NY City Land: Will High Prices Cure High Prices?
I have been contemplating a piece on NY City land prices for a month or two. A while back I was told about a development site in Long Island City that was going to be sold for under $130 per FAR (buildable square foot) in an area zoned for residential development (residential if permissible is currently still vying with hotel as the highest and best use of land in most of the New York City area, except for the central city, where a combination of retail and office can also make sense). This sale price was a significant downtick from the $140 - $150 per FAR that was typical in Long Island City heretofore, with some sites going for even more. I had also heard of some deals for downtown parcels, attempting to hit new highs failing to close. These were my first whiffs of a land price downturn - of course, developers really in the know, may have seen this happening ahead of me. Give yourself a pat on the back if you did. Since I consider myself a somewhat educated observer, not a super maven, I didn't get really interested in the subject until I saw an article in the Real Deal entitled Dirt Cheapens. The article confirmed my suspicions and quoted several brokers, including John Reinertsen, a senior vice president at CB Richard Ellis, who reportedly said:
there is "probably" a 20 percent reduction in land prices in the boroughs. "But," he said, "It's going on in the negotiations. It's not in the asking price as yet."
However, sources for the article were practically universal in saying that prices were not collapsing, but merely back sliding after spiking up in the last 24 months. Changes in the construction financing environment (banks are willing to lend a lower percentage of project cost) and imminent expiration of the 421a benefits were cited as the chief catalysts for the pullback.
So I was going to write an article talking about how fundamental land prices are to real estate development. How you can try to add value with better design, but you often have to pay an equivalent amount for the best architects and designers. I was going to mention that, while some try to compete on construction costs, inevitably quality, delivery speed or safety are sacrificed, and I was going to note the rash of crane wrecks and other accidents that have broken out recently.
Then I saw a little blurb in Crain's about a recent study by the Federal Reserve Bank of New York on New York metro area land prices, and the chart that accompanied it made the hair on the back of my neck stand up. The short commentary indicated that the authors at the Federal Reserve Bank of New York (FRBNY) had concluded that the meteoric rise in the price of land in the city from 1999 to 2006, was an indicator of the area's economic vitality. O.K., I don't have a Ph.D. in economics, but hey, I get it. Things were good in New York City so land prices rose, a continued rise in land prices would reflect anticipation by investors that times would continue to be good in New York.
But judging from the numbers provided, in the five years ended in 2006 (before a further increase in H1 2007), New York metro area land prices appreciated roughly 409%. To me that implies more than just good times....that's Margaritaville. Just so you can see it visually, below is a graph of the FRBNY data set, with separate lines for the prices of land zoned for residential and land zoned for commercial and industrial use.
Please note that the data set the FRBNY used includes NY City and Northern New Jersey land transactions of greater than $250,000. However, the subset of numbers for New York City and the boroughs were found not to be statistically significantly different than that of the entire data set in terms of appreciation over the period. As you can see, land zoned for residential has gone parabolic....or at least half of parabolic.
I am also including a chart of the NASDAQ bubble, Las Vegas home price bubble and recent oil price run up from a recent wall Street Journal article on Ben Bernanke's laboratory at Princeton that studies asset bubbles, for comparison.
So is New York City land pricing a bubble that is starting to deflate? Just as a reality test I
looked at oil prices for the last five years. They were roughly $25 a barrel in 2003 and are now roughly $125 per barrel. That's a 400% move. So if oil is a bubble, then New York City land may be a bubble too.
Note that most bubbles are accompanied by a significant pick up in trading volume of the underlying asset. This has been true in the case of oil trading volumes, the FRBNY did not comment on whether this has been true of NY City land, but I suspect it to be so. The issue with both of these assets is "they ain't making any more oil" and "they ain't making any more New York real estate." So maybe these bull markets can keep going longer than Las Vegas homes and the dot com stock market.
Another indication of a separation of land prices from reality was notable in the Fed study. According to the study, the increase in land values generally, and in prices for land zoned for residential use in particular, ran well ahead of the roughly 130% run-up in finished residential property prices in the area over the same period, according to the OFHEO index (this index measures home price appreciation while controlling for the quality of units by using repeat sales data). In the process, the profits for land development were transferred directly to land owners, leaving very little for developers.
Andrew Haughwout, one of the principal authors of the FRBNY study, was kind enough to go through it with me. His comment was "At the time that we assembled the data set, we were still in a market that was in a strong uptrend and the likelihood of it being a bubble had not really jumped out at us. In light of the changing conditions of the market, the possibility of a bubble-induced run-up is one that certainly should be considered".
So what does this mean for New York City real estate? We all know construction permits are way down in the city and that there will be a lull in new supply after the last 421a projects get out of the ground. This lull should cushion prices of finished condos on the downside somewhat. My guess is that land prices will continue to fall to the point where spreads available to be earned by developers widen out and eventually encourage significant new building again. With materials costs remaining firm, costs of money up, available leverage down and sell out prices of finished product being somewhat squishy, the adjustment in land prices could be pretty severe. This will be to the benefit of buyers of new developments, who will end up carrying a less maniacal land cost embedded in their condo prices and have more potential for future upside.