Frustrated buyers looking for higher yields might be tempted to look outside their comfort zone. 9% caps do exist in NYC, but they aren't located south of 96th Street.
2608 Creston Avenue in the Bronx is located less than 12 miles from my desk in Midtown Manhattan. This corner elevatored apartment building is 121' wide with 54 units. The building sold late last year for $4,000,000, which equated to a 9.2% cap or 6.1 times the gross rent. This price also translated to only $74,074 per unit or a shockingly low $68/SF, which is probably only 20% of replacement cost, assuming the land was free.
I checked with one of our Bronx specialists, Karl Brumback, to see if this was an exception. While it was a higher cap than average, it was not an anomaly. Karl is currently handling the sale of 2095 Mohegan Avenue in Bronx Park South. It's a corner, five-story, mixed-use, walk-up building with 22 apartments and four stores. It can be yours for only $1,950,000, which on paper would represent a 10.2% cap rate or 5.2 times the rent roll.
Mohegan Avenue is fully occupied with a variety of program tenants, including several section 8 tenants, who receive subsidies from the federal government. The average collected monthly residential rent is $1,042. The property also has a low number of DOB and HPD violations. Located in the Bronx Park South section of the Bronx, the property is a short walk from the MTA #2/5 subway line at East Tremont Avenue/West Farms Square.
By comparison, eight miles south of Mohegan Avenue is 530-34 East 88th Street. My company recently sold this elevatored apartment building for a 4.2% cap. This property also had predominantly rent-regulated tenants; however, it lacked a corner location and a retail component, which can offer diversification. This begs the question: How can the returns vary by more than two times between these boroughs?
I believe an investor must decide whether they're looking for something with stable cash flow with limited upside potential, or something with a lower return and much greater future potential.
East 88th Street had similar average rents, but if those units were vacated, rents could be more than doubled. The hope would be that one day that 4% cap could turn into a double digit return. Better yet, if caps continue to compress, an investor could, hopefully, sell a prime Manhattan property at a substantial profit. However, with rates sure to go up, it's uncertain whether or not cap rates can continue to compress.
Another case to be made for buying south of 96th Street is that you spend the same amount for construction regardless of where it takes place (within NYC), so if you're going to pay $25,000 to renovate an apartment, it would be better to spend that in a place where you'll get a much larger pop in the rent.
Finally, our experience is that most new buyers coming into the market are looking south of 96th Street, which is established. This is especially true with foreign buyers. If your plan is to buy and sell within five years, the supply and demand imbalance should definitely be taken into account. Manhattan properties are in much stronger demand, making them much more liquid.
As far as the case for buying in the Bronx, if cap rates don't continue to dip and the exit sale no longer boosts returns, it might be worthwhile to take advantage of the in-place cash flow these buildings have to offer.
Another case for the Bronx is that if the proposed rent regulation changes go into effect (such as raising the luxury decontrol amount and lowering the vacancy allowance to make decontrolling a unit more difficult), it will not have as dramatic impact as in Manhattan. This is because Bronx rents are mostly regulated anyway, and would not command monthly rents above $2,000.
In all, if you are considering making an investment in the Bronx, make sure you're underwriting accounts for the proper vacancy and credit loss, which can run as high as 10% as compared to Manhattan's 3-5%. Furthermore, operating costs can run at about 50% of the rental income, which is much higher than a typical Manhattan building. This is due to higher management, repair, and legal costs.
Finally, having a good managing agent will be key, unless someone already has experience operating such buildings. Many of the buildings, which are project based, require that you have this experience anyway.