Real Estate Investors: Neither Villains Nor Heroes

Disincentives Cause Disarray

Real estate investors are simple creatures; they want one thing, which is to make a profit off their properties. Disincentives levy a threat to investors by taking money away from them, which can definitely motivate a behavior change. But Alex Offut, managing director at Constructive Capital, explained that sometimes those disincentives motivate them in the wrong direction, which is why it’s essential to understand real estate investors’ primary motive, which is, again, to make a profit.

This is what Offut saw happen in New York. Stringent restrictions for short-term rentals, rooted in Local Law 18, were implemented in September 2023. City officials argued that renting those homes to tourists instead of New Yorkers exacerbates the city’s housing shortage and makes it even more expensive to live there.

However, what this disincentive actually produced is a booming black market. Since only about 3% of short-term rentals were successfully registered with the city by December 2023, owners are now listing their properties on unregulated platforms like Facebook and Craigslist, which do not have the same checks and balances as platforms like Airbnb, VRBO, and Booking.com. By searching for vacation rentals in New York City on Craigslist, tens of thousands of results come up, many of which state “nightly” or “short stays” on the listing title. Similarly, a plethora of “nightly” and “short-term stays” pop up on Houfy and Facebook Marketplace as well.

Offut explained that the reason for this disastrous outcome is that it was based on a false premise: if short-term renting doesn’t bring in money, investors will need to convert to long-term renting or sell, which would bring more housing to the market and, in turn, lower rents and home prices. However, Offut, whose company lends to investors in New York City, said investors would lose money whether they sell or convert to a long-term rental.

“When you’re charging $200 to $300 a day or more to stay in a short-term rental, I can assure you, you’re probably making two or sometimes three times the amount of monthly revenue you could make on that property versus putting in a long-term tenant,” Offut said.

But selling the property means losing money as well. Many investors who planned on listing their properties as short-term rentals bought them at an inflated price based on their projected revenue stream.

“If I know that I can generate, say, $6,000 a month in income on a short-term rental versus, say, $3,000 a month as a long-term rental, well, when you start doing your cash flow exercises … you realize that property might be listed for $400,000, but now I can afford to pay $450,000,” Offut said.

Essentially, the present conditions of the housing market and the economics behind long-term leasing also disincentivize real estate investors from pursuing those options. But whether non-compliance is merely an early outcome or the only outcome of New York City restrictions, depends on enforceability.

“These folks are very entrepreneurial and have figured out very clever ways to maximize revenue out of their real estate,” said Farrar. “It wouldn’t surprise me if they figure out new and creative ways to get around some of these regulations.”

Need For Enforceability

Another thing to know about real estate investors is they’re risk-takers. As evident by the rising black market of short-term rentals in NYC, investors will weigh the pros and cons of every available pathway, even if it’s an illegal one.

Sean Block, New York City mortgage broker and founder of Block Financial Resources, said his short-term rental investors began ringing him up once Local Law 18 was enacted, mainly to ask him, “Do you think it will be enforced?” Though he had no idea of how well the restrictions would be enforced, he said the question likely implies they think they’ll get away with it.

“Maybe they think it’s worth the gamble,” Bloch said. “The fines are between $1,000 and $5,000, so they think it’s worth taking the risk.”

Though Bloch said he follows rules by nature and would personally advise them not to list their rental on different platforms, he’s also not looking over their shoulders to ensure they are abiding by the new law.

“I don’t think our responsibility really extends to other terms of the market,” Bloch said. “I’m not the enforcer of that. I’m just the loan originator.”

However, a few of Bloch’s clients who do not want to gamble on the city’s ability to enforce the rules, told him they’d rather convert to a long-term rental than sell at a discount.

“I have no way of knowing,” said Bloch. “They wouldn’t tell me if they were breaking the rules.”

Similar restrictions were placed on short-term rentals in Los Angeles in 2019 by passage of the LA Home Sharing Ordinance. But, a 2022 report from Better Neighbors LA found that more than half of them were non-compliant. Many were either using fake or expired registration numbers, disguising the property as a long-term rental, falsely claiming it as a primary residence, or misrepresenting the property’s location. The report states the rise in non-compliance in 2022 is due to the lack of enforcement, with a 54% decrease in warning letters and an 85% decrease in fines.

Whether New York City can reduce or slow the growth of rent and home prices by essentially banning short-term rentals remains to be seen. But Charles Tassel, chief operating officer of the National Real Estate Investors Association, doesn’t feel very confident about that.

“If you are trying to disincentivize good business, you have to really know what’s the real incentive behind the scenes,” Tassel said.

Incentives Are Clear

Incentives, on the other hand, get right to the point. Rather than throwing obstacles in the way of investors they could potentially out-maneuver, more industry experts believe it’s better to present them with a better offer and let them chase it.

“They’re exactly like entrepreneurs. They’re going to figure out how to get to yes. How do I get this done? And that mindset typically out-maneuvers the point paint put in place with a disincentive,” Tassel said.

An example of an incentive for real estate investors to provide more affordable housing is the Lease to Locals program in Summit County, Colorado, which incentivizes short-term rental property owners by giving between $10,000 and $22,000 per lease in exchange for renting their properties long-term to local workers at a capped rental rate. Owners must cap their rent between $1,000 and $1,500 per bedroom, depending on the unit size.

Since the program launched in the Fall of 2021, 107 properties have been converted from short-term to long-term rentals, according to the Summit Daily. The majority, 87 units, reside in unincorporated areas and have helped house 192 residents — 79 of which have signed 12-month leases. The other 32 opted to rent for six months for a seasonal lease.

“If you want something to happen by incentivizing it, you get more of it,” said Anthony Geraci, founder and vice chairman of the American Association of Private Lenders. “You get this carrot with the stick of capping rents; to me, that does more, if you will, for affordable housing than saying you must live in your apartment in New York with a stranger.”

The one problem with this incentive is that demand is exceeding funding. Local officials have spent about $1.65 million since the program launched in 2021, and with 24 leases due to expire in 2023, 48 residents are at risk of losing their affordable homes.

Velocity CEO Farrar is not all that surprised, saying incentives can sometimes fall short of expectations.

“What I’ve seen through my career is these, most of these incentive programs are very well intended, but typically fall short and don’t end up helping the people that they’re intended to help,” Farrar said. “Sometimes, they are muted in their response and effectiveness.”

Live And Let Be

Alternatively, Farrar believes in a laissez-faire approach.

“The most effective way to change that dynamic is to create more supply,” Farrar said. “My view is that the way that we’re gonna get the cheapest cost of housing is to let the free markets work.”

Middle-class buyers are facing the largest shortage of homes, nearly 320,000, in their price range. According to a National Association of Realtors report, those borrowers can afford to buy home listings valued at up to $256,000, which comprises only 23% of listings in the market nationwide.

New inventory is primarily added with either new construction, house flipping, or existing homes put up for sale. Of those three options, industry experts think renovated homes are likely the most affordable option.

“Flippers will continue to be a particularly important source of housing supply in markets where new home construction is limited, and current homeowners cling to their low mortgage rates as long as possible,” said Rick Palacios, John Burns Research and Consulting. Many homeowners still have low interest rates from purchasing or refinancing their mortgages between 2020 and 2022.

Home builders are working diligently as Redfin reports that newly built single-family properties comprise a record share of homes on the market in the second quarter — nearly one-third of housing inventory nationwide. However, most of those homes are not affordable for middle-class buyers, with a median sale price of $409,300, according to Federal Reserve economic data for October 2023.

Then, there are fix-and-flip investors who bring distressed, vacant properties back to life and sell them for a profit. Nearly 230,000 single-family homes and condominiums across the nation were flipped by the end of the third quarter in 2023, ATTOM reports. But are they affordable?

Although renovated homes are cheaper, on average, than newly constructed homes, they are still hovering above the middle-class budget range. The typical resale price on flipped homes was $305,000 in the third quarter, according to ATTOM. However, the median sale price has been trending downwards recently with profit margins trending upwards. That’s why the vast majority of house flippers in New Silver’s survey said they intend to flip more houses in 2024 than in 2023. Plus, as the market shifted over the past year, investors are using fix-and-rent and fix-and flip equally in 2023.

As we enter the new year with continued low inventory, local investors are providing solutions to the shortage as consumers look for housing options,” Carlton said. “These investors are fueled by the opportunity to capitalize while delivering much-needed residential properties back to the market.”