I haven’t been writing as much on new development of late. In this case, I wanted to think through what buying in a particular new building would look like if you decided, from the building, that you would be buying as an investor. In this case, after five years, the math could work so that walking away made sense. Could that be true?
I think about this like “The Producers,” where the characters had sold 200% of the equity in the Broadway show “Springtime for Hitler,” and then would simply walk away when the show was a failure. Except…the show was a success. In this case, if the investment is a success it would be a home run. Enough chatting, though. Let’s make the case.
I have a plan to make money on residential real estate…
269 West 87th
Off, Off-Broadway, at 269 west 87th street, this new coop with condo rules was just rebranded to “West End & 87” and you can visit it here. This has been marketed on and off for about 2 1/2 years.
Originally the building had been marketed as “The Chamberlain.” They’ve gone from a name to a corner, except that it’s not on the corner. Either way, I’m sure that some market research indicated that keeping things simple and less pretentious could be a winning strategy.
Further, they reduced prices that that you can buy a nearly 2800 square foot apartment for $4.5mm when a typical side 4bedroom in this condition would be around $6-7mm. What is the catch? It’s not just that the developers felt like giving the apartments away.
Rather, the building is a built on leased land and pays ground rent to the owner of the land.
You may recall that a few months ago I made the case FOR buying in an East Side landlease apartment building, which I offered as a value relative to other properties nearby. At 175 e 62nd, the discount was significant, and the building well-established, AND the definitions around the increases in monthly maintenance were fairly benign, though still worthy of deep due diligence.
With West End & 87, and on the upside, there are set definitions in the ground lease which provide a buyer clarity in some cases what the ground rent will be for many years to come This clarity is different than it would be for apartment owners who are directly responsible for real estate taxes. In this case, the land owner deals with the vagaries of whatever current real estate taxes are, instead of apartment owners With fixed increases during the term of the ground lease, owners can sleep easy knowing what things will look like.
On the downside, though, the concern can bethat this ground rent ends up being quite a bit higher than typical monthly charges. Not only that, but there’s also a “reset” when these lease terms expire, which can be seriously STEEP. In this building on 87th, the increases are tied to inflation. Somewhat concerning from what I’m seeing.
To sidestep this issue and the upfront high charges, the developer and its new marketing team put in place offers to cover the monthly costs entirely(!) for the first five years. That is, if you pay cash you have ZERO carrying charges for 5 years
You live for free…except that in 5 years, the monthly charges for this 4-bed may jump from $7000/month to perhaps $10-12,000. Yes, we could discuss whether other building’s maintenance will increase at the same rate as it would here…perhaps in 2024 or 2025, the monthlies won’t look so insane. But…they may be even higher here.
Bear in mind- this isn’t tax advice, investment advice- just a fun thought experiment about what one could do, not entirely different than what our perma-tanned presidente seems to have done with some of his failed real estate deals (not that it’s uncommon, though).
How would this purchase work to an investor’s advantage?
First, let’s assume that one would purchase this unit at the current asking price. One would put down 10% ($450,000) and finance the rest with a mortgage. Closing costs would be minimal because technically this is a cooperative. So a buyer would save on title insurance and mortgage tax, neither of which would exist. Further, I’m assuming that the seller would pay for his/her closing costs, rather than pushing them to a buyer. So a buyer would incur “mansion tax” and few other closing costs, but assume under $100k in closing costs, not $200k of most condos.
A mortgage today with 4% interest, would be, at this purchase price, less than $14,000/month to carry the apartment.
Then you would turn around and rent the apartment for $18,000/month, which seems very reasonable. This could easily be higher, too but let’s be conservative…I mean, in our thought experiment this isn’t risky…
Net, per year, you’re going to make about $50,000 per year in income (assuming no property management, de minimus property insurance, and no problem finding a tenant).
In addition, you get to depreciate the property by $164,000 per YEAR.
Let’s quickly describe this. For an investor, you can depreciate a rental property over 27 years. So with a purchase price of $4.5mm, each year you could conceivably depreciate $166,000 against any positive cash flow. If you make $50,000 cash after the mortgage interest costs, your losses offset that income so you don’t pay taxes on that income. It’s a paper loss, mind you, and not one every investor could be as efficient using. But a loss nonetheless.
So the net benefit to you will be about $50,000 tax free income, and another $100K or more in tax benefits (aka losses) per year that you could use later
Don’t forget, You are getting free monthlies for 5 years. So at the end of 5 years, you will have gotten about $550,000 in tax benefts in the depreciation, plus $250,000 or more in income, tax free, which you can think about as much as $500,000 in normal income. Okay.
Maybe you can even borrow the downpayment from another source, you will also have that interest to pay, which will be about $1500/month.
In this case, you’ve borrowed 100% of the purchase. You’re getting this massive depreciation against your rental income. In many cases, certainly for an active real estate investor, one can possibly count depreciation against active income, too- though not every accountant will agree with me.
And after five years, you have this asset with probably $7000/month carrying charges. At that point, it won’t necessarily make sense anymore to rent it out, and you would have some choices. Sell it at a $500,000 discount to what you paid, plan on losing your down payment, or perhaps have a “producers” moment where the property ends up being a solid investment.
If you end up instead walking away from the mortgage altogether, you still received a net of at least $800,000 in benefits for potentially far less invested. You may have had actually almost nothing invested. And may have been able to not be personally responsible for the mortgage at all. And if you walk, then you get to take the full loss of the downpayment.
BUT BACK TO REALITY
This has been a lot of fun, and something that I’d love to talk through on a future video- but I actually don’t think that one could actually pull this off without a ding on one’s credit, or without filing bankruptcy. Not ideal.
All of this said, a real estate developer could absolutely do it, provided there was a non-recourse loan, and probably a situation that works in real estate real life, just on a much, much larger scale than one apartment.
This bizarre situation, with a developer thinking creatively for solutions to sell their building, brings out the creative in me, too. I really hope that eveyrone jumps all over me on this one and tells me how crazy and nefarious I am for even thinking this way…please!