With President Obama taking office for another four years, there has been an immediate impact and several long term implications for the NYC real estate market.
For months leading up to the election, many long term owners chose to sell this year in order to avoid the anticipated capital gains tax increase. This was apparent in Manhattan’s 3Q12 sales figures, which recorded the highest number of sales since 2007. We expect the 4Q12 to be even busier, as there still remains a rush to close sales this year. Thus, many expected that Obama would remain in office, or that capital gains would increase even if Romney prevailed. Clearly, there is a massive deficit, as the 2012 enacted budget calls for $1.327 trillion in deficit, which needs to be offset.
As a result, we did not receive dozens of calls on November 7th from owners looking to sell. However, we are still getting the inquiries from sellers asking if there’s still time to market a property and close this year. Fortunately for them, the answer is yes. We have witnessed scores of opportunistic buyers who have been waiting for this moment, and are able to close with all equity to meet this short time frame.
With all the 2012 activity, 2013 sales could slow down significantly. Historically, the year following record sales numbers tends to lag, especially with unfavorable tax implications.
Another near term result of the election was stated by SL Green’s CEO, Marc Holliday, at a REBNY lunch yesterday. Marc pointed out that NYC could now be a large beneficiary of the US government. After years of sending out many more multiples of tax dollars to DC then we received in return, we could finally receive the largest share of support to rebuild our infrastructure after Hurricane Sandy.
As far as the long term results of the election for our market, we must look at the national and global picture. Often times we believe that we are in a real estate market in a universe of its own. We were saved in this last cycle as we were not overbuilt. (In fact, in 2009 there was only one speculative office building built.) Furthermore, we are now seeing vacancy rates reaching all time lows and rents reaching all time highs, and financing is still plentiful for core assets fueling recording pricing. We are at the opposite end of the spectrum of many secondary and tertiary cities.
With the listing inventory still low, NYC remains a seller’s market. At our firm, we have been unable to keep up with the demand. In 2007, our company had about 750 exclusive listings. Today, we have around 500, which is the same amount we had in 2009. The only difference is that today we are churning through our inventory a lot faster, as we are seeing far more sales.
As rosy as this picture looks for NYC, there are several fundamental concerns lurking at the national and global levels. The current so-called fiscal cliff and congressional deadlock will lead to significant volatility in markets ahead. A supposed $600 Billion near term, short fall only tells a fraction of the story. With the national debt rising now to $16 trillion and unfunded Medicare and Social Security obligations adding to this for a shocking $86.8 trillion combined, it is hard to see how the US will dig its way out, especially since our annual deficit now exceeds our GDP.
In light of this downward spiral, the short term benefit for the real estate investors is that interest rates should stay low for the time being. Bernanke will likely have a renewed term in 2014 and continue his dovish policies, if the market will allow him to do so. Treasuries are expected to go lower because of volatility and increased pessimism. As a result, we may actually see the market rally on continued QE and dollar devaluing. To paraphrase Extell’s Gary Barnett, as long as the stock market holds up, people will feel wealthy, and continue to buy apartments. However, long term inflation should remain a major concern. With rates low, a hard asset bubble could be created (real estate, commodities, gold etc).
We would expect significant compression in yields for anything with short-term cash-flow rollover and long-term debt. Think multifamily and hotels, as the revenue will keep up with inflation, combined with fixed long-term debt and price appreciation. Short term, the government should keep printing to keep interest rates low and status quo. Although when the music finally stops, it’s going to be bad. How long that will take, is the big question.
For most CRE, inflation is a serious issue. If you have fixed long-term income streams (commercial leases) and floating fixed debt, the defaults begin once yields tick up. We think part of the recent MF/Hotel bubble is funds buying inflation protection. The real value of the fixed debt on these assets will go down, while the revenue should at least not fall too far behind real purchasing power.
Unless Congress begins to reduce the deficit through a disciplined combination of increased revenue via taxes and cuts spending/entitlements while maintaining social balance, we risk becoming like Japan; which runs at 200-220% debt to GDP. With this comes stagnant rates and low growth.
The austerity and de-leveraging would cause some pain across the markets and main street, but the country would emerge in a much stronger fiscal position, and a new cycle of GDP growth carries us forward.
Whether or not inflation negatively affects the ability of rents to keep up with inflation depends on supply growth, relative to demand growth. As long as new supply remains muted and demand strong, rents can continue to rise. NYC should be fine, but secondary and tertiary markets will likely be hurt.
In an inflationary environment cap rates will also begin to expand as Treasury yields rise, which will compress values. Given the ultra-low cap rates that properties are trading at, especially in gateway markets, this is a real concern for asset holders, particularly those looking to roll debt.
Unfortunately we cannot become Japan (ex Federal Reserve action) since there is no appetite or ability within the US institutional space to float the entire debt, and permanently accept negative real interest rates. Let’s hope we are not in for a Weimar republic.
James P. Nelson, Partner & Matt Nickerson, Associate
James Nelson is a Partner at Massey Knakal Realty Services. Since 1998, he has been involved in the sale of more than 200 properties and loans with an aggregate value of over $1.3 billion in the NY Metro Area. He can be reached at firstname.lastname@example.org or 212-696-2500 x7710.
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