Buying a multi family home in NYC is a bad investment because rental yields are extremely low, opportunity costs are high, dealing with bad tenants is mind-numbing, evictions are impossible, local rent laws are stifling and labor and maintenance costs are exorbitant.
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Buying a multi-family home in NYC is a poor investment choice because rental yields are extremely low, often under 3% in terms of cap rate. This is the case not just in Manhattan, but also in outer boroughs such as Brooklyn where investment properties have been bid up excessively over the past decade.
With that said, yields may start to rise and become more attractive again because of New York’s recent passage of the Housing Stability and Tenant Protection Act of 2019 which swings the balance of power heavily in favor of tenants vs landlords.
The passage of these rent regulations followed the recent enactment by the New York State government of increases and changes to the NYC Mansion Tax and NYS Transfer Tax in 2019. These changes increased transaction closing costs in NYC considerably higher for both buyers and sellers, especially in the luxury segment of the market.
New York may certainly enact further legislation unfavorable to landlords and investors in the future since the state government is now entirely controlled by the Democratic Party. Whereas there had been some checks and balances in the past because the Republican Party controlled the State Senate, now both houses of the state legislature are wholly controlled by the Democratic Party. Furthermore, the governor has been a Democrat for some time and has shown that he is willing to sign anything that the legislature puts forth.
As a result, rental yields may indeed become more attractive once more in New York City if landlords start exiting their investments en masse.
Investing in multi-family properties is a poor idea primarily because the alternatives are so much better. For example, buying a S&P 500 ETF or index fund and just holding it indefinitely as Warren Buffet suggests is not only so much easier, but so much cheaper.
Not only is the dividend yield on the S&P 500 comparable to that of your typical multi-family investment’s cap rate, many S&P 500 ETFs have essentially unlimited liquidity with extremely low transaction costs. Try liquidating a $20 million multi-family building vs $20 million of SPY (a popular S&P 500 ETF).
We bet that you can sell $20 million of SPY without even moving the market, with a bid ask spread of one penny or less (on a share price of 292.4 as of this writing, which equates to a transaction cost of 0.003%). In contrast, a $20 million building can literally take years to sell, and your transaction costs will be a little over 8% assuming you pay a typical real estate commission in NYC.
Furthermore, whereas there is heavy competition between ETF providers on expense ratios, there is literally zero competition on property taxes. If you bought an ETF, you could choose to hold the biggest and most liquid ETF (SPY) for a 0.09% gross expense ratio, but you could also choose to go with a smaller ETF that does the same thing for as low 0.03% (IVV). There are even ETFs out there that charge 0% in expense ratios as asset managers compete intensely for assets.
In contrast, the New York State government doesn’t have any competition in a single party state, not that Republicans are known to cut property taxes or keep a balanced budget either. As a result, your equivalent expense ratio on your investment property, otherwise known as property taxes, will keep creeping up with no way for you to switch or opt out. Property taxes in NYC average around 1% of the market value, and roughly 2% of the market value in suburbs like Westchester. That’s significantly higher than your typical ETF’s expense ratio no matter how you cut it!
While there certainly are unscrupulous slumlords out there, the media often ignores stories of nightmare tenants who take advantage of small time property investors who often don’t know the city’s myriad of rental regulations as well as they do.
We’ve heard stories of nightmare tenants literally harassing the property owner who lived in the same multi-family building as them. For example, we had a single immigrant lady from South Korea who had saved up enough money to buy a multi-family brownstone in Brooklyn. She lived on the first floor and rented out the upper floor. Unfortunately for her, the tenants were professionals who knew all about the various protections and rental laws and treated her as if she was the tenant
These tenants caused all sorts of damage, consistently smoked marijuana and played loud music. But because the tenants always denied doing anything to the contrary, the property owner was in a bind and literally had to accommodate their lifestyle choices to her own detriment, because she didn’t want to make their relationship and thus her life any worse.
Do you really want to deal with this scenario for a less than 3% rental yield? Even if you’re able to get the rent tax free because of depreciation tax benefits, what’s the point?
It’s extremely difficult to evict tenants in New York and evictions must done through the courts, which can literally take months or even years. An owner can face fines or even jail time if he or she attempts to evict a tenant, either directly or indirectly. This includes trying to evict someone by cutting off utilities or otherwise making the residence uninhabitable or uncomfortable. And don’t even think about trying to force your way in to physically evict a tenant, that’s a serious offence!
As a result, do you really wish to park your money in an illiquid asset that could face potentially years of zero rental income and damages as a tenant you’ve failed to evict lives in your property rent free? What about the stress and anguish that results from a conflict like this?
New York has some of the toughest tenant protection laws in the country. To start with, roughly half of the city’s private rental market is protected by rent stabilization (almost one million apartments) or rent control (roughly 22,000 apartments), which translates to a whole slew of regulations not only on rent increases, but even the ability for tenants to pass down these preferential leases to heirs.
The recent enactment of the the Housing Stability and Tenant Protection act of 2019 made rent regulation a permanent feature of New York’s housing law, meaning that rent regulation won’t need to be fought over periodically just to renew it.
Furthermore, the new housing laws have been it much harder for enterprising landlords to take apartments out of rent regulation. Previously, apartments could be taken out of rent regulation once the rent reached a certain threshold ($2,774.76 per month before the recent law change). This so called “vacancy decontrol” will no longer be possible.
Furthermore, rent regulated apartments won’t be subject to deregulation anymore just because a tenant’s income exceeds $200,000.
In addition, the vacancy bonus which allows landlords to increase the rent by 20% every time a rent regulated apartment becomes vacant will also be repealed.
The annual rent increase as a result of building wide improvements that landlords make will be capped at 2 percent per year and will end after 30 years, vs being permanent in the old law.
If the landlord does improvements in a tenant’s specific apartment, the amount of sometimes arbitrary “improvements” will be limited to $15,000 over a 15 year period, and rent increases related to these improvements expire after 30 years instead of being permanent.
The end result of these new regulations is that many investors of multi-family buildings with rent regulated units will no longer have a clear path to continually increase rents with the goal of deregulation once a certain threshold is hit. Furthermore, many vulture investors who had bought apartment buildings with rent regulated units with the aim of deregulating them have taken a significant hit because that avenue is no longer possible.
New Yorks’s rent laws don’t just affect rent regulated apartments. The new rental laws in New York affect everyone in that security deposits are now regulated. Landlords can now take a maximum of one month’s rent as a security deposit, and new measures have been enacted to make it easier for tenants to get their security deposit back after exiting their lease.
While laudable in spirit, this blanket regulation increases the risk for landlords and ensures that potential damages caused by a troublesome tenant won’t be covered by their security deposit. Remember that the average NYC apartment costs $2 million and rental yields are largely sub 3%, which means one month’s rent as a security deposit is largely a joke vs what potential repair costs can be.
As a result, buying a multi-family home in NYC means landlords, especially smaller ones without the means to recover from significant damages, will have to screen potential tenants even more. This could mean that landlords will have to become even more restrictive in financial requirements and guarantors. For example, landlords may start having to rent only to people with very high incomes and good credit histories.
Even though revenue on half of the city’s apartment inventory is capped, there are no such caps on maintenance, labor and repair costs. As a result, costs to maintain buildings continue to surge in the country’s most expensive city while revenue is regulated and protections are minimized for landlords.
If you’ve ever had to gut renovate a bathroom in NYC let alone a whole apartment, you’ll recall how everything from labor to materials will cost 10 times as much as it does in the rest of the country. Plumbers, electricians and other contractors think it’s their God given right to bleed you dry, because after all, you must be rich to own property in NYC right?
Worse yet, these contractors in NYC are so brazen and confident in their abilities in small claims court that they will mail you a bill for an arbitrary amount of money as soon as they step foot in your door. Worse yet, this can happen when you thought it was just a free consultation to get a quote.
And if you don’t agree to pay $5,000 for someone stepping in your home, never fixing the issue, and never mentioning anything about cost until after they’ve left? They’ll take you to small claims court where the judges and arbitrators are extremely partial towards these poor “blue collar” workers who are being stiffed by greedy landlords who all must be as rich as Donald Trump.
Disclosure: Hauseit® and its affiliates do not provide tax, legal, financial or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, financial or accounting advice. No representation, guarantee or warranty of any kind is made regarding the completeness or accuracy of information provided.