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Manhattan Apartment Investors Seek Big Returns by Buying Small

March 20 (Bloomberg) — Invesco Real Estate, manager of almost $50 billion of property investments, wanted to expand the number of apartment buildings it owned in Manhattan. To do so, it had to start thinking small.

The Dallas-based company, which has more than 51,000 apartments across the U.S., entered a partnership in October to buy a 48-unit property on East 86th Street for $76 million.

“It’s the smallest in any city we’ve bought,” said Greg Kraus, head of acquisitions at Invesco Real Estate.

Investors, seeking to capitalize on rents poised to surpass their 2006 peak, are buying Manhattan properties with fewer than 50 units after a surge in demand drained the market of bigger buildings. Bidding wars for the few large towers that are for sale drive prices so high that buyers in search of yield must look elsewhere, said Ben Carlos Thypin, an analyst at Real Capital Analytics Inc. Smaller properties, which tend to be older, offer opportunities for higher income after renovations, making them appealing as rent growth slows.

“People will buy what the inventory is,” said George Niblock, managing partner at New York brokerage Friedman-Roth Realty Services LLC, who specializes in sales of apartment buildings priced at $30 million or less. In December, he found a five-story walk-up on West 47th Street for an investment firm that had previously focused on high-rises.

20 Units

“If we have to buy the 20-unit building, that’s what we’ll do,” he said the client told him before purchasing the 93-year- old property for $7.6 million, 36 percent more than its previous owners paid in 2007.

The dollar volume of Manhattan apartment-building sales more than doubled in 2012 to $9.1 billion, data from New York- based Real Capital show. At the same time, the average price paid per unit dropped 14 percent to $421,968, indicating buyers may have shifted toward smaller properties in need of rehabilitation, Thypin said. Portfolio sales — multiple, often small, buildings purchased as a package — accounted for 34 percent of Manhattan multifamily transactions in 2012, up from 5 percent the previous year.

Buyers aren’t getting bargains, no matter what the building size, Thypin said. For all Manhattan apartment deals, the average capitalization rate, a measure of investment yield that declines as prices rise, reached a six-year low of 4.4 percent in the first quarter of 2012 and hovered near there all year, according to Real Capital. That compares with a 6 percent average return for multifamily transactions nationally.

‘Extremely Selective’

“Pricing has gotten very full right now, and I think we’re going to be extremely selective,” said Kraus of Invesco, which bought the 86th Street building with New York-based Stonehenge Partners Inc. for $1.58 million a unit.

The deal will pay off because the partners will renovate the building and enlarge the units to generate greater rental income, an option they wouldn’t have with a newer high-rise, said Kraus, whose company is part of Atlanta-based Invesco Ltd.

Stonehenge and Invesco plan to gut the building and create rentals with three to five bedrooms that will lease from $15,000 to $25,000 a month, said Ofer Yardeni, chief executive officer of Stonehenge. The units will be marketed to luxury-seeking tenants who have the means to buy but prefer to lease.

“Everybody’s doing condominium now,” said Yardeni, whose company owns 27 residential buildings in Manhattan. “I’m saying it’s the time for me to do rental.”

Stonehenge Fund

Stonehenge is starting a fund that aims to buy 50 to 100 walk-up buildings in Greenwich Village, where the company will benefit from some of the city’s highest rents without the costs of a large building staff.

“People think I only want the big buildings,” Yardeni said. “But I’m not discriminating because of size.”

Manhattan’s median monthly apartment rent climbed 4.7 percent in the 12 months through February to $3,190, or $75 short of its 2006 peak, New York-based appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate said in a report last week. Super-luxury rentals, the top 5 percent of the market by price, jumped 12 percent to a median of $12,000 a month.

In buildings without doormen, which smaller properties tend to be, rents rose 11 percent from a year earlier to a median of $2,685, according to Miller Samuel and Douglas Elliman. The median rent in doorman buildings slipped 1.7 percent to $3,475.

Younger workers moving to Manhattan “want to be in hot, happening neighborhoods, they don’t care if there’s a doorman” or how small the apartments are, said David Berger, a partner at Rosewood Realty Group, the brokerage that arranged Invesco and Stonehenge’s 86th Street purchase.

Former Tenements

“That’s why Hell’s Kitchen has exploded,” he said. “Chinatown, East Village — that’s where you have a lot of formerly tenement buildings that were chopped into very small apartments. And if you have some creativity, you can reconfigure them and make them look nice.”

Standard improvements an investor might make to a 500- square-foot (46-square-meter) unit include adding a second bedroom and new appliances, he said.

The median monthly rent for a one-bedroom apartment below 34th Street was $3,350 in February, Miller Samuel and Douglas Elliman said. Apartments with two bedrooms leased for a median of $4,838.

The value that renovations add will become more critical for property owners as the fevered pace of rent increases cools, according to Jonathan Miller, president of Miller Samuel.

Manhattan apartment rents will increase modestly in the next two years as an improving job market boosts competition among tenants for a limited supply of new units, he said. While leasing costs will probably pass the 2006 peak this year, the pace of growth will decline as low mortgage rates push some renters to become buyers, he said.

Landlords Vulnerable

Smaller-building landlords will be more vulnerable if property values drop when interest rates rise, according to Sam Chandan, a real estate economist.

“If you’ve got a large building in Manhattan, you have lots of institutional investors who will buy it,” said Chandan, president of research firm Chandan Economics LLC. “If you’ve got a 40-unit property, it’s always going to be less liquid than the 400-unit property.”

Investors are rushing to acquire apartments to take advantage of cheap financing costs. The average interest rate for a 10-year fixed multifamily loan designated for purchase by Fannie Mae was 3.74 percent on March 18, near a historic low, according to Cushman & Wakefield Sonnenblick Goldman, a New York-based real estate investment banking firm. The rate is for a loan that covers as much as 55 percent of the asset value.

Borrowing Costs

“There’s never been more available capital that I’ve seen in the last 15 years in the market,” Berger of Rosewood said.

Building prices “are starting to exceed what I consider fair-market value,” he said. “But when you’re borrowing 3 percent money, you can make it work for almost anything.”

Berger’s firm brokered a series of apartment deals for Jared Kushner, the president and chief executive officer of Kushner Cos., which focused on office properties since 2006.

In the past year, Kushner was the biggest buyer of apartment properties below 96th Street with fewer than 100 units. His company has made deals totaling $242.5 million, for 24 buildings with a combined 570 units, according to Real Capital. All are non-elevator buildings of no more than six stories and fewer than 50 units. Most are in the East Village.

Kushner, who began his buying spree in August with the purchase of six properties, said he has a “strong appetite” for more walk-ups.

‘Hotly Contested’

“We really wanted to play in the market and we felt that the larger elevator buildings were very hotly contested and being chased by a ton of capital from all around the world,” he said. “We decided the best way was to try the smaller buildings and see if we could buy enough of them.”

Kushner said he plans to refurbish the properties from “soup to nuts,” giving the hallways a “modern feel” and improving the living areas. The changes will translate into higher rents for the market-rate units, which account for about 70 percent of the apartments.

“Walk-ups are really a phenomenal asset class” because they’re a hedge against inflation, Kushner said. “They are like gold, only they cash flow.”

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