NY Real Estate Investors Venturing Outside of New York Due to New Rent Regulation Face Unfamiliar Practices

It is has been more than four months since Governor Andrew Cuomo signed into law an historic change to the rent regulation laws of the State of New York, commonly known as the Housing Stability and Tenant Protection Act of 2019. Since then much has been written and debated about whether these new regulations may help solve (or worsen) the housing crisis. But one impact of these regulations has become readily apparent. Many traditional New York City real estate investors have concluded that it is now time to consider investing outside of New York.

Prior to the passing of the new regulations, real estate investors were already finding it challenging to acquire viable real estate investments in New York City, given the high property valuations. In addition, there is a little doubt that the new regulations have had a material impact on the prospective revenue that can be generated from rent-regulated apartment units, and accordingly, a material adverse impact on the value of rent-regulated apartment buildings. With the pricey New York City market in the backdrop, it appears that these new rent laws may have been the “tipping point” for many real estate investors, who historically have invested within New York City, to reallocate their investment dollars outside of New York.

New Rent Regulations

Under the new regulations, among other significant limitations, landlords are no longer permitted to

  1. have units removed from rent stabilization per “luxury deregulation” (a provision that provided for a unit to be deregulated when the tenant’s income exceeded a certain income threshold),
  2. have units removed from rent stabilization per “vacancy deregulation” (a provision that provided for a unit to be deregulated if the legal rent for the unit exceeds certain rent levels upon vacancy), or
  3. utilize the “vacancy bonus” (a provision that permitted rents to increase by as much as 20% when a unit becomes vacant).

In addition, the landlord’s ability to recoup the costs of capital improvements through rent increases has been materially reduced.

Developers and investors who seek to acquire real estate investments outside of New York City for the first time will certainly witness customs and practices in the acquisition of real estate that differ substantially from those they have grown accustomed to, from the negotiation of the purchase and sale agreement through closing. Through our experience representing developers and investors in the acquisition of real properties across the U.S., highlighted below are some of the most significant legal differences a purchaser of commercial real estate should be aware of in the negotiation of the contract of sale for, and the closing on, real properties outside of New York.

Contract Terms

In general, the terms of purchase and sale agreements for properties located outside of New York City are more buyer-friendly. Purchasers are very often able to negotiate a due diligence period (with an unconditional termination right) into the purchase and sale agreement, thereby enabling them to have the property under contract prior to spending money on due diligence reviews (including title, survey, zoning, environmental, engineering and lease review). In addition, purchasers will find that they are able to negotiate more extensive representations and warranties with lengthier post-closing survival periods and collateral (e.g., escrows, guarantees, etc.) to secure seller’s breaches and indemnities post-closing. Additionally, buyers may be able to negotiate for more considerable covenants from the seller to maintain the property in a required condition.

Due Diligence

No aspect of a real estate acquisition is inherently more “local” than confirming compliance with zoning, construction and occupancy laws and regulations, and that the property is free of local code violations. Purchasers will find that these activities will vary considerably from jurisdiction to jurisdiction, and very few jurisdictions will have procedures similar to those of New York City, where the typical process is to check the records of the relevant municipal departments and obtain violation search results and a copy of the certificate of occupancy. In many jurisdictions, you can simply obtain a letter from the local zoning and/or building department confirming compliance with local zoning and building codes. However, some jurisdictions require a governmental inspection of certain types of properties for zoning and/or building code violations prior to issuing a certificate of compliance in the purchaser’s name, which the purchaser must obtain in order to verify (and have standing to rely on) that the property is in compliance with local laws upon the purchaser’s acquisition of the property. Even more atypical, in the City of Gardena, California, purchasers are entitled by law to a Property Information Report, which confirms the current legally permitted use, and includes a report of open code violations and restrictions of record. The report also provides the results of an exterior inspection to confirm the existence of any exterior code violations, which is performed by a city official prior to closing. Failure of the seller (or the seller’s broker) to provide the Property Information Report to the purchaser constitutes a misdemeanor.

Title Insurance

Insuring title to properties outside of New York State will invariably be accomplished at considerable lower costs, as New York has some of the highest title insurance premiums in the country. In addition, there are additional title insurance endorsements available to purchasers of properties outside of New York, such as a zoning endorsement, which protects against loss or damage that may be incurred as a result of an inaccuracy in the zoning information supplied by a third party vendor or by reason of a final judicial determination invalidating the zoning ordinance. At the same time, there are also challenging title clearance issues outside of New York that are avoided, or more easily addressed, with transactions within New York. One example involves the risk of mechanic liens where there is on-going work (or recent work) performed at the property. Due to the “relation-back” of the mechanic lien provided by many state statutes (i.e., a subsequently filed mechanic lien will be deemed filed of record as of the date the work commenced, and in some jurisdictions, as of the date the applicable construction project commenced), the title insurance company’s ability to insure the purchaser’s title to the property will require considerable due diligence and indemnities from “deep-pocket” principals of the seller (or other collateral).

Closing Costs

Although the responsibility for the payment of closing costs is subject to negotiations, most purchase and sale agreements will allocate the costs between the seller and the purchaser in accordance with local customs. Unlike New York, where the seller typically pays the transfer taxes, in many jurisdictions it is customary for the purchaser to pay a portion, or even all, of the transfer taxes. And unlike New York, where the purchaser typically pays all title search expenses, title insurance premiums and survey expenses, the seller may pay a portion (or all) of these expenses in many jurisdictions. If the purchaser is financing the acquisition, New York is one of the few states that charges a mortgage tax, and New York City has one of the highest mortgage taxes in the country. Accordingly, the significant cost of mortgage financing in New York can be reduced significantly (and even eliminated) in connection with real estate investments made outside of New York.

While the jury is still out on the long-term impact the Housing Stability and Tenant Protection Act of 2019 will have on the New York City housing stock over the next several years, traditional New York City real estate investors are already reacting to the law by seeking investment opportunities across the country. These investors will certainly encounter different customs and practices in the processing of real estate acquisitions from contract to closing.

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10.22.2019  |  PUBLICATION: Note From The Real Estate Group  |  TOPICS: Real Estate  |  INDUSTRIES: Real Estate

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