Podcast Summary
NYCB's struggles raise concerns about multifamily market and banking sector: NYCB's missed earnings, dividend cut, and increased loan loss reserves in commercial real estate and multifamily sectors sparked concerns about the health of these loans and the potential systemic risks in the banking industry, specifically in the multifamily market
New York Community Bancorp (NYCB) experienced significant challenges in early February 2023, leading to a nearly 40% decrease in its stock price. The bank reported missed earnings per share, a dividend cut, and increased reserves for potential loan losses, specifically in commercial real estate and multifamily sectors. This situation sparked concerns about the health of these types of loans, not only for NYCB but potentially for the industry as a whole. Previous debates about idiosyncratic issues in the banking sector have led to increasing worry about potential systemic risks. Previously, we discussed the multifamily real estate boom and the potential for problems in this sector on the Odd Lots podcast. NYCB's struggles bring this issue back to the forefront, raising questions about the future of the multifamily market and its impact on the banking sector.
New York City Real Estate Market Challenges for Landlords: Rising YIMBYism, shifting political landscape, regulations, affordability crisis, and rising interest rates pose challenges for New York City landlords. Some investors explore betting against the market by shorting New York Community Bank.
The New York City real estate market, specifically for landlords, is facing increasing challenges due to a combination of factors including rising YIMBYism, shifting political landscape, and regulations, as well as an affordability crisis and rising interest rates. This has led some players, like our guest Ben, to explore ways to bet against the market, such as shorting New York Community Bank. Ben has advised several hedge funds on this potential target based on publicly available information, but neither he nor his firm have any direct or indirect compensation tied to the performance of that stock. Ben himself has sold one of his buildings in New York City but still has a few more to sell. This conversation highlights the complexities and challenges facing the New York City real estate market, particularly for landlords, and the potential opportunities for those looking to bet against it.
NYCB's focus on rent stabilized multifamily loans in NYC: NYCB is the largest lender on rent stabilized buildings in NYC, with 44% of their loan book dedicated to multifamily loans and 22% to rent stabilized loans. Historically, these properties were attractive due to their consistency and bond status, but policy changes in the 1990s led to higher rents.
New York City Bank (NYCB) is a leading player in the multifamily lending market, with a significant focus on rent stabilized buildings in New York City. Multifamily loans make up 44% of NYCB's entire loan book, and rent stabilized loans represent 22%. NYCB's involvement in this sector dates back five decades, making it the largest lender on rent stabilized buildings, even surpassing the now-failed Signature Bank. Historically, rent stabilized apartments were attractive due to their consistent occupancy and bond status. However, in the early 1990s, vacancy decontrol was introduced, allowing apartments to be deregulated once the legal rent surpassed a certain threshold. This policy change significantly increased rents, which was a controversial response to the city's financial struggles. This background provides context for the high rents many New Yorkers pay for apartments built before 1974 with six or more units. The allure of rent stabilized properties for developers and lenders was once rooted in their stability, but the policy changes in the early 1990s shifted the landscape, leading to the high rents we see today.
Deregulation of rent-stabilized apartments fueled New York Community Bank's growth: New York City Council's deregulation of rents led to increased apartment values, incentivizing landlords to raise rents and narrow the gap between desirable and less desirable areas, driving New York Community Bank's growth.
New York Community Bank significantly grew during the economic boom in New York City from 1994 to 2019 due to the deregulation of rent-stabilized apartments. The value of apartment buildings increased, leading to a narrowing spread between buildings in areas with weak credit profiles and those in desirable areas like Manhattan. The New York City Council's deregulation of rents in 1994, allowing for larger rent increases when apartments reached a certain threshold and every time an apartment turned over, created an incentive structure for landlords to try and reach that threshold. Landlords employed various tactics, including buyouts, harassment, and inflating renovation costs, to speed up the process and raise rents to market rates. Despite this deregulation, stories of affordable apartments in desirable areas persisted due to the existence of older rent-controlled units.
Deregulation of rent control in NYC led to significant rent increases in desirable areas: Post-deregulation, landlords invested in property improvements to reach rent threshold, leading to easy capital flow and significant rent increases in desirable areas, while non-gentrifying areas saw only higher rents without significant regulation
The deregulation of rent control in New York City post-1994 led to a significant increase in rents in desirable areas, making it worthwhile for landlords to invest in property improvements to reach the deregulation threshold. This trend was particularly prevalent in the early 2000s due to increased institutionalization and private equity involvement in the real estate market. However, in non-gentrifying areas, rents rarely reached the threshold for regulation, leading mainly to higher rents without significant regulation. The financing picture reflected this dynamic, with capital flowing easily into the sector based on the expectation of raising rents significantly. Principal Asset Management, as a leading real estate manager, actively invested in this sector, leveraging local insights and global expertise to uncover compelling opportunities. However, investing in real estate involves risk, including the possible loss of principal.
Leveraging Rent-Controlled Buildings for Banking Opportunities: New York Community Bancorp grew its deposit bases and loan books by building relationships with rent-stabilized landlords, benefiting from requirements for mortgage borrowers to maintain deposits and holding tenant security deposits. However, recent legislation may impact the profitability of multifamily investments in New York City.
While rent-controlled or rent-stabilized buildings may not seem like exciting places to lend, they can present above-market opportunities for those willing to put in the effort. New York Community Bancorp, for instance, built relationships with rent-stabilized landlords, benefiting from the requirement that mortgage borrowers maintain deposits at the bank and holding tenant security deposits. This strategy helped the bank expand its deposit bases and loan books in a complex market where out-of-town lenders were less inclined to engage. However, the landscape for multifamily in New York City has changed with the passage of the Housing Stability and Tenant Protection Act of 2019. This legislation ended vacancy decontrol, removing the incentive for landlords to harass tenants and deregulate apartments. It also removed the 20% vacancy bonus and severely curtailed the ability for landlords to recapture renovation costs in rents. These changes could impact the profitability of multifamily investments in the city.
Impact of Rent Regulations, Inflation, and Interest Rates on NYC Multifamily Market: Rent regulations, inflation, and interest rates have made the multifamily real estate market in NYC uncertain, with rent-stabilized buildings being high-maintenance, expensive to maintain, and tenants having weak credit profiles. Landlords are hesitant to get new tenants due to rent control changes, and the market's belief in deregulation may be a delusion.
The intersection of rent regulations, inflation, and interest rates has significantly impacted the multifamily real estate market in New York City. After the HSTPA, the market for rent-stabilized buildings dried up due to a lack of price discovery and uncertainty. The explosion of renovation costs, driven by inflation, further complicated the situation. Despite the belief that real estate investment drives economic conditions, the data shows that economic conditions often drive real estate investment. The vast majority of rent-stabilized buildings are in lower-income submarkets, making them high-maintenance and expensive to maintain. Even if rent increases were allowed, the tenants' weak credit profiles and the increasing operating costs would result in higher collection costs and legal fees. The future of these buildings is uncertain, as landlords are hesitant to get new tenants due to the changes in rent control. The collective delusion in the market is that the Supreme Court or the legislature will overturn rent control, but the data suggests that the deregulatory trade tapered off before the HSTPA and that the majority of rent-stabilized buildings remain subprime real estate.
The true value of rent-stabilized buildings in NYC may differ from market perception: Investors should consider the real market value of rent-stabilized buildings, accounting for current regulations and location, instead of relying solely on perceived value.
The value of rent-stabilized buildings in New York City may not be as high as some investors believe due to the current regulations and the location of the properties. The gap between the market's perceived value and the actual value based on cash flow and fundamentals can be significant. Some landlords may be in a standoff with the government over subsidies, and the political will to inject capital into these buildings may not be present yet. However, the potential for changes in laws that could increase the value of these buildings through deregulation or other means is a factor that some investors are betting on. But, even if such changes were to occur, the value increase may not be as great as imagined, especially for buildings in less desirable locations. It's important for investors to consider the real estate market's collective delusion and the current fundamentals when evaluating the value of rent-stabilized buildings.
Innovative solutions needed for neglected rent-controlled buildings: Creative approaches like vouchers, city leasing, nonprofits, and financing are necessary to maintain neglected rent-controlled buildings, ensuring tenants' stable living conditions and investors' viable returns.
While the argument against rent control is that some building owners may not have the financial capacity to maintain their properties, the reality is that many of these buildings have been neglected despite legal obligations to keep them in good repair. This situation arises from an inadequate regulatory apparatus for housing, leading to a need for creative solutions to inject capital into these buildings. These solutions include providing vouchers to tenants, cities leasing them directly, nonprofits taking them over, and various other forms of financing. The buildings' unique situations require tailored approaches. It's important to note that these buildings are depreciating assets, but they are not uninvestable. The relationship between landlords and lenders, as discussed, can lead to overexposure and a focus on one industry, but it also has the potential to build expertise and strong relationships. Overall, the housing situation in New York City requires innovative solutions to ensure tenants have stable living conditions and investors can see a viable return on their investment.
Unique market dynamics in NYC housing: Assumptions of embedded value in NYC housing can be fragile and subject to market shifts, leading to potential market collapse
New York City's complex housing laws create a unique market where a small number of investors put in the legwork to understand it, leading to a self-reinforcing feedback loop of increasing value and investment. However, this dynamic can be fragile, as the assumption of embedded value in these buildings may not hold up in changing economic conditions. In the past, the rent stabilized market functioned like a bond business, but as investors sought higher returns, they began to view it as an equity business, which eventually led to its demise. This shift in perspective, driven by the narrative of impending value increases, contributed to the eventual collapse of the market.
Support Odd Lots and check out Money Stuff: Listeners can leave a positive review for Odd Lots and enjoy ad-free listening as Bloomberg subscribers. A new podcast, Money Stuff, featuring Matt Levine and Katie Greifeld, is now available.
If you're a fan of the Odd Lots podcast and appreciate our deep dives into multifamily and the forgotten Commercial Real Estate sector, please leave us a positive review on your favorite podcast platform. Additionally, if you're a Bloomberg subscriber, you can listen to all Odd Lots episodes ad-free by connecting your Bloomberg subscription with Apple Podcasts. Another exciting announcement is the launch of a new podcast, Money Stuff, from Bloomberg. Our friend and colleague, Matt Levine, along with Katie Greifeld, will be hosting this new podcast every Friday. They will be discussing Wall Street finance and other topics that have made Matt's newsletter so popular. You can listen to Money Stuff on Apple Podcasts, Spotify, or wherever you get your podcasts. In summary, support the Odd Lots podcast by leaving a review and enjoy ad-free listening as a Bloomberg subscriber. Also, don't miss out on Money Stuff, the new podcast from Bloomberg, featuring Matt Levine and Katie Greifeld.
