A New Wave of Boutique Hotels

A New Wave of Boutique Hotels

Boutique or independent hotels are not a novel concept for New York City. Ian Schrager popularized this concept when he opened the Morgans Hotel, in 1984, and started a company named after it. According to Oysterblog, Schrager introduced exclusivity, superstar designers and chefs, destination lobby-cum-lounges, and above all, celebrity.

Schrager’s hotels also included The Royalton, The Mondrian and The Hudson.  All of these are now managed by Morgans Hotel, which Schrager left in 2005 when he created the Ian Schrager Company with his friend, artist and filmmaker Julian Schnabel, to open the Gramercy Park Hotel.

Shortly after the Morgans Hotel launched, Richard Born partnered with Ira Drukier, to form BD Hotels in 1986. Today, they own and operate 25 hotels with over 5,000 rooms; making them the largest independent hotel owners in the New York City. Born and Drukier have developed small luxury hotels (The Bowery Hotel, The Greenwich, The Jane, The Maritime & The Mercer), as well as large commercial hotels (The Wellington & The Holiday Inn Midtown). BD is currently working on two new developments, The Marlton in Greenwich Village, which is called a “Baby Grand” hotel (opening in Summer 2013), and The Ludlow Hotel on the Lower East Side which is slated for a Fall 2013 debut.

Will Obeid’s Gemini is also active in this arena. Like Born, they develop, own and operate their boutique, neighborhood-inspired lifestyle hotels. Gemini created “The GEM Collection” after they discovered there is a ceiling on the room rates they could achieve in a SoHo hotel with a Howard Johnson’s flag.  As soon as they made the switch, they saw their ADR’s jump 12% the next year. GEM hotels are currently located in four Manhattan neighborhoods.

Today large chains also capitalize on this demand from business and foreign travelers who want a more intimate and customized experience. Hyatt has Andaz and Marriott has The Renaissance. Starwood’s The W represents 8.8% of the total US boutique hotel stock, making it second only to Kimpton which has 11.5% of this segment according to Smith Travel Research.

Smith counts a total of 777 US boutique hotels with 93,920 total rooms, of which 48% are independent and non-flagged. They account for 4.4% of the annual hotel room revenue, making them a small part of the landscape.  However, in NYC they are becoming more prevalent.  With NYC’s 2012 overall occupancy rate of 87.5%, these new additions have been welcomed.

I recently interviewed Richard Born at Greenpearl’s Hotelsnyc event. He talked about his new Pod Hotel concept, which he said targets the intelligent traveler as opposed to the “hip” traveler. Currently, they have two locations on East 51st and 39th Street. The Yotel on West 42nd Street offers the same concept with similarly sized rooms of only about 100 SF, many of which have bunk beds.

Finding a specific niche will be key for new hotels to succeed. Manhattan currently has over 70,000 rooms with over 30,000 more planned. An additional 12,000 rooms in the outer boroughs bring the New York City total to 92,000 rooms citywide. Born feels that there will ultimately be demand for the additional 30,000 rooms (plus inevitable future projects) as first time travelers from around the world all want to come to NYC.  However he feels this initial increase will be a shock to the system, lowering ADRs.

Born talked about how new sites, such as Yapta, that monitor hotel rates and automatically cancel a current reservation in exchange for a cheaper room at the same hotel. This type of technology can cut both ways. Born also mentioned that Expedia has the potential to rent out ever hotel room in NYC in 10 minutes, but rates would surely have to suffer.

The big hope for hoteliers is that NYC tourism will continue to increase. Last year, NYC hit another record of 52 million visitors. These tourists accounted for $36.9 billion in City spending. With this in mind, the mayor’s office is now pushing to get to 55 million visitors over the next few years.

Owners with manufacturing zoned sites should take note, as hotel developers are looking to expand. With construction financing now available to build ground up, more and more of these sites will be built. Born and others now have their eye on Brooklyn, as there seems to be plenty of demand for hotels outside Manhattan. However, the pricing has already pushed it out of consideration for many. Echoing this sentiment, Obeid said, “I missed my opportunity,” when he could have picked up land in Williamsburg years ago, but chose to pass on the opportunity.

James P. Nelson, Partner

Massey Knakal Realty Services

275 Madison Avenue, 3rd Floor

New York, NY 10016

(212) 660-7710

jn@masseyknakal.com

 

James Nelson is a Partner at Massey Knakal Realty Services. Since 1998, he has been involved in the sale of more than 250 properties and loans with an aggregate value of close to $2 billion in the NY Metro Area. He can be reached at jn@masseyknakal.com or 212-660-7710.

To follow James on Twitter, please go to http://twitter.com/JamesNelsonMKRS or LinkedIn at  http://www.linkedin.com/in/jamesnelsonmasseyknakal.

IS NYC REAL ESTATE OVERVALUED?

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At the recent Stoler Summit, I was fortunate to hear some very telling observations about the drivers of the NYC investment sales market. Many spoke to NYC being the number one choice for global investors when they want to check the US real estate “box”. Since that isn’t news, what’s surprising is the varying opinions on if this was warranted or if NYC is in fact overvalued.

Richard Mack, the North America Chief Executive Officer of AREA, said that they have been priced out of NYC for some time. He believes this market is dictated by the inflow of new capital. He almost went as far as to say that it was like a pyramid scheme, where someone would eventually be left holding the bag. AREA prefers more attractive yields in cities such as Seattle, which has a rapidly growing workforce and offers much in the way of the lifestyle for those who live there.

Not surprisingly, Scott Rechler from RXR, one of the most aggressive NYC office building buyers of late, was the most vocal to speak out against this. He believes NYC has the best workforce in the world because people want to live and work here. He thought the fundamentals couldn’t be stronger.

Many of the panelists concurred that the slowdown in the NYC office leasing market (according to Cushman only 23.2M SF of office space was leased last year compared to 2011’s 30.1M SF) was attributed to companies using space more efficiently and not necessarily due to lay offs. Furthermore, Wall Street’s pause in leasing new space has been replaced by creative tenants who have flooded submarkets such as Midtown South.

As far as pricing, the general consensus was that it is very challenging to make core acquisitions work, as sub 4% caps have become the norm. The competition can also be fierce for these types of investments. When I recently interviewed Giacamo Barbieri, Head of Northeast Acquisitions for TIAA-CREF, he talked about their recent JV with a Norwegian Pension Fund, the largest sovereign wealth fund in the world, which oversees $600 billion, which is just one of the new entrants to the market.

Since NYC “only” had $40 billion of sales last year (with $19.8 billion coming from the 83 sales over $100m+ institutional sized sales), the Norwegians could have bought every sold NYC property last year and it still would have only accounted for 6.7% of their portfolio. With hundreds of similar institutional players chasing NYC, I believe there could be well in excess of a trillion dollars allocated to this market. If so, that is over 50 times the institutional grade properties that actually sell.

Thus, a core buyer is going to have major challenges securing product in this market unless they can find ways to be creative such as TIAA-CREFs recent JVs at 8 Spruce and MiMi where they recapped the properties.   With these supply and demand dynamics, one could easily say that yes, the core market is overheated.  The good news for those participants is that segment of the market couldn’t be more liquid.

Conversely with value-add, Rechler said there was few equity partners who could underwrite a value-add play aggressively enough to make the numbers work. He referenced the Sony Building and 11 Madison where there was little institutional action. Ultimately, Sony sold to Chetrit a private investor.

In addition to value-add, small non-institutional sized assets, especially those in the outer boroughs, are where institutional investor may have to turn to. Bloomberg News recently reported this trend and cited that Invesco, which has $50B in real estate under management including 51,000 apartments in the US, just made their smallest apartment building purchase ever, as they bought a 48-unit property on East 86th Street. That being said this was a $76 million dollar acquisition due in part to the retail and over sized apartments. Thus, the institutional players are still looking to write an eight figure check when making an investment.

Massey Knakal and RiverOak Investment Corp. had taken note of the lack of institutional players in the $25 million capitilization and under space. As a result, they co-sponsored a private equity real estate fund, MKRO, which will target smaller, value-added segment of the market, particularly for well-located assets in the outer boroughs in close proximity to transportation.    Although the partnership is new, George Yerrall, co-founder of RiverOak, has been investing in small to mid-size transactions in the northeast corridor for more than 13 years. With more than 90% of the sales in NYC valued at $25 million or less for the past four years, he believes there is no shortage of deal flow for the foreseeable future.

Although institutional investors are starting to turn their attention towards these smaller deals in their search for yields, they still must find a way to invest vast amounts of equity programmatically and either complete the value-add, not always an easy feat, or continue to focus on stabilized assets that are now cash flowing.  In all cases, however, the fact that institutional investors are starting to shift their focus to this space is a plus as it provides for additional liquidity on the exit.

No matter which perspective, all agree that given the uncertainty in the world today, global investors see the US, and specifically, NYC as a safe haven for real estate investing and capital inflows are expected to continue. With the core market heated, I think the opportunity now is on value-add plays especially for capital markets sized assets.

James P. Nelson, Partner

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 jn@masseyknakal.com or 212-660-7710.

To follow James on Twitter, please go to http://twitter.com/JamesNelsonMKRS or LinkedIn at  http://www.linkedin.com/in/jamesnelsonmasseyknakal.

World Trade Center vs Hudson Yards

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According to the Dept of City Planning, NYC will need to accommodate over 440,000 new workers with 111M SF of office by 2025. NYC’s answer: Hudson Yards and The World Trade Center. Both neighborhoods will be transformed to bring much needed life to the areas. In addition to millions of square feet of office and retail being created thousands of apartments will compliment these developments. Large open public spaces and cultural attractions will be the finishing touches Accessibility is key to both of these initiatives as the transportation will be greatly improved to support the tens of millions of workers, residents, and tourists who are are already there or who will soon flock to these areas. Sometimes charts tell more than a narrative. Below is a chart outlining the important components to these initiatives.

Hudson Yards WTC
Major Developers Related, Brookfield, Sherwood, Moinian, Rockrose, Avalon Bay, and Vornado Silverstein, Durst, Westfield, Port Authority and Brookfield
Size: 32 Blocks or 360 Acres (Related’s Hudson Yard is 26 Acres alone) 1 16 acre Super block (equivalent to 6+ Tribeca / Finanacial district blocks surrounding it)
Estimated Completion TBD Beginning This Year
Major Tenants Secured Coach, JP Morgan, Associated Press Conde Nast, Vantone, Port Authority, GSA, City of New York
Estimated Office SF To Be Built: Currently 9.4M SF including Manhattan West; may eventually span 25M SF 7.4M between towers 1, 3, and 4; 10M in total
Estimated Residential Units: 3,000 to date; 20,000 – 48,000 units planned N/A; Surrounding area has grown from 10,000 to 60,000 residents in the last 10 years
Estimated Hotel Rooms To Be Built: 3,200 hotel rooms 13 current projects equaling 2,273 total rooms (lower Manhattan)
Transportation Hubs: Penn Station Calatrava’s WTC Hub (which will accommodate 250k pedestrians/day), PATH, Staten Island Ferry, Battery Park Ferry
Subway Lines: 7 Train Extension 1, 2, 3, 4, 5, 6, A, C, E, J, M, Z, R
Cultural: TBD 9/11 Memorial & Museum,  Jazz Hall, Performing Arts Center
Parks/Outdoor Space New Park and Esplanade (4 acre, 10 blocks long); Highline; and Hudson River Park 8 Acre Plaza; Waterfront
Estimated Retail SF: 1,000,000 SF Westfield: 365,000 SF
Trendy Adjacent Neighborhood West Chelsea and Meat Packing TriBeCa

Will 1031s Save the 2013 NYC Property Sales Volume?

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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.

What the Election Means For the NYC Real Estate Market

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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 jnelson@masseyknakal.com or 212-696-2500 x7710.

To follow James on Twitter, please go to http://twitter.com/JamesNelsonMKRS or LinkedIn at  http://www.linkedin.com/in/jamesnelsonmasseyknakal.

The Rush for What’s Left of NYC Land

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In 1624, when the Dutch West India Company sent about 30 families to live and work in a tiny settlement on “Nutten Island” (today’s Governors Island), there was plenty of land for families to spread out.

According to the United States Census Bureau, in 2011 the estimated NYC population was over 8,244,000 people. NYC covers only 303 square miles, so that equates to roughly 27,207 people per square mile. This is a far cry from Manila in the Philippines, the most densely populated city in the world, with over 111,000 people per square mile.

Furthermore, NYC only ranks #5 in the US in terms of density, behind 4 other cities located in New Jersey.  However, NYC is more than double the density of the next two largest cities, Chicago and Philadelphia.

So just how much of NYC’s land has been developed to accommodate all these people? And is there any land left to build?

If you consider that there is 27,878,400 square feet per square mile and 303 square miles in NYC, that would mean there is a total of 8,447,155,200 SF of land.  Manhattan accounts for 641,203,200 SF of this total, or less than 8% of the NYC land area.

Property Shark researched all the vacant land in each of the boroughs based on properties classified as vacant and parking lots. Below is a summary of their findings and the % of vacant space:

Borough

SQ Miles

Total Area (SF)

Total Unimproved Land Area *(SF)

% Unimproved Land*

Manhattan

23

641,203,200

19,532,503

3.0%

Bronx

42

1,170,892,800

59,685,245

5.1%

Brooklyn

71

1,979,366,400

70,224,364

3.5%

Queens

109

3,038,745,600

138,704,544

4.6%

Staten Island

58

1,616,947,200

203,230,832

12.6%

NYC

303

8,447,155,200

491,377,488

5.8%

* Not Including park space

As you can see, there is not much land left to develop in Manhattan with only 3% remaining; less than one square mile, whereas Staten Island offers the most land to build. In all, there is less than 20 square miles of open space left in NYC to build.

My grandfather is fond of saying why he likes buying real estate. “They’re not making any more land”. The lack of NYC land, especially land that is being actively marketed, is certainly what is driving record pricing. We have recently witnessed several Manhattan sites trade above $750/BSF. 

These premium sales have, for the most part, been boutique sites. Finding residentially zoned, large scale sites in Manhattan is becoming increasingly difficult, as almost all of it has been developed.

What we are now seeing is a trend where Manhattan developers are building in the outer boroughs. Brooklyn, where residential rents have achieved the same levels as some neighborhoods in Manhattan, has been a much sought after area.

Another trend we are seeing is developers considering commercially zoned land in Manhattan with hopes of rezoning.  Spot variances can be difficult to obtain, but City Planning has shown that they are open to rezoning, under the right circumstances.

As commercially zoned sites are more readily available, developers are looking to buy in at a lesser basis and capitalize if they are successful. If not, they will need to fall back on a commercial game plan, which usually means a hotel, unless the site is in a suitable location for office.  

Developers definitely need to figure out a way to create new product, as there is a massive shortage. According to Corcoran Sunshine, 1,980 units were absorbed during the 12-month period ended March 31st. In contrast, just 1,676 units are expected to be released into the market in each of the next three years.

Our population continues to grow and New York City’s population grew 2.1% in the last 10 years.  Meanwhile, Chicago’s population dropped 6.9% in the same period.  

I applaud the Bloomberg administration as they have looked to rezone areas that have underutilized land. Hopefully they will succeed in some of their final initiatives such as the Park Avenue rezoning, before this administration leaves office. In order for this city to continue to grow, we need to be able to build to support it.

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James P. Nelson, Partner

 

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 jnelson@masseyknakal.com or 212-696-2500 x7710.

 

To follow James on Twitter, please go to http://twitter.com/JamesNelsonMKRS or LinkedIn at  http://www.linkedin.com/in/jamesnelsonmasseyknakal.

10 Driving Factors of the NYC Investment Sales Market

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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.

THE 6 BIGGEST MISTAKES MADE WHEN SELLING PROPERTY AND WAYS TO AVOID THEM

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When selling a property usually you only get one chance to do so. As such, every owner should want to secure the highest price, except in a few rare instances such as when one charity sells to another.

With this in mind, how can a seller be assured that they receive the best price and terms? There are specific approaches owners should make, if their objective is to secure the maximum price.  Ultimately maximum promotion and exposure of your asset will lead to the maximum price.

Unfortunately we continually witness 6 key mistakes that sellers make which ultimately result in them leaving money on the table.

  1. Owners sell off market because they think they are getting a price which is too good to pass up. The issue with this is that one can never be sure unless there are offers to compare to. Unfortunately many owners find out the hard way when their buyer flips the contract, which in some cases can be for millions of dollars more in a short time frame. Inevitably, a multitude of buyers, who did not see the listing originally, become aware and are willing to pay substantially more.
  2. Owners choose to sell off-market, because they wish to be discreet. They do not openly market their property.  Common rationale is off market sales will help them remain under the radar.  However, once the asset sells it quickly becomes market knowledge, including the price paid.  Even if there are tenancy issues or complications, proper steps can still be taken to ensure confidentiality.
  3. Owners sell without brokerage representation in an effort to avoid associate brokerage fees.  There are two problems here.  First, if a buyer is represented, even if the buyer’s broker isn’t asking for a fee from the seller, the buyers’ offer will reflect this cost. Secondly, they do not have someone working in their corner to advise them.
  4. Owners do not want to “tie themselves up” with one exclusive broker and instead prefer “work with everyone”.  However, with an open listing, the marketing effort will ultimately be shared with a half dozen brokers.  These brokers will not consider sharing the sale information with other brokers as they will not want to share the fee.  Furthermore brokers who take open listings will only approach their select best buyers, who they are essentially working for, to get the best price. They will not have an incentive to get the best price for a seller, but simply put together a quick deal and make a commission.
  5. Seller’s offer a discounted brokerage fee.  The misconception is that saving 1 or 2 percent on a brokerage fee will be a direct increase on the net proceeds.  This is just not the case.  Brokerage fees should not be viewed as an expense, but an investment. Offering attractive brokerage fees can be one of the most valuable marketing tools a seller can offer as it will provide more incentive for co-brokers to work on the listing.
  6. Sellers align themselves with non-cooperating brokers.  Even if an exclusive listing and attractive fee is provided, many brokers still will only promote the asset to select buyers in an effort to keep the entire fee.  Owners must ask the question “how many of your listings are co-brokered and how do you intend on sharing your fee”.  Always compare brokerage firms and ask for their track record in cooperating.

In the New York Market place today hundreds, if not thousands, of buyers exist.  Why would a seller want to limit themselves to the option of so few buyers? Roughly 4,000 investment properties sell in NYC each year.  At the very least, wouldn’t a seller want those buyers of similar properties and neighborhoods to know about their offering?

So, how can sellers avoid these mistakes?

  1. An owner should engage a broker who will proactively market the property and cooperate with the entire broker community.  Create a scenario akin to yelling out the news from the top of a mountain that the property is for sale. It’s simple: the more the exposure a property receives, the more offers are received, and the higher the price. Competition between 20 qualified buyers will produce more than a discreet negotiation between a select number of possible buyers.
  2. Prepare a professional marketing brochure with all the due diligence materials provided. This way a non-contingent offer can be negotiated as the buyer’s homework is done.
  3. For marketing, direct outreach is essential. A broker must have a comprehensive buyer and broker’s list. They should also have a strong market share in the neighborhood where they are selling so they can reach out to past buyers. The information should also be sent to every neighboring property owner who is often times the buyer willing to pay the maximum price.
  4. The broker’s marketing campaign should include not only picking up the phone and call the buyers, but also meeting directly with them. People receive so much email and mail today that it loses its effectiveness. There is no substitute for direct outreach.
  5. An online effort in today’s day and age is essential. There are several national and regional web sites that reach millions of buyers worldwide. LinkedIn and Twitter are another great way to spread the word.
  6. After your property information is distributed to such a large audience of buyers, dozens of offers in some cases can be expected. At that point, a competitive bidding process will further increase offers and weed out contingencies. Doing this in a controlled time frame is essential so the listing does not drag out to long.Finally, throughout the process the seller must be kept apprised so they know every step of the way where the process stands. After a contract is signed, the process should run smoothly with the right team in place.

There is no rule that a seller needs to get the highest possible price, but if these steps are taken with the right broker, they can rest assured that no money was left on the table.

James P. Nelson, Partner

 

James Nelson is a Partner at Massey Knakal Realty Services. Since 1998, he has been involved in the sale of more than200 properties and loans with an aggregate value of over $1.3 billion in the NY Metro Area. He can be reached atjnelson@masseyknakal.com or 212-696-2500 x7710.

To follow James on Twitter, please go to http://twitter.com/JamesNelsonMKRS or LinkedIn at http://www.linkedin.com/in/jamesnelsonmasseyknakal.

 

AN OPEN LETTER TO WARREN BUFFETT – BUY BROOKLYN

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JULY 31ST, 2012

Dear Mr. Buffett:

I have followed you over the years and am a tremendous fan. I have always been impressed with your eye to invest in companies which have strong fundamentals and great long-term earnings potential. You have also lead by example, by not following the herd. You have taken bold positions (“being greedy” at times when others have sat on the sidelines in fear.

You have no doubt some exposure to real estate by investing in Wells Fargo and companies which benefit from a housing market uptick such, as Benjamin Moore and Cort. You have faired well. In your last quarterly letter, you mentioned that the housing market has bottomed and that you see this as an opportunity. I couldn’t agree with you more.

With all this in mind, I still don’t believe that Berkshire Hathaway has proper real estate diversification. You could greatly enhance your holdings by owing real estate directly. To rectify this, I have a recommendation: buy Brooklyn, specifically every investment property in Brooklyn.

Last year, you could’ve done so for the very reasonable sum of $1.5 billion dollars, which would have only been a fraction of the estimated $37 billion in cash in Berkshire’s portfolio. According to Massey Knakal’s estimates, this would have included 742 properties.  Not a bad investment, seeing how this would have only bought two or three trophy office buildings in Manhattan.

In 2010, the US Census said Brooklyn’s population was 2,504,700 people, which is 30.6% of New York City. It is the 5thlargest city in the US. That has certainly grown as many now prefer to live in the borough. When else could you “buy” a top 5 city for $1.5B?

The fundamentals of this market are also very strong. Accordingly to the 2011 NYC Housing and Vacancy survey, Brooklyn had a vacancy rate of only 2.61% compared to the city of average of 3.12%. Even Manhattan had more vacancy. As a result, the rents there have soared. MNS reports that residential rents have grown 10% in the last year. This trend should continue as little new product is being built as land is few and far between.

The office market is also very strong in Brooklyn. According to Newmark, the vacancy rate is only 6.9% with affordable asking rents of $30/SF, which is almost half of Manhattan’s, a great value considering it is only 10-15 minutes away by subway.

You would be able to benefit by immediate attractive cash flows. The current average returns for apartment buildings range from 5.4% for an elevator building to 7.28% for a walk-up. Seeing how you can borrow money today at 3% for 5 years at 65% loan-to-value, this would create cash-on-cash returns of over 8% in some cases. These cap rates are about 100-150 basis points above 2006-07 levels when interest rates were considerably higher.

Better yet, these investments have tremendous upside as most apartments in New York City are rent regulated and the rents are artificially low. As the units become vacant, there is only upside. You will be able to buy the real estate at well below replacement cost. Apartment buildings sold for under $200/SF on average last year in the borough. Even if land was free, you could barely build new for double the cost.

With all this in mind, now is the time to strike. We will look back on this window of time when interest rates were low and returns for hard assets are attractive. In 2006-07 rates were higher creating negative leverage in many cases. Today you can receive great cash-on-cash returns. Others are already starting to notice as Brooklyn’s dollar volume is on pace to double this year. I’d make your move before Bill Gates decides to diversify.

James P. Nelson, Partner

 

James Nelson is a Partner at Massey Knakal Realty Services. Since 1998, he has been involved in the sale of more than200 properties and loans with an aggregate value of over $1.3 billion in the NY Metro Area. He can be reached atjnelson@masseyknakal.com or 212-696-2500 x7710.

To follow James on Twitter, please go to http://twitter.com/JamesNelsonMKRS or LinkedIn at http://www.linkedin.com/in/jamesnelsonmasseyknakal.