New Dev Closings: A Potential Problem?

A: I want to discuss something that has NOT happened, is not even in the very near term horizon, but very well may impact the Manhattan marketplace at some point in 2008; buyers with expected new development closings amidst the new credit world. How may it impact our marketplace that has held up solidly in the face of a nationwide housing slump.

Why does this matter? Well...

The secondary mortgage markets (where rmbs, cdo's, cmo's are traded) exist to provide a market for lenders, banks, or specialized firms to sell existing holdings in order to free up capital for new loans. That secondary market is still seized up, although I'm hearing not as bad as it was a few months ago. Nevertheless, if investors are still not willing to buy these securities due to the changing risk associated with it, the lending world will continue to experience a drying up of liquidity resulting in tighter standards, fewer loan options, fewer lenders in general, and less $$$ to provide to the consumer via a home loan!

We still don't know how this will play out and I'll show you how I can tell these markets are still not functioning properly. First, look at this incomplete list of new developments that are awaiting their CofO so that they can start closing the deals:

NEW DEVS / CONVERSIONS COMING OCCUPANCY'S: 75 Wall St, Ariel East, Ariel West, 205 W 76th, Chelsea Stratus, 157 Hudson St, 215 W 88th, 517 W 46th, The Link, The Element, The Platinum, Sky House, 166 Perry, 200 West End Avenue, The Ansonia, Avonova, 10 West End Ave, 520 W 19th, 447 W 18th, 246 W 17th, 39 E 29th St, 459 W 18th, 225 E 74th St, The Lucida, The Brompton, 265 W 122nd, Chatham 44, The Laurel, The Stanhope, 300 E 79th St, 212 E 47th, 170 East End Ave, 1200 Fifth Ave, The Rushmore, The Avery, Linden78, 100 11th Avenue, SoHo Mews, Artisan Lofts, 45 John St, Tribeca Summit, 330 E 57th, 240 PAS, 225 E 34th, Gramercy Starck, 55 Wall St, 5 East 44th St, Park Avenue Place, Thorndale, Hit Factory, Cocoa Exchange, Kalahari Condo, Miraval Condo, 650 Sixth Avenue, The Clement Clarke, William Beaver House, BE@William, 80 John St, 106 W 116th St, and on and on...
*ran out of time. I couldn't check on every one of these and this isn't nearly close to the full list!

I don't need to explain why Manhattan real estate has held up (just read this, or this, or this), but I do like to discuss dynamics that may come into play down the road! Why? It's just more fun to me than to read a lagging quarterly report about what happened 3 months ago, thats why!

Since the credit squeeze made it to the surface (for the media that is) in mid July, there have been a number of adverse side effects as the investment world changed it's appetite for risk:

the secondary mortgage markets siezed up; hence the tightening of lending standards, fewer loan options, bankrupt lenders, and rising loan rates

asset backed commercial paper market dried up, although there have been signs of life of late

equities markets experienced a short term blip; and a great recovery response thanks to the fed

fed did its job to inject liquidity to help normalize the credit markets; the fed moved aggressively with monetary policy to prevent future economic shock at the expense of inflation in the pipeline

jumbo mortgage rates disconnected from other loan products

...just to name a few. The psychological effect however is still lingering as in my mind I cannot understand how 4 years of ultra low rates and lax lending standards can be self-corrected in 3 months time; but hey, thats just me. That bolded items I listed above are what scares me.

What no one wants to discuss is:

WHAT ABOUT ALL THE BUYERS THAT SIGNED CONTRACTS ON EXPENSIVE NEW DEVELOPMENT PROPERTIES BEFORE THIS MESS HIT, AND WILL NOW CLOSE THEIR DEAL IN A LENDING ENVIRONMENT THAT IS TIGHTER & MORE EXPENSIVE?

Will this become a problem? I don't know, but it's something I'm watching very carefully; are you?

You can tell that the mortgage markets are still not functioning by the continued widening of spreads; in this case between Jumbo & Conforming loan rates. Thanks to Calculated Risk, I can see the disconnect in Jumbo Loan Rates (which is what a majority of new dev purchases will require to close) in relationship to the Conforming Loan Rates; notice the widening spread when the credit mess hit showing dysfunction in the market!

Whenever you see the spread disconnect this much from the norm, it is a sign of distress in that particular marketplace! We saw the same thing with yield premiums in the asset back commercial paper market as well when that seized up; I wrote about that back in my posts "Its a Risky New World: Credit Spreads" & "Markets Forcing The Fed Into Rate Cut":

Credit spreads are widening as a result of all this. In other words, the difference between corporate bond yields and US government treasury yields are increasing as the risk associated with corporate paper rises! Relating this to the mortgage markets, while short and medium term US gov't treasury yields are falling fast due to a flight to quality as stock prices fall, the rates on mortgage products are NOT falling at the same pace! This is because mortgage debt is now MORE RISKY than treasury bond notes and therefore demands a HIGHER RISK PREMIUM to gather investors; i.e. higher yields. This is causing the spread between the two to widen.

I know what you are saying, "stocks are at records, the fed is cutting rates, everything is wonderful and will always be wonderful, ahhhhhhh"...well, sure if you live in fantasyland. But we are not messing around on this site. We need to be critical of what is really going on in the world to understand WHY things happen that effect our local housing markets! Look at what Fannie Mae said about the continued distress in the Jumbo credit markets (via Weekly Commentary):

"... lenders reported a lack of investor demand for high credit quality jumbo mortgages and other mortgages not eligible for agency purchase. This dislocation pushed the cost of prime jumbo financing significantly higher relative to rates on conforming loans.

In mid-August this spread spiked to above 90 basis points after fluctuating between 15 and 25 basis points for the prior year-and-a-half (about equal to its historic spread). This spread has moderated somewhat over the past couple of weeks, however, and fell below 80 basis points in late September, suggesting some modest improvement in the market conditions for prime loans with balances above the conforming loan limit. Even so, the spread remains historically wide -- suggesting that the prime jumbo market remains in distress."

Hmm, lets be creative here for a second. What happens to all those new development buyers that are currently in contract, waiting for building completion to close, if the jumbo credit markets continue to be in distress and there is a much different lending world than when the original contract was signed?

What if the buyer doesn't have the doc's to get the commitment, if lending/underwriting standards have tightened so much in the past 3-6 months? What if the buyer gets a much higher interest rate than was originally anticipated? What if the bonus doesn't come in as expected? What if they lose their job? What if the property becomes unaffordable? What if the appraisal doesn't come in and you signed a contract without the financing contingency?

While these are valid questions, they are also on the doomsday side and must be looked at with an open mind; after all, if it wasn't for new dev units we would have an extreme shortage of supply! This is a very wealthy city, with great salary's / bonuses and plenty of qualified demand. But with some 17,000 - 20,000+ units set to close in the next 1-2 years or so, questions should be raised given the change in the macro environment and re-pricing of risk in the mortgage markets!

Strange how this topic has not been raised in the major media? Too negative maybe?

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