Walk-ups Step Up

Prices shoot up, even as rents decline; still a good buy

By Carl Unegbu
September/October 2004
TheRealDeal.net

A rising tide may be lifting all the boats bobbing atop the New York real estate market, but some investors are finding potential rewards in a market niche where it’s better to climb the stairs than float on market currents.

In the real estate downturn that followed the 1987 stock market crash, the city’s 40,000 walk-up apartment buildings lost about 75 percent of their value as lenders initiated a spate of foreclosures and ended an era of easy credit.

Brokers say prices for walk-ups are now reaching levels they would never have believed a decade ago, which makes them attractive to investors seeking diversification in a weak stock market. With the benchmark S & P 500 stock index up only about 1.5 percent for the year to date, some brokers say owning a walk-up apartment or a small building may be a good investment hedge. This is despite potentially onerous regulations that make many walk-up apartments subject to rent controls or stabilized rental rates.

While they may not offer the highest rental rolls in the city, walk-ups constitute about 25 percent of New York’s housing stock, and are now getting a good long look from investors.

"They are the most conservative, I think, best real estate investment in the city," said Georgia Malone, president of Georgia Malone & Co, Inc., a commercial brokerage that sees a significant percentage of walk-up apartment sales.

Malone sees walk-ups, most of which are rent stabilized, as low-risk investments with high upside potential. She says there is substantial potential for rent appreciation as low-rent tenants move on and landlords increase rents. In a rental market where walk-ups now have a 95 percent occupancy rate, the demand supports the proposition, she says.

Bob Knakal, chairman of Massey Knakal Realty Services, which specializes in small building sales, says some buildings have increased their value tenfold in a decade.

"The overall prices are astounding," he says. "The same buildings that sold for $300,000 in 1994 may be selling for $3 million today."

Knakal calls the newfound allure of these buildings a surprise in the context of other market trends.

"What is striking here is that rents have been going down over the past two years while the prices of apartments have been increasing." He says a typical 10-unit walk-up in the five boroughs today would sell for about $2.1 million.

Rising rents have also prompted long-time investors to forego potential gains from market appreciation to sustain revenues from rising rent rolls, says Marc Lewis, vice president and managing director of Manhattan Apartments, Inc.

Lewis says monthly one-bedroom rents in walk-up buildings averaged $150 in the 1970s, when he began his career. The same units fetch $1,500 today.

"People can now retire on [the income from] one walk-up and many buildings bought five years ago are now worth double."

Over the past decade dropping cap rates – the net building income divided by purchase price — and rising rent multiples – the difference between the purchase price and the rent roll – paint a healthy picture for walk-ups. While the cap rate has dropped from 10 percent to 4 or 5 percent over the past decade, the rent multiple has risen to between 5 to 12 times over the same period, Malone said.

It’s a big change from two decades ago when walk-ups were being foreclosed upon, selling for 25 percent of their original purchase prices.

With strong economics, walk-ups are drawing a new class of owners. In addition to veteran property owners, new investors, mostly professionals from other walks of life, are buying single buildings, and make up as much as 20 percent of the market, according to Lewis. He says veteran owners make up about 50 percent of the market, and the rest of the market is user dealers (those who also live in their buildings) and bargain hunters who convert walk-ups to higher priced condos for sale, especially in emerging neighborhoods.

Institutional investors have taken a closer look as well, says Malone, who is working with Apartment Investment & Management Co. (AIMCO), a Denver-based real estate investment trust, which she says is on a shopping binge throughout the city. She says REITS are drawn to walk-ups because they are long-term investments with a strong upside that meets the buying parameters of these public companies.

But not everyone has been able to join the gold rush of the walk-up market, where extensive rent regulations create barriers to players unfamiliar with their workings. Malone says foreign investors have mostly stayed away from the unfamiliar walk-up market with its thicket of regulations, which could expose the unwary to booby traps of stiff fines and penalties for violations. They prefer the safety of office buildings and elevator residential properties.

Also, not every walk-up building is going to be part of the bonanza, because many are being torn down and rebuilt as elevator buildings, especially along the avenues of Manhattan, where zoning laws allow high-rise residential properties.

"On the avenues, you can go up to 30 stories and people can buy three or four walk-ups in a row [which are about 25 feet wide] and build them into more modern apartment buildings," says Malone. The profits from larger condos and co-ops are causing the stock of walk-up buildings to "diminish greatly," she says.

Low interest rates and easy credit have made larger development an easier option for investors able to come up with the initial capital, according to Malone.

But previously neglected neighborhoods, such as East Harlem in Manhattan and Bedford-Stuyvesant and Williamsburg in Brooklyn are still being mined for walk-up opportunities, says Joel Radmin, president of Extreme Realty, LLC.

"Rehabilitation of brownstones is the only inventory that is growing in walk-ups," he says.