The New York tenant protection legislation enacted last week by the state Legislature has negative credit implications for multifamily lenders with concentrated exposure to the NY metropolitan area, Fitch Ratings says. The new laws, which strengthen tenant protections in New York City (NYC) and the state, do not necessarily translate into immediate ratings revisions for impacted banks. The new law limits the circumstances, frequency and amount by which landlords can raise rents on rent-stabilized units in NYC apartment buildings. This will translate into lower growth in rental and operating income, less room for capital improvements and potentially result in declining property values.
To the extent that loans secured by stabilized apartments have been underwritten to in-place rents, the impact on default risk is relatively neutral over the near term. However, the law may deter investment and reduce investor appetite for rent-stabilized apartments, resulting in downward pressure on property values.
If realized, a significant decline in property values, and hence borrower equity, presents refinancing risk for highly leveraged borrowers, which Fitch views as the primary downside credit impact associated with the new law. The typical tenor of multifamily loans securing rent-stabilized properties is five years to seven years; potential losses associated with such an outcome will likely only manifest over time.
Concentrated NYC multifamily lenders have been sensitive to changes in rent regulations for some time, which Fitch has factored into current ratings. The stable cash flow generation demonstrated by rent-stabilized multifamily properties over economic cycles has historically been viewed positively. The proven stability of through-the-cycle occupancy rates relative to more expensive luxury apartments has supported the ratings of concentrated multifamily lenders. Stable occupancy in these buildings is expected to be maintained in light of the tenant-friendly proposals. However, over the longer term, to the extent that these regulations deter maintenance and capital expenditure needed to maintain these properties, occupancy rates and property values may also be negatively affected.
The new law abolishes certain provisions that have allowed landlords to remove units from rent stabilization when a unit becomes become vacant and the rent is above the statutory high-rent threshold. It also abolishes deregulation when a tenant’s income exceeds $200,000 in the preceding two years.
Preferential rents are set below the legal maximum that can be charged. For lease renewals, owners who have offered tenants a preferential rent below the legal rent are prohibited from raising the rent up to the full legal rent upon lease renewal. However, once a tenant vacates, the owner can charge rent up to the full regulated rent if the tenant did not vacate due to the owner’s failure to maintain the unit in habitable condition. The law also eliminates the “vacancy bonus” rule that have allowed landlords to raise rents by up to 20% upon vacancy as well as the “longevity bonus” that allows rents to be raised by additional amounts based on the previous tenancy’s duration.
Landlords’ ability to impose rent increases after major capital improvements (MCI) has also been hindered. Rent increases for MCI have been capped at 2% from 6% with qualifying expenditures significantly curtailed. Unlike loans funding rent-stabilized properties, loans that back apartment capital improvements tend to be higher risk. Absent significant creditor protections, exposure to such loans is viewed as incrementally credit negative in light of the MCI proposals.