done by RFR Davis – others believe that government assistance is the only way to create rental properties in the city.

"What's happened today is that prices of condos have been going over $1,000 a square foot, so the spread on the return between a condo and a rental is so big, why would you do a rental?" asks Ofer Yardeni, a managing director of Stonehenge Partners, a firm which purchases rental buildings, most recently buying the 333-unit Pennmark at 315 West 33rd Street.

The huge spread between the return on rentals and condominiums even makes it undesirable to develop a rental project on an empty parking lot or in combination with sales units, though The Related Companies is doing the latter at 215 East 96th Street.

Fred Harris, senior vice president for development at AvalonBay Communities, says the disparity between rental and sales prices is a national phenomenon, with the ratio of home values to rental costs skewed even further in cities in California and Florida. New York City's spread is currently about 25.5 versus 34 in San Francisco.

"Our market is not the most disparate," Harris says. He maintains that rental housing can be created in New York. AvalonBay is doing so in a 361-unit mixed-used complex being developed on the Lower East Side called Avalon Chrystie Place. Twenty percent of the units there are priced for families with lower incomes.

Besides government incentives like the 80-20 provision that provides for affordable housing, there are market forces that are pushing for the creation of rental housing, Harris says. "One way you can get some rental housing – and it's a vanishing type deal – is a city government RFP (request for proposal)," he says. "That doesn't absolutely require rental, but it is difficult to do it any other way."

Also, REITs (real estate investment trusts) such as AvalonBay are limited in their ability to build condominiums.

With the majority of the New York City real estate market being rentals in 2002 – the opposite of all other U.S. markets – Harris says the market is due for a turn toward increased home ownership.

A shortage of rental housing is not going to make much difference in the sense that rental prices are going to go up wildly," Packes says. "But if you're an employer, and you're looking at the cost index of living someplace, and you have a younger work population, we don't want people moving to New Jersey anymore.