The hit television series “Seinfeld” painted a bleak picture of New York apartments. Jerry and his friends lived in cramped buildings that were plagued by unpredictable tenants. The televised image may have confirmed views held by national real estate investment trusts (REITs), which generally avoided the Big Apple.

But times are changing. In recent years, four large REITs have been buying or developing apartments in New York City. Active players include Archstone-Smith, Post Properties, Apartment Investment and Management Company (AIMCO) and AvalonBay Communities.

Market Timing Is Right

What's behind the strategy of these publicly traded giants? Perhaps the biggest draw is the city's relatively low vacancy rate. “If you are a national REIT, you may have double-digit vacancy rates in Arizona,” says Steven Heller, vice president of ARCS Commercial Mortgage Co. LP, a mortgage banker in Princeton, N.J. “The idea of having 97% occupancy in New York looks tempting.”

Apartment vacancy rates in the city climbed from 3.5% at the end of 2000 to 4.8% in 2003, according to Torto Wheaton Research. That compares favorably with a national vacancy rate of 7%. The space glut is especially evident in the Sunbelt cities. Dallas, for example, posts a 9.8% vacancy rate and Atlanta is only marginally better at 9.6%.

In New York, the average monthly rent rose from $826 at the end of 2000 to $861 at the end of 2003. But the average figures mask several trends, cautions Gleb Nechayev, an economist with Torto Wheaton. “New York is a complicated market that includes many subsidized apartments and very expensive luxury units.” While prices of some cheap units have climbed, luxury apartments have faced soft demand as many potential tenants have raced to buy condominiums. Brokers say that rents of many high-end apartments have dropped 20% since the height of the market in 2000.

But brokers believe that the downward trend was a temporary blip and that rents are poised to rise again this spring. “Rents have stabilized from a year ago, and we are seeing brisk activity in the rental market,” says Fritz Frigan, director of leasing for Halstead/Feathered Nest, a New York broker.

Attractive Factors

A low vacancy rate isn't the only reason REITs are penetrating the New York market. Under former Mayor Rudolph Giuliani, crime rates dropped sharply, and the progress has continued under current Mayor Michael Bloomberg. In recent years, the city has benefited from construction that has replaced slums with apartments and single-family homes in many parts of Brooklyn and the Bronx.

New York's notorious rent regulations also have become less troublesome. In the 1970s and 1980s, the rules changed every two years, and landlords never knew what they would face in the next round. Then in 1997, the state laid out rules that remained in place until 2003.

Recently the rules were extended until 2011. “Now there is some sense that the rules won't change overnight,” says Dan Margulies, senior vice president of Georgia Malone & Co., a Manhattan broker. “That allows out-of-town investors to learn the system and feel comfortable with it.”

Margulies says the crazy-quilt rent system now creates smaller inequities than it once did. In the 1970s, rents were often much lower for stabilized apartments than for units subject to market rates. In those days, a stabilized tenant might pay $400, while his market-rate neighbor would be charged $2,000 for an identical apartment. Over time, the big gaps have typically narrowed to $600 or less, as rent rules have permitted increases in stabilized prices.

Spreading Their Bets

The changes in the city's apartment market have encouraged several REITs to sell properties in the Sunbelt and shift assets to New York. By moving into once-forbidding cities, REITs achieve diversification, obtaining properties in places that thrive when other regions suffer hard times.

Entry into the New York market could provide an important boost for the bottom lines of REITs. Apartment markets in many parts of the country have been weak, as low mortgage rates have encouraged potential renters to buy homes. That has led to a decline in revenues.

In the fourth quarter of 2003, AIMCO noted that revenues from its “same store” portfolio dropped mainly due to lower average rents. The declines from the year-earlier period were particularly severe in Texas and the Midwest, where revenues fell in the fourth quarter of 2003 by 5.3% and 4.6% respectively. Conversely, revenues increased by 2.6% in California and 1.2% in the Northeast.

Since March 2003, AIMCO has made three acquisitions in New York, including buildings with a combined 167 apartment units for a total of $104.6 million. Focusing on Class-B apartments, AIMCO owns a total of 300,000 units in 47 states.

The move to New York is part of a repositioning of the REIT's portfolio away from competitive markets in the Sunbelt. In 2003, AIMCO sold 110 properties, including several in Texas and Alabama.

“In the last three years, we realized that we were under-represented in the Northeast,” says Harry Alcock, executive vice president of AIMCO. “We bought 4,000 units in Boston in 2002, and now we are moving into New York.”

Rental buildings in New York traditionally have been owned by families and private groups. With vacancy rates low and profits steady, many owners have held their buildings for generations. Such patient landlords rarely sell, and when they do the properties command high prices.

Alcock says the capitalization rate, or the initial return on investment based on the purchase price, is approximately 6% on many New York buildings. That is comparable to yields in Boston and Washington, but below figures in the Sunbelt where rates can exceed 7%.

While their prices are high, New York buildings provide security because the barriers to entry are high. “It keeps getting more expensive to build in the city,” says Alcock. In other words, new entrants face many hurdles.

Price of Entry Is Expensive

The costs are particularly high to build upscale apartments. Post, which owns 28,000 units in 76 communities, spent heavily to develop 138 luxury units at Post Luminaria on First Avenue. Studio rents start at $2,253 a month.

Total development costs were around $500 per sq. ft., double the amount for a comparable building in Washington, D.C., says John Mears, executive vice president of Post. In Atlanta, Post recently developed a luxury high-rise where total costs per square foot were $180.

Many factors contribute to New York's hefty price tab. Property taxes are high, and labor is more expensive than in other cities. Obtaining the necessary permits takes time, and opposition from neighborhood groups often slows the process. But the biggest cost is land prices, which have risen significantly in the last three years.

Mears says that with interest rates low, New York renters have been eager to buy condominiums. That has encouraged condo developers who have pushed up property prices beyond what apartment REITs can generally pay.

The high cost of acquisitions lowers initial yields, but REITs figure they can make up for the slow beginning with steady rent increases over the years. Under the rent rules, a city board decides the maximum rent increase each year. During the past decade, the average annual boost has been about 3.5%.

When tenants vacate, the landlord may raise the rent on stabilized apartments by a specified amount that is reset every year. The exact amount of the increase changes each year, but the boost is typically about 15%.

On average, about 25% of all tenants leave their apartments every year. In Manhattan's strong rental market, eager renters are almost always lined up to pay the regulated rates. REITs have been just as eager to buy stabilized units and benefit from that healthy demand.

Overall, a luxury building in a strong neighborhood can increase its rental income by 6% a year, says Mears of Post. “In most other places in the country you would be lucky to see a 3% increase.”

The Allure of Tax Breaks

While New York imposes rent rules, the city does provide some carrots that developers can use to make projects viable. When it paid $209 million for a 506-unit upscale building, Archstone-Smith agreed to charge below-market rents for 20% of the apartments. In return, the developer was able to finance the project partly with tax-exempt bonds carrying low rates of 2.4%.

In addition, real estate taxes on the building were frozen for 12 years at the levels they had been before the developer arrived. Under the abatement rules, the landlord starts paying taxes at a low level. But the property is not protected from tax increases.

The luxury project includes a two-tower 35-story building located at 64th Street and West End Avenue. Units range from 509 sq. ft. to 1,771 sq. ft with rents ranging from $2,350 to $8,590. Outside New York, Archstone has investments in 88,000 units in cities such as Chicago, Boston and San Francisco.

AvalonBay Communities, another REIT benefiting from tax abatements, specializes in luxury apartments and owns 142 properties in 10 states and Washington, D.C. In partnership with New York State Common Retirement Fund, AvalonBay is building 360 rental apartments on East Houston Street in Manhattan's Lower East Side.

The $150 million project calls for 20% of the apartments to be offered at below-market rents. The REIT is investing $6 million, while its pension partner is chipping in $25 million. Additional financing is coming from tax-exempt bonds.

Increasing Its Bench Strength

For any outsider, moving to New York can be difficult. To manage, REITs are hiring local experts. Al Neely, executive vice president of Archstone-Smith, says his firm isn't a casual tourist. The REIT's recent acquisitions in Manhattan are part of a long-term effort to leave intensely competitive markets and expand in New York. To handle the task, Archstone-Smith has opened a local office staffed by three people, Neely says. “It demonstrates that we want to have a presence in the New York marketplace every day.”

Stan Luxenberg is New York-based writer.