The New York City Investment Sales Market over the last three or four weeks has been nearly, and happily, reminiscent of the market in 2007. This is the best market we have seen in 5 years! In fact, this summer was Massey Knakal’s busiest period for contract executions since the same time in 2007. In this typically sleepy vacation stretch, our offices had a total of 111 contracts signed. Why is this significant? While many owners are holding their investments, fueled by a strong rental market and the potential to utilize extremely low burrowing rates that may allow for positive leverage, those who are not, are benefiting from an investment market already low on inventory, that is being inundated with an influx of national / foreign buyers desperate to gain the stability of New York City Real Estate. Pricing for many asset classes are at all time highs. Since lenders have become more conservative since the previous peak and buyers are weary from the previous collapse, how can this be? Below are 10 key reasons:
1) A flight to quality hard assets: With all the uncertainty in Europe and stock market volatility, investors are turning to hard assets, specifically cash flowing real estate. Rather than sitting in T-bills with negligible results, investors are happy with returns, which are in some cases dipping into the 3-4% range.
2) NYC’s residential and commercial fundamentals: are extremely strong as rents have climbed back to all time highs for both luxury residential and prime office and retail space. Meanwhile, vacancy rates are approaching all time lows. This is due in large part to NYC not being overbuilt in this last cycle. Few if any speculative office buildings were built post 2009 while new residential projects have only satisfied a fraction of the demand.
3) A sharp supply / demand imbalance: In 2007 our office was handling 750+ exclusive listings. Today, we are only at slightly above 500, which is in line with the bottom in 2009. Although the dollar volume in sales has increased 4.9 times since then, we can not keep enough inventory on hand. Rather than the months it took to sell properties in 2009, in some cases we will contract and close on a property in a matter of weeks. Many potential sellers have indicated that they are not interested in selling because of a lack of good alternative investments into which to deploy the proceeds from the sale. We have also not seen as many sellers as we anticipated coming to market (so far) to take advantage of this year’s capital gains tax rates which are likely to increase next year.
4) Demand drivers appear to be at an all-time high. The institutional capital which inflated the asset bubble in the 2005-2007 period had been on the sidelines for a couple of years, but has now reemerged, in some cases stronger than before. They are now actively competing with high net worth individuals and established New York families who
have been extremely active since the downturn. These investors are also being joined by foreign investors in record numbers, who our website tracks from 131 different countries. This supply / demand imbalance is exerting tremendous upward pressure on values as we have seen cap rate compression of nearly 100 basis points just within the past few months. Many of the properties that we have on the market now are achieving pricing above expectations from just months before, in many cases, investment properties are being sold at or above their asking prices.
5) Record low interest rates: Much of the activity in the market has been caused by the extraordinarily (and artificially) low interest rate environment that exists today. About 3 months ago we saw several banks begin to offer 5 year fixed-rate loans at approximately 3 ½ percent. I was informed by a client yesterday that they just received a fixed rate loan below 3 percent. These low rates are also exerting tremendous upward pressure on property values. In 2007, investors were purchasing at an average cap rate of 4 to 5 percent (in Manhattan) but borrowing at approximately 6 percent, therefore, negative leverage was significant. Today, cap rates are once again averaging around 4 to 5 percent, however, borrowers are still getting positive leverage.
6) Capital Gains: should the Bush tax cuts sunset at the end of the year as scheduled, cap gains will increase from 15 percent to 20 percent. In the National Healthcare Program, a covert 3.8 percent capital gains tax is imbedded which would bring the rate to 23.8 percent. Additionally, should the President get reelected, he has made it clear that he would like to see cap gains go to 30 percent, not inclusive of the 3.8 percent health care capital gains tax. This means that we could be facing a 33.8 percent capital gains tax rate in 2013.
7) Massive Debt Looming: Low interest rates, in the broader economy, are having the effect of numbing the short-term pain of the monstrous debt that the country has and is, simultaneously, masking the long-term
burden of constant, massive, budget deficits. For the real estate industry, it is creating a dynamic in which property values are being correlated with these low rates which we believe has led buyers into a position, in some cases, of paying more for properties than they probably should.
8) Low interest rate bubble: History has shown us that low interest rates always inure to the benefit of sellers not buyers. Historically, low interest rates over a long period of time also create asset bubbles. Just as the extended period of time when interest rates were low during the Greenspan chairmanship of the Fed led to the housing bubble in 2005- 2007, we believe a strong case could be made that the low interest rate environment of today is creating the same type of asset bubble in the commercial property market.
9) Increased Operating Expenses: Top line revenue growth in many income producing property classifications is being eroded by the real estate tax increases that have been implemented by the city leaving net operating incomes flat. To the extent this condition continues and interest rates rise, cap rates will rise accordingly producing a lower value in the future. Given these dynamics, we believe that there is a better than 50/50 chance that property values for properties with stable cash flows could be lower in two years than they are today. Clearly, over the long-term, properties will be worth more in the future, but in the short-term we could be facing a condition where property values do drop, particularly if the city continues to use income producing properties as an ATM machine to plug holes in the budget.
10) Exchanging Core Assets for Value Add: To the extent this all comes to pass, it is a case for focusing acquisitions on value-added plays and would encourage a strategy of selling properties with stable cash flows. I am bringing these dynamics to your attention today because I think we are seeing a wonderful moment in time for potential sellers to take advantage of these market dynamics. This may come across the most self-serving correspondence that I have ever sent to you, however, if you follow the points I outline above, you may agree with my conclusions. To the extent that there is anything in your portfolio that you would consider selling, or know of anyone who might consider selling a property, I would be more than happy to discuss these market conditions in more details. Please call me at 212-696-2500 x7710 or email me to discuss further. I look forward to being in touch.