Real estate developers in Queens have enjoyed enviable returns in recent years, but generous rent concessions are complicating their efforts to obtain permanent financing for completed projects. Traditional banks have pulled back as they continue to stress the importance of in-place cash flow, but a bevy of bridge lenders and debt funds, are adroitly filling their void. This trend is particularly prevalent in Astoria and Long Island City (LIC), where tenant incentives have become the norm.
As economic conditions continue to improve, the federal reserve is expected to further tighten monetary policy in 2018, ultimately leading to higher interest rates. For most of the past decade, historically low interest rates fostered ferocious demand for vacant land in Queens, but higher costs of capital and tighter regulations for construction lending are among many factors that have taken a toll.
In the first quarter of 2018, 11 development sites traded in Queens, a 45% drop from the fourth quarter of 2017 and 30% lower than the same period a year earlier, according to Ariel Property Advisors’ Investment Research Division. Northwestern Queens – which includes Astoria and LIC – dominated activity in the first quarter, snaring 20% and 16% of the borough’s dollar volume and transaction volume, respectively.
The yield on the 10-year Treasury note, which influences everything from mortgage rates to corporate loans, pierced 3% in April for the first time in four years. Unsurprisingly, it has become more expensive to finance construction projects. The WSJ Prime Rate Index, used by many banks to price construction loans, reached 4.75% in April, 0.75% higher than the same month last year.
Developers in Astoria and LIC have resigned themselves to lower loan proceeds and loan-to-cost ratios, but as properties pass inspections and receive Temporary Certificates of Occupancy (TCOs), their current focus is how to get their money back. Developers are aware that achieving full occupancy right now includes concessions, such as one-to-two months free rent, and/or no broker fees.
A record-setting 65.1% of new leases signed in Northwest Queens included concessions in April, up from 45.4% during the same month a year earlier, according to a report from real estate appraiser Miller Samuel and brokerage Douglas Elliman. Queens far outpaces Brooklyn, where 51% of new leases offered concessions.
Overall in Queens, after accounting for incentives, the median rent fell 11.7% year-over-year to $2,646 in April, the eighth decline in nine months. Meanwhile, the year-over-year length of time for rent concessions climbed from 1.1 months to 1.6 months, or roughly $300 per month on a one-year lease.
Rental units are staying on the market for a shorter period of time due to the concessions. Indeed, units in Queens stayed on the market for 25 days in April, down from 37 days a year ago, according to the Miller Samuel/Douglas Elliman report. Builders are banking on a decline in supply due to the 16-month construction lull that emerged after the expiration of 421-a over two years ago. The popular tax incentive’s replacement, called Affordable New York, was enacted in April 2017.
From a financing perspective, free rent has created a conundrum. That’s because in the eyes of a traditional bank, the net effect of one-month free rent is lower income for a landlord. To these institutions, a landlord charging $2,200 per month in rent is only collecting $24,200 over 12 months, not $26,400. Developers are therefore not receiving credit for a full lease, only the actual net income, thereby hindering developers’ ability to maximize their permanent loan proceeds.
Fully aware of this void, alternative, transitory creditors, such as debt funds and bridge lenders, have swooped in, offering bridge financing to builders in Astoria and LIC. Unlike traditional lenders, these entities tend to look at a property’s long-term potential, overlooking the short-term impact of rent concessions. Credit availability in this space has exploded, creating an increasingly competitive market for these lenders, and thus pushing rates down.
These interim loans can be structured without prepayment penalties and offer developers the flexibility of a 30-day closing period. Many platforms offer the ability to roll the loan over to an amortizing mortgage once certain hurdles are met, allowing developers to increase the amount of their loan while saving on due diligence and closing costs.
Obtaining a seasoned mortgage broker is crucial as they can obtain the best possible terms for a client. Ariel Property Advisors capital services division recently secured financing for a renovated multifamily walk-up building in Astoria, tapping a relationship with an out-of-state lender. These lenders tend to offer more competitive terms to strengthen their foothold in NYC. Ariel was able to acquire favorable terms, including a 3.92% interest rate on a 10-year fixed-rate loan.
Rising rent concessions and declining rents in Northwest Queens can be attributed to a surge in supply stemming from 421-a. The are currently 88 and 92 residential projects underway In Astoria and LIC, respectively, according to estimates by Recity.
However, as in every real estate cycle, demand will eventually outpace supply. So, despite the recent onslaught of development, investors will likely continue to enjoy handsome returns in Queens.
Indeed, the average price per buildable square foot stood at $218 in the first quarter, an astonishing 160% higher than 2012, respectively.
While interest rates have risen, they remain historically low, and thanks to alternative lenders, the commercial lending spigot in Queens remains wide open. With the guidance of an experienced mortgage broker, a developer can obtain interim financing via institutions that are more than eager to extend credit at competitive rates.
Matthew Swerdlow is a director – capital service and Arriann Weiss is an analyst - investment research at Ariel Property Advisors, New York, N.Y.