Playing the Waiting Game

There’s nothing wrong with the spacious, bright apartment at 328 West 86th Street. So why is it priced at $549,000, barely half what it’s worth? You can buy it, but you can’t move in. The current occupants have a rent-controlled lease, and they can stay put for as long as they pay the bill. Which means a ghoulish calculation: “You pretty much have to wait for them to pass away, which could take five years or 30,” says listing agent Ray Kiswani of Bellmarc Realty.

For the very patient, an “encumbered” apartment can be a rare bargain. How else could one get a two-bedroom Sutton Place penthouse for less than a million? “The payoff is really terrific!” says Prudential Douglas Elliman agent Jerri Sherman, who’s representing two such apartments on West 13th. Of course, doing so “absolutely doesn’t make any sense for the typical buyer,” says Frederick Peters, president of Warburg Realty. Those old leases aren’t likely to cover the mortgage, let alone monthly charges. (The lucky soul in the Sutton Place penthouse pays $1,080 a month; the maintenance is $1,900.) These purchases are considered investments, which require commercial loans with higher interest rates than standard mortgages. You can try buying out the tenants, but they usually say no, says developer Andy Field, who co-owns the West 86th Street apartment.

How do you figure the price? It depends on three assumptions: how long the resident will stick around, what the real-estate market will do over that time, and what real dollars will do as well. Let’s say you think you’ll take possession in twenty years, and assume a 5 percent annual increase in the market, and expect a 10 percent compounded return on the investment—all decent guesses. An apartment that would ordinarily be priced at $500,000 today will, under those conditions, be worth $1.32 million twenty years hence. That amount, calculated backward into today’s dollars, with a risk factor calculated in, is about $200,000, which is how much you should offer.* Suggest less if your tenant jogs, and more if he or she loves bacon.

You also need to remember that you’ll pay any difference between the tenant’s rent and the maintenance fees. And remember that you’re gambling: If rent-control or -stabilization laws change radically, or if the lease is about to be destabilized, all your computations go south. (On the upside, there’s that luxury-decontrol clause: If your tenant makes over $175,000 for two years in a row and the rent edges past $2,000, you get to hike it as high as you want.)

All-cash buyers are the best candidates, because they can park money in these properties, treating them like a 401(k), says Kiswani. No matter what kind of buyer you are, though, Peters says, you’re still betting that real estate will continue to appreciate. Besides, “in the event your analysis goes awry, it could be a very expensive mistake. Actuarial tables aside, your 90-year-old tenant could live to 105.”

* Thanks to Jonathan Miller at Miller Samuel for these computations.

Playing the Waiting Game