I have written a lot about the effects of 2013’s anticipated capital gains increase. There is no question that there was a mass sell off in 2012 by long term owners looking to lock in the 15% Federal capital gains tax rate. As a result, the third quarter in Manhattan was the busiest quarter for sales since 2007.
We believe the 4th quarter might have even surpass that. The last two weeks of 2012 were nothing short of remarkable. In my 14 year career, I have never witnessed anything like this. Our office had 6-7 closings scheduled for every day. Our CFO stated that he stopped trying to estimate where 2012 would end up as newly scheduled closings were coming in every day.
When all is said and done, we believe there will be close to 3,500 NYC property sales in 2012. This will be double what it was in 2010 and a 50% increase from 2011. It will still be off 2005-2007 levels, but only by about 25-30%.
As far as the total dollar amount, NYC property sales should end up at over a total of $31 billion dollars which once again is over double 2012 and about 15% greater than 2011. This figure is still only about half of 2007, when large institutional sales dominated the headlines. 2012’s estimated total sales will be more in line with normalized years like 2005.
But when and if the capital gains rise in 2013, how much of a bucket of cold water will this be on the market? We do believe transactional volume could drop 20-30% as long term owners looking to sell this cycle will have already done so.
Furthermore, drop offs in sales activity after banner years have been seen in the past three NYC real estate cycles. Typically after large sell off years such as 1989, 2000, and 2007, the following years tapered off. This was especially noticeable in 1990 after the tax law changed.
However, there is one saving grace which could greatly offset this loss in potential volume: 1031s. The 1031 exchange has existed for decades, but we found that even 5-10 years ago only the most sophisticated investors took advantage of them. Today, 1031s are common place as ordinary investors and non-real estate professionals are choosing to defer their gains and keep their money in real estate.
If the federal capital gains increase by over 50% to effectively 23.8% when the health care surcharge is factored in, even more investors will look to exchange. I predict we could see the percentage of sellers doubling or even tripling.
NYC’s greatest challenge will still be to keep this exchange money here. Typically long term owners who are selling want to exchange into something passive such as a NNN leased single tenant asset, which are a rare find in NYC.
NYC sellers who want to keep their money here will either have to become more flexible in the assets and tenancies they look for, otherwise they may take their exchanges elsewhere in the US where they can receive higher yields. For example a Walgreens in NYC will bring a 4.75% cap, whereas in Wisconsin and Indiana two recent Walgreens sales offered 6.8% and 6.3% caps. However, NYC’s appreciation on the whole far outpaces the US on average if someone is considering what the land will be worth 20-30 years down the line with the lease expires.
Regardless, I believe caps from NNN lease properties across the US will compress in 2013 by at least 100-150 basis points, as exchanging and deferring increased capital gains seems like the most viable strategy. Someone might do well to buy a large quantity of these in anticipation to resell as the tax consequences become a reality.