Stephen G. Kliegerman
President of Development Marketing
For certain developers, switching from condos to rentals makes financial sense
By David Jones
While condo buildings throughout the city are going rental to deal with the economic slowdown and fewer buyers, the decision to make that switch comes with complicated financial realities that vary from project to project.
Historically, condo projects went rental as a backup plan, but that is far from a universally safe bet today — and sometimes, it's flat-out financially impossible. Obviously, the developer must consider how much rental income can be generated from the building. In many cases, that amount is not enough to turn a profit — and sometimes, not even enough to cover what was borrowed for the project in the first place.
The formula for determining whether a building would be viable as a rental depends on several key factors: the underlying land development and construction costs; the strength of the submarket the building is in; the size of the developer; the financial standing of the lender; and, of course, how much each apartment can rake in.
Barry LePatner, a leading construction lawyer, noted that large and established developers often have enough of a financial cushion to ride out a soft market, even if means warehousing empty apartments.
But, he said, other developers who launched during the peak of the condo boom are in tough spots, because high carrying costs can make it hard for their numbers to work with monthly rental income.
So exactly when can a developer rely on renting out units to bring in enough money to tide them over a rough economic stretch rather than try to sell the units?
Many experts interviewed said the original price of the land acquired is key — so it's more financially feasible to execute the rental option in Brooklyn, Queens and in less prime areas of Manhattan, because acquisition and land prices are lower. The option of simply building a rental tower also works for some of the old-time, established real estate firms that have been sitting on land for years and don't have to factor in today's sticker shocker prices.
Still, real estate experts said rental backups almost never bring in what they would if the developer were selling condos.
According to Susan Hewitt, president of the Cheshire Group, a firm that restructures co-op and condo buildings, if an apartment is selling at $1,000 a square foot, and the developer wants a 10 percent return on investment, that would require the rental equivalent of $100 a square foot.
"I can promise you that is well above the rental level anywhere in the city," said Hewitt. "That is why [almost] nobody was building rental buildings over the past 10 years."
Paul Massey, chief executive of Massey Knakal, reiterated that point, estimating that rents would only bring in $30 to $60 per buildable square foot in many locations. "Land values went up, and construction costs went up to such an extent that in most parts of the city, you couldn't afford to build a rental," Massey said.
Scott Stringer, executive vice president of the Singer & Bassuk Organization, a firm that arranges financing for developers, said banks typically require a 125 percent coverage factor to lend money on condo projects. That means the net operating income — income minus basic expenses like taxes, insurance, management fees and repairs — must be 25 percent higher than debt service, which includes mortgage payments made by the sponsor to the bank.
In first-class Manhattan locations, it often makes more financial sense for developers to stick wtih condos because prices, while softening, are still holding up fairly well. As a result, many of the recent rental conversions are taking place in more up-and-coming locations like the Financial District, Harlem and parts of Brooklyn and Queens, where rezonings or relatively low land costs have allowed smaller developers to establish a toehold during the recent boom.
Just two years ago, a small Harlem-based developer called North Manhattan Construction Corp. secured a loan to develop a small, two-building condo project called the Bridges. The seven-story buildings were to be developed as 31 apartments, ranging from one- to three-bedrooms, plus 25,000 square feet of ground-floor retail space.
After being declared effective by the Attorney General's office in December, the developers were able to close on the first building, called Bridges South, at 2279 Third Avenue, off 124th Street.
Halstead Property is marketing the site, where prices range from $449,000 for a small one-bedroom to $927,000 for a two-bedroom, two-bath apartment. But the developer has decided to be more cautious with the Bridges North and is going rental, according to Steve Kliegerman, executive director of development marketing at Halstead.
"[The developer] has enough equity in the job and potentially enough income from the commercial space to carry the building as a rental," said Kliegerman.
Kliegerman said he is working on more than 20 different projects right now and that lenders are demanding solid fallback plans to operate condo projects as rentals, unlike in the boom times, when they abandoned traditional financing standards.
He said the Bridges is the only one of his projects that has converted an entire building into rentals so far.
Halstead began listing apartments in the Bridges North in May, with rents starting at $4,000 a month for a two-bedroom and ranging up to $5,600 for a three-bedroom.
Meanwhile, in Long Island City, where about 4,000 apartments are either under construction or have recently opened, hundreds of units have gone into the rental market either directly from the sponsor or as investor-owned apartments. The same phenomenon is happening on a smaller scale in nearby Astoria.
Charles Sciberras, associate salesman at ReMax Today in Astoria, estimated that two-thirds of the condo developers in the area were speculators trying to cash in on a hot market, but when the market turned, their base of young Manhattan professionals could no longer qualify for a mortgage.
Sciberras said he spoke to one Astoria developer, whom he declined to name, who has sold only 12 apartments in a 200-unit building. That developer said he plans to convert the remaining inventory into rental apartments. Other high-profile buildings, including Arris Lofts in Long Island City, have placed unsold apartments directly on the rental market, according to brokers.
The developer Crescent Street has decided to go rental with nearly one-third of its units at View 59 at 24-15 Queens Plaza North. The condo, designed by Andres Escobar, has been on the market through the Developers Group since October 2006. Two-bedrooms are starting at $410,000.
The developer sold 27 units, but by late May decided to offer the remaining 11 two-bedroom apartments as rentals ranging from $3,800 to $7,900 a month. According to Mary Crocker, a sales agent at Prudential Douglas Elliman, the firm was brought on to handle those rentals.
In Brooklyn, several neighborhoods — including Downtown Brooklyn, Williamsburg, Dumbo and Greenpoint — have seen condo inventory enter the rental pool.
Developer Two Trees Management recently began listing its unsold inventory at 110 Livingston — the former Board of Education building that was converted into 300 condos — as rentals.
Asher Abehsera, vice president of sales and marketing at Two Trees, said the company sold its first 260 units and decided to go rental with the remaining 40. He denied the decision had anything to do with slow sales, but he said the units can command $50 a square foot in rent.
StreetEasy lists 223 recorded sales in the building, at prices ranging from $365,000 to $1.4 million. Asking rents, meanwhile, range from $2,500 for a studio to $6,850 for a three-bedroom, two-bath unit.
In Manhattan, some luxury rental buildings work because they were never expected to be condos in the first place.
The Chelsea Landmark, a 38-story luxury rental building developed by Rose Associates and Marine Estates, is one of them. Rents at the building, which is located on Sixth Avenue and 25th Street, range from $3,400 for studios to $4,400 for one-bedroom units.
Bob Scaglion, managing director of Rose Associates, said because they built the tower as a rental rather than converting it and trying to shoehorn a condo layout into their vision, they were able to design an efficient unit mix and size that generates more revenue per square foot. He said the building brings in $80 a square foot in rents, whereas competing buildings are generating only an average of around $55 a square foot.
Whether other developers, especially those starting with condo plans, will be able to replicate that success is another question.
"The rental scenario will be very, very marginal," said David von Spreckelsen, senior vice president at Toll Brothers. "It will be difficult to stomach. Some may go rental; some condo people will reduce prices and take what they can get."
Tuesday, July 01, 2008