New York City—On the Far West Side of Manhattan, a vast stretch of old warehouses and defunct railyards is about to turn into an extension of Midtown.

This February, workers for Rockrose Development Corp. started digging the foundations of two apartment towers on 10th Avenue between 37th and 38th streets. The projects will eventually bring more than 400 new rental apartments to a 310-acre area renamed “Hudson Yards” by city officials and rezoned for a mix of residential and commercial development.

Over the next six months, a half-dozen other developers will join Rockrose and start construction on nearly 6,000 units of housing in the new neighborhood.

New York City is in the middle of a tremendous building boom. The city issued more building permits in 2005 and 2006 than in any two-year period since 1965, the earliest year for which there is reliable data. But with a few exceptions, like the Rockrose project, rental developers are being locked out of this party by the twin bouncers of high construction costs and competition for land from condominium developers.

In fact, the city’s developers only finished 1,668 new rental apartments in 2006. That’s dramatically less than the 5,628 rental apartments that came online in 2001, according to Reis, Inc., a New York City-based real estate research firm.

Reis expects the number of new rental apartments to increase to 2,671 in 2007. But the city’s condominium market hasn’t crashed, and new condominium projects will continue to compete with rental developments for land, workers, and the attention of developers.

The resulting shortage of rental apartments, coupled with a high demand for housing, has made rentals more valuable than ever, provided developers like Rockrose can afford a site to build on and are not tempted to build condos. New apartments can now earn top rents on almost any corner in Manhattan.

“The whole map of Manhattan is open for the rental market,” said Nancy Pakes, president of Halstead Leasing Co., a New York City-based real estate brokerage firm.

Relatively few rental apartment buildings convert to condominiums, in part because the income from rental apartments is so strong here. Fewer than 2,000 rental apartments, or roughly 1.5 percent of the apartment inventory, were converted to condominiums in 2006.

But even that small number was more than enough to make up for the paltry number of new apartments that entered the market, so that the total number of rental apartments in Manhattan actually shrank in 2006 by 0.2 percent.

As a result, the percentage of vacant apartments, which had risen to 4 percent in 2003, dropped to 2.3 percent in 2006.

Those declining vacancies might help explain why the average effective rent rose 7.5 percent in 2006 in New York City to reach $2,512 a month. In many Manhattan submarkets, average effective rents rose even higher to more than $3,000 a month, and in submarkets like the Upper West Side, rents grew 9 percent in 2006 to approach $4,000 a month, according to Reis.

Still, as rental production rises this year, analysts expect the market to slacken a bit. City officials are doing everything in their power to keep new construction moving forward, from rezoning land for residential construction, like Hudson Yards, to implementing a simpler building code.

As the production of rental units increases to about 2,000 a year, the experts at Reis expect the vacancy rate to grow to 3.1 percent by 2009.

Owners are already taking the modest uptick in supply into consideration. The market’s effective rents include concessions that average out to a fifth of a month’s free rent. That’s not much, but until the city’s building boom began a few years ago, concessions were unheard of in Manhattan.

New apartment properties are also offering residents better amenities. This February, the Related Cos., one of the biggest apartment managers in the market, closed a deal to buy Equinox Holdings, Inc., one of the fanciest physical fitness companies in the city, to provide fitness centers to its residents.

Most of the new units in Manhattan are downtown or on the western edge of Midtown, markets that were once solely commercial or industrial. And a large share of these new buildings are condominiums that are selling quickly to entry-level homeowners who, until recently, would have bought houses in the suburbs or rented, according to Pakes.

Buyers hunt Manhattan real estate

Institutional investors continue to buy their way into the Manhattan real estate market, bidding prices to new heights. The analysts at Real Capital Analytics, based in Manhattan, counted 211 sales of apartment properties in 2006, totaling $10 billion. That’s more than 10 times the $750 million of apartment property transactions that buyers and sellers completed in Manhattan in 2003.

It’s also about five times the volume of transactions in the other four boroughs of New York City combined and nearly nine times the volume of transactions in all of Boston in 2006.

Institutional capital has made the difference. New York’s apartment properties used to be owned almost exclusively by private New Yorkers. But in 2006, 60 percent of the buyers were institutional investors. Another 5 percent were real estate investment trusts and other public companies.

For example, real estate investment trust Archstone-Smith has become the fourth-biggest landlord in the city in just a few years by rapidly buying up properties in Manhattan. “They outbid everybody,” Pakes said.

These outside investors bid up the price of apartment properties to an average of $383,000 per unit, with an average capitalization rate, which represents the income from the property as a percentage of the sales price, of 4.7 percent, according to Real Capital.

Condominium converters often are willing to pay much lower cap rates, though only 4 percent of the buyers in Manhattan in 2006 were converters, compared to 11 percent in the rest of the country. Rental apartment operators can afford to bid against condominium converters in Manhattan in part because of the strong income from rents, and also because of the wild enthusiasm of apartment investors to get into the nation’s highest barrier-to-entry market.