As the second month of 2008 comes to an end, members of the real estate community are beginning to accept the fact that the market has seen a price correction. Purchasers of residential rental property in New York City have had to adopt a whole new terminology, with phrases like “all-cash purchaser,” “seller financing,” “full and limited recourse,” “higher debt service coverage,” “lower loan to values,” and “personal guarantees.”

Despite the new rules now in place, investors are actively pursuing ownership of residential rental developments across New York City. With steady and even rising rents, demand is booming for the city’s rental apartment buildings, which represent a safe haven for investors weary of uncertainty elsewhere in the real estate market.

As reported in the press earlier this month, a joint venture of Vantage Properties and an international real estate investment fund purchased the Haros Queens portfolio. The joint venture paid about $300 million for 47 buildings spread across 11 neighborhoods in Queens, as well as one town on Long Island. The portfolio encompasses 1,948 residential rental apartments, 20 retail stores, and 96 parking spaces.

“We continue to see strong fundamentals in the New York rental market,” the president of Vantage Properties, Neil Rubler, said: “While operating expenses, particularly energy costs, have inflated significantly in the past 24 months, demand for rental units remains strong, with vacancy rates running south of 3% in most neighborhoods.” Mr. Rubler added: “On the investment sales side, continued support for the asset class among both balance sheet lenders and financing agencies, like Fannie Mae and Freddie Mac, make both acquisition financing and refinancing far easier than in other asset classes. This said, leverage levels are generally in the 65% range versus the 80% and plus range that had been commonplace at this time last year, and spreads are up by several hundred basis points, offsetting lower benchmark pricing, which include Swaps or Treasuries. The net effect is that a buyer’s overall cost of capital has significantly increased, and deals are generally being underwritten at levels of between 5% to 15% off of the highs achieved in the second quarter of 2007. Sellers generally have taken a wait-and-see attitude, and many aren’t yet willing to accept enough of a price adjustment to make most deals work. This said, New York rental multifamily property remains far more liquid than other real estate categories, and we continue to have a very full pipeline of pending transactions.”

The co-founder and managing director of Stonehenge Partners, Ofer Yardeni, is very bullish on New York, and especially its residential rental market. Late last year, his firm closed its Stonehenge Opportunity Fund II, and in the last three months it has closed on more than $400 million in property acquisitions. Last month, Stonehenge acquired both 360 E. 65th St. and 347–351 E. 58th St. for $126 million and $10 million, respectively. Last week, Stonehenge closed on the acquisition of 8 Gramercy Park South and 141 E. 33rd St. for $82 million.

“All of these properties were acquired for prices that represented discounts to replacement costs, with rents in place that were significantly below market,” Mr. Yardeni said. “Many of these properties were also acquired for all cash, which gave sellers confidence that Stonehenge would be able to close.”

The president of Beck Street Capital, Kevin Comer, said: “We were very close to becoming the winner for the Gramercy Park and East 33rd Street package, with a total of 171 units, that was a mixture of regulated and free market units. Ultimately, like almost every time we’ve been the bridesmaid, we should have paid the extra 10% and got the ring instead.”

The chairman of the real estate practice at Herrick Feinstein, Carl Schwartz, said: “Sellers living in the very recent past continue to believe that a 3 cap rate is a fair price for residential apartments. Yet smart buyers who seek financing from the debt market are looking to buy these assets at a cap rate of 6 or 6.5. The result is that no trades are taking place.” “I don’t believe it is likely that a New York seller who has a mortgage maturing in the next year is going to feel pressure to sell,” Mr. Schwartz added. “My sense is that very few stable residential properties are highly leveraged. Rents are up dramatically over the past five years. New York City residential rental properties are every lender’s darling and a favored asset class. Therefore, as a result of rent increases, the value of the asset has risen since the last refinance. Even if an owner can only get a loan to value of 65% to refinance what was a 75% loan to value, there is probably plenty of equity in the project. Investors seeking a 65% loan to value shouldn’t have a tough time. Therefore, residential rentals will hold their value for the immediate future. Not because they are not impacted by the debt market, but because owners will be reluctant to adjust their expectations and they won’t need to face the new reality.”

“Today, we have a situation where there is still a significant amount of capital available and very strong real estate market fundamentals,” Mr. Yardeni said. “We believe that the market will recover from the current credit crunch by the end of 2008. We also believe 2008 will be the year of the bargain. Properties will trade for discounts as highly levered buyers are forced to the sidelines. All-cash buyers will be at the forefront in the marketplace, with property values strengthening towards the end of 2008 and into 2009.”

The chairman of Massey Knakal Realty Services, Robert Knakal, said: “Without a doubt, the segment of the market capturing the greatest amount of buying demand is rental apartments. Even with the challenges the capital market is presenting, apartment buildings are still, by far, the easiest to obtain financing for. More equity is required, but the debt is available and is available from more sources than for any other product type.”

Mr. Knakal added: “Rent regulation has created an exciting opportunity for purchasers who will outwardly object to regulations but inwardly know that those same regulations provide tremendous benefits to them. The artificially low rents provide built-in upside potential which can be unlocked with expertise and a lot of hard work. Going-in cap rates might be minuscule at 2% to 4%, but over time, junk bond yields are realized with better than U.S. government-quality credit. Even if the country went into a depression, a two-room apartment in Manhattan will still be able to achieve the regulated rent of $538.87 per month. Owners can also take advantage of a 30% return on capital invested to renovate regulated units.”

“Rent regulation provides an amazing amount of inertia to the tenant base, which will simply not move. This constrains supply and makes unregulated apartments attain rents above what a completely free market system would dictate. It’s no wonder that we are still receiving about 30 to 40 offers on each apartment building we are marketing,” he added.

The president of Citi Habitats, Gary Malin, noted: “New York remains a renter-centric city, with 75% of its overall housing stock comprised of rental properties. Vacancy rates for Manhattan averaged at or below 1% for the past few years and were .97% for 2007 and .76% in 2006, primarily due to the lack of rental inventory and high demand.”

“Clearly, when and if Manhattan faces an economic downturn, rental buildings will still prove to be a safe harbor for investors, as New York City is a major economic center and will continue to draw interest from rents at every financial level that desire or need to live in Manhattan. Additional demand would also be drawn from renters previously priced out of the market, families moving back to increasing housing options, and those downsizing and returning to the city,” he added.

An associate at Ackman-Ziff Real Estate Group, Eli Weiss, said: “In a nutshell, New York City multifamily investment is keenly sought after by investors today because of a simple but powerful force: supply and demand. As a historical rental market, demand for multifamily units in New York will grow commensurately with its population, which is currently 8.2 million people, and projected to grow to 9.4 million by 2025. In the face of this obvious long-term demand stands an array of factors that will greatly impede new multifamily development: the ever rising cost of construction, the scarcity of land, the pending shortage of tax-exempt bonds, and the new 421a legislation, to name just a few.”

“If the total cost to develop a ground-up, multifamily unit in the Bronx is roughly $300,000 per unit, why then shouldn’t investors snap up existing rental stock for half the price and take no construction risk, even if it implies a very low cap rate? As long as you have patient money, cap rate is not the be all and end all metric in an environment in which vacancy rates are at historical lows and long-term rent growth is in the cards. However, with the recent increase in the cost of capital and the steep decrease in leverage offered by lenders, investors must now be prepared to put up more cash to win deals as sellers understand the long-term value of their assets and have not yet altered their expectations to match the adjustment in the credit markets,” he added.

Perhaps the biggest difficulty in purchasing rental units is the source of financing. The chairman of the Lightstone Group, David Lichtenstein, said: “It’s simple. Fannie and Freddie Mac are the last lenders still standing. If they pull out, whatever happened to the collateralized mortgage-backed securities market will happen and only multiply.”

He added, “If Fannie Mae or Freddie Mac’s widen out spreads, today’s cap rates may seem a bit pricey in retrospect. Nothing is without risk.”

The senior executive vice president and chief credit officer at Emigrant Savings Bank, Patricia Goldstein, said: “When you talk about multifamily, you should differentiate between market-rate buildings, rent-controlled and -stabilized units. The problem with the stabilized units is that, when purchased, cash flow did not cover debt service, and there was not a clear understanding of growth in cash flow.”

“Banks looking at these deals today want better cash flow, debt service coverage, and therefore are offering lower loans and higher spreads due to capital market issues,” she added. “Another issue is new construction, where many developers are projecting $75 to $80 rents in less desirable locations. Not all locations are the same, particularly as we come into a possible recession and financial service types are losing their jobs. Although apartments are always good in New York, new properties are affected by the slowdown in the economy.”

A senior broker at Besen Associates, Adelaide Polsinelli, said: “What the banks give with one hand, they take away with the other. Rates are ridiculously low, yet financing is practically impossible to get. I just had a deal fall apart because the buyer, a longtime customer of the particular bank, could not get enough financing. The buyer was a regular trader with a great track record, and the bank was an active player in this asset type. The gross income was approximately $1 million and the deal price was $13 million. The buildings were in a prime location in Little Italy. The bank would only commit to a first mortgage of $3.5 million. Six months ago, that same bank was offering $8 million.”

An executive vice president at Anglo Irish Bank, Paul Brophy, said: “In today’s market, the financing of residential apartment buildings remains one of the few asset classes where lenders feel good about the outlook for the sector. Given the slowdown in the for-sale housing market and the conversion of apartment buildings to hotels and condominiums, supply of apartment product has remained controlled, and if anything there is possibly a shortage of supply in certain urban markets.”

All I can say is that I hope that Mr. Yardeni is on the mark when he says: “We are very positive about the real estate market in Manhattan and believe that the best is yet to come for the city.”

Mr. Stoler, a contributing editor of The New York Sun, is a television and radio broadcaster and a senior principal at a real estate investment fund. He can be reached at mstoler@newyorkrealestate.