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By: S.H. Spencer Compton, COMMONWEALTH LAND TITLE INSURANCE COMPANY
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CLIMATE CHANGE AND THE NEED FOR AFFORDABLE HOUSING are looming concerns in most U.S. cities. The impact of COVID-19 is still being felt as remote and hybrid work reshape the real estate landscape. Substantial rises in interest rates have dampened investor appetites for commercial real estate buying and lending. Commercial real estate owners, tenants, and lenders are facing unprecedented challenges and raising novel issues for their attorneys to address. Market intelligence has a crucial role to play in helping industry players navigate this rapidly changing environment. It is important for real estate attorneys to keep up to date with market data to maintain a competitive edge in deal negotiations, thereby producing additional value for their clients beyond the traditional legal realm.
This article discusses the important role market data plays in helping attorneys provide practical and effective counsel to clients, using the New York City real estate market as an example.
Buildings generate the largest share of greenhouse gas emissions in many U.S. cities. In New York City, for example, buildings account for about two-thirds of greenhouse gas emissions. It is no surprise, then, that cities like New York are focusing their climate change legislation on reducing building emissions. In 2019, New York City enacted Local Law 97 as part of the Climate Mobilization Act, which commits the city to reducing its emissions 40% below a 2005 baseline by 2030 and 80% by 2050.1 The law establishes carbon emission limits for New York City buildings over 25,000 gross square feet. Buildings that exceed annual emissions limits will face an annual financial penalty of $268 per ton of carbon dioxide equivalent over the limit based on 2024 energy usage and emissions. Most buildings have until 2024 to meet Local Law 97 emission targets. Annual fines for buildings that fail to meet the 2024 deadline will begin in 2025. These emission caps will become more stringent over time.
It is critical for developers, owners, tenants, lenders, and their attorneys to be mindful of how climate legislation across the country affects the commercial real estate market. Market data can offer unparalleled insight into how deal terms are evolving against this legislative backdrop.
Local laws governing building inspections can impact the cost of owning, operating, and maintaining real property. These laws often require the building owner to hire professionals to conduct inspections and impose fines for failure to comply. Real estate owners and lenders should be aware of how laws that increase the cost of ownership can interact with, and potentially drive, market trends in their geographic region.
For example, last year New York City implemented new inspection requirements for parking garages.2 Real estate owners must hire a professional engineer registered with the Department of Buildings (DOB) as a Qualified Parking Structure Inspector (QPSI) to survey the condition of their parking structures every six years and file a compliance report with the DOB. After conducting the condition assessment, the QPSI then files the compliance report with the DOB, classifying the parking structure as one of the following:
As another example, look to New York City’s Facade Inspection & Safety Program, a set of regulations addressing the condition of buildings’ exterior walls and appurtenances.3 The purpose of the regulations is to protect the aesthetic quality and structural integrity of all buildings in New York City, particularly those located on busy streets or other high-traffic areas. Every five years, facades of all New York City buildings over six stories must be examined by a Qualified Exterior Wall Inspector (QEWI) and a report filed with the DOB. A QEWI must be a licensed architect or professional engineer with at least seven years of relevant experience. In addition to substantial fees paid to QEWIs and other professionals, the DOB charges filing fees, amended filing fees, late filing fees, failure to file penalties, and failure to repair penalties.
Similar inspection requirements can be found in cities across the country and may impact owners’ capital repair obligations. Real estate owners and lenders should watch how the market responds to increasing costs of ownership, and their attorneys should keep these market considerations in mind during deal negotiations to get the best results for their clients.
Building owners, tenants, and lenders should pay particular attention to market trends around rent and eviction.
Housing Stability and Tenant Protection Act
In New York, the Housing Stability and Tenant Protection Act of 2019 (HSTPA)4 increased protections for residential tenants. Among the law’s expanded tenant rights, landlords should be aware of the following:
Good Cause Eviction
Under New York State law, a residential tenant may be evicted only if a landlord has brought a court proceeding and secured a judgment of possession from the court. Only a sheriff, marshal, or constable can carry out a court ordered eviction. A landlord may not evict a residential tenant by use of force or unlawful means.
First proposed in 2019, a good cause eviction statute would apply to residential premises and would amend the existing law to provide that a landlord cannot evict a residential tenant who pays rent on time, except under specific circumstances. Although there are already eviction regulations, current New York law allows landlords to raise rents at their discretion and deny a lease renewal to any tenant who does not inhabit a rent-controlled or rent-stabilized apartment.
A good cause eviction law would effectively cap residential rent increases in New York State at 3% per year regardless of the percentage increase in real estate taxes or other operating expenses and give judges the power to decide if repairs and improvements are necessary in privately owned real estate. Such a law would also mandate renewal leases and limit landlords from being able to regain apartments they own. Proposed good cause eviction legislation seemingly is premised on the belief that landlords can subsidize their tenants indefinitely while slowly working through the courts to be able to operate their properties.
Under a good cause eviction regime, building owners would be unable to evict a squatter without demonstrating to the satisfaction of a judge (and then most likely an appellate court) that they have good cause in wanting to reclaim the apartment in order to demolish it even after the lease requires the tenant to vacate. In addition, an employee who is provided housing (e.g., a superintendent) cannot be evicted after being terminated until the landlord demonstrates that the employment was lawfully terminated. Note that the HSTPA already permits judges to allow tenants to remain in occupancy for a year after a default in the event of a hardship, while the landlord has to continue making payments for real estate taxes, heat, insurance, repairs, etc.
Not surprisingly, good cause eviction legislation is opposed by most landlords and, if past is prologue, likely will be sponsored in one or both houses again. Residential building owners will want to follow the progress of any proposed housing legislation closely.
In addition to legislative compliance costs, a building owner must also pay real property taxes, debt service on its mortgage and other financing, insurance premiums, and utilities and other operating expenses, all of which historically increase every year whether or not the property’s rental income rises or falls.
Some building owners today have the financial resources to withstand a down real estate market because either the building they own is in a desirable location, recently constructed with strong tenancies and vibrant amenities, or they have deep pockets.
Other owners have buildings where leases are gradually expiring with many tenants not opting to renew, resulting in diminishing available cash flow to pay for improvements or the cost of refinancing their mortgage at today’s substantially higher interest rates. What can these owners do to protect their real estate investments in today’s changing market?
Let’s look at a worst-case scenario: An urban commercial building owner is faced with diminishing tenancies and increasing property taxes, utilities, and maintenance costs, as well as interest rates significantly higher than when the property was last financed. When the owner offers the building for sale at a reduced price, there are no takers and so it elects to default on its mortgage and walk away from its asset. Not wanting to own this abandoned collateral, the mortgagee writes off the loan, preferring to take a loss on its balance sheet rather than become a real estate operator in a distressed market. The abandoned property reverts to the city. Real property taxes go unpaid, weeds grow, and windows and doors are smashed. The values of neighboring properties go down.
Potentially, entire commercial neighborhoods could shrivel and lie fallow for decades.
What should owners, buyers, tenants, lenders, and their counsel be paying attention to in the months and years ahead? What can a commercial building owner do to maximize the value of its property? Here are some suggestions:
In all cases, data on market trends can be a critical resource for real estate owners, tenants, and lenders. By knowing where the market stands and where it’s headed, real estate players can develop practical strategies to deal with rising ownership and compliance costs. It is important for real estate attorneys to stay on top of market intelligence to best advise their clients and protect their interests in deal negotiations and beyond.
With climate change, hybrid work patterns, and changing market trends, today’s commercial building owners are faced with more costly regulatory compliance and marketplace considerations than ever before. New York and other U.S. cities have insufficient affordable housing at too high a cost. Many legislative solutions have been proposed but few enacted. Although the recent good cause eviction bill did not become law in New York, as the urban housing crisis persists, bills to address housing concerns likely will be passed. Owners, lenders, tenants, and their lawyers must pay attention to market intelligence to navigate these increasingly challenging real estate trends.
S.H. Spencer Compton is Senior Vice-President and Senior Counsel, Commonwealth Land Title Insurance Company.
To find this article in Practical Guidance, follow this research path:
RESEARCH PATH: Real Estate > Trends & Insights > Articles
For an overview on commercial real estate purchase and sale transactions, see
> PURCHASING AND SELLING COMMERCIAL REAL ESTATE RESOURCE KIT
To learn more about the retail leasing process, see
> RETAIL LEASING RESOURCE KIT
> SUBLEASING RESOURCE KIT
> RESIDENTIAL TENANT REPRESENTATION RESOURCE KIT (NY)
> COMMERCIAL REAL ESTATE ACQUISITION LOAN RESOURCE KIT
> TENANT REPRESENTATION IN A RESIDENTIAL NONPAYMENT PROCEEDING (NY)