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The Pros and Cons of 421A Tax Extensions

10/30/2015

Thriving in the commercial real estate marketplace depends upon making well-informed decisions and practicing due diligence. Knowledge of applicable regulations and laws can feel like full-time job, but it’s critical to stay on top of revisions and be aware of the advantages offered by legislation that affects investments, property valuation, CAP rates, and profitability. Tax considerations are a big part of this, and the tax code in New York offers abatements for commercial property owners.

The Cooperative and Condominium Tax Abatement Program gives partial tax relief to owners and tenant-shareholders of Residential Class 2 properties, through section 421-A.

This tax benefit was established in 1970 and provides tax relief extending for up to 25 years in multi-family properties. The owner is exempt from paying the increase in property tax resulting from new construction and development, a very attractive offer.

Factors like method of construction, location, and alignment with affordable housing requirements determine the level of abatement. The law was originally intended to encourage developers to provide affordable housing, but according to the Pratt Center only 7% of the properties receiving the subsidy were affordable for low or moderate-income families.

The 25-year abatements are primarily in Harlem and Upper Manhattan. Under the law, property owners pay a reduced real estate tax, but taxes generally increases by 20% every 2 years. The tax at maturity is considerably higher than at the time of purchase.

This past June, this tax break law was renewed in response to a long campaign from the tenant and affordable housing movement. What exactly does this mean for New York neighborhoods, and how does it affect developers?

One effect will be on affordability of rents. The Association for Neighborhoods and Housing Development provides a thorough overview of the implications and requirements of the law. This organization is concerned that in some neighborhoods rents can now be set at rates that are double existing rates. Depending on location, developers can choose from 4 options with slight variations in the requirements for the inclusion of affordable units in a project.

Some other changes that will affect developers include:

  • Abatement period increased to 35 years, in some cases

  • Market-rate units are no longer covered by rent regulation

  • Affordability is negotiated on a case-by-case basis

The tax abatement continues to be a positive for property owners who can give back to the city by building public spaces or providing affordable housing.  In many cases, it’s a good move, but like any financial decision, it has pros and cons.

The pros are fairly obvious. A reduced tax bill for 10 to 35 years makes the property more affordable. It may also increase the short-term sale price of the property, resulting in bigger profits.

Some scenarios suggest cons to this plan, and should be considered. The value of the property may decrease after the abatement, due to the higher tax amount. The monthly expenses are one factor that determines the sales price for a commercial property.  With this taken into account, tax abatements may not be a good strategy for someone with a fixed income.

On the other hand, the increase in taxes could be offset by an increase in the value of the property. If the plan is to sell the property in a relatively short time, a tax abatement will make the purchase more affordable. The caution here is to enter into the deal knowing that the tax rate on the property is actually set at a higher amount, due to new construction, and being subsidized by the city for a period (10-35 years). The buyer should be capable of covering the increased tax burden and not assume that increased property value will take care of that cost.

As the implications of this revision sink in we will be watching the city council’s reaction. It’s possible that they will impose further restrictions on 421-A.  Any decisions they reach would likely go into effect in June 2016.

Avant Capital Partners creates and manages investments in commercial real estate debt. The firm focuses exclusively on first mortgage loans secured by commercial property, primarily in the New York metropolitan area, with a secondary focus on the Washington, D.C. to Boston corridor. For more information on Avant Capital Partners, please visit www.avant-capital.com.

 
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