Adjustment Phase Will Reveal Skinny Dippers

A: As the first stage of the adjustment is underway in Manhattan, we get our first glimpse of who was swimming naked. Lets face it, Manhattan is not rampant with speculative flippers or shady subprime borrowers, but that doesn't mean distressed sellers won't rise to the surface here. With the market highly illiquid right now as buyers back off, sellers that were overexposed, over-leveraged, lost their job, bought on the currency trade with expectations to flip at a profit, or just scared about the future, aggressive price reductions are the only way to move property. As I said before, I think the level that deals are happening at right now puts the market down about 15%-18% from peak levels. Illiquidity being the main reason. Hindsight will probably show the peak being contracts signed in early-mid 2007; with delayed new dev closings skewing the actual peak.

Those who signed contracts for new development as the market was near its peak, had to sit tight and wait to close on their property before putting it back on for resale; if that was the plan originally or if the plan changed during the 'waiting period'. With the credit crisis beginning in mid 2007, some 'in contract' buyers were helpless to do anything about their pre-crisis purchase other than to make the tough decision to walk away and surrender their 10% deposit.

I think we will see the sharpest adjustment from peak levels in these forced resales of very expensive new developments first. It's early in the process, as most will choose to wait for things to improve before forcibly selling their property in a tough market.

Just the dynamics surrounding the transaction process for a new development, make it the most exposed to the downturn when buyers simply disappear. Why? Because not only were these products very expensive, with closing costs some 1.5% above a resale condo's closing costs, but the contracts were signed well in advance of the closing as the buyer waited for the building to be completed. This means signing the dotted line for a product before the credit crisis began, waiting to close as the market deteriorated, and pushing back the ultimate resale until AFTER the Manhattan housing market turned illiquid. In addition, foreigners buying on the currency trade with the intention of renting out or flipping for a profit, tended to buy new developments that were marketed directly to them. Second homes and investment properties are usually the first large assets to go on sale when financial distress hits home.

For this discussion, lets take a look at Ariel West, a luxury new development in the Upper West Side that started closings in late 2007, to see what I mean.

Take a look at what appears to be the first resale at Ariel West, Apt. 7-C:

ORIGINALLY CLOSED ---> January 10th, 2008 for $1,558,000
ASKING PRICE TODAY ---> November 16th, 2008 asking $1,450,000

First let me be clear that this is NOT occuring en mass yet in Manhattan, and in fact this is only one of a few new dev resales that I am finding with an asking price below the closing price. Clearly the property is at least trying to be marketed aggressively, ahead of the curve to get a deal done. This apartment probably went into contract in early 2007, before the crisis began and reflects a price near peak levels just under $1,200 per square foot. If the seller didn't have to sell, they probably wouldn't. But as is the case even in the Manhattan market, there are always a number of sellers that must move their property.

This property is currently being listed at a 7% discount from the closing price. But where will it sell for? Its a problem of lack of bids that describes this marketplace right now. There is a big difference between what a property is asking and what it ultimately sells for, especially in a illiquid market like today. In addition, add in that the original buyer probably paid about $85,000 in buy side closing costs, and will have to pay about $100,000 in sell side closing costs (assuming 6% commission and a full ask deal), and you are looking at a minimum loss of approximately $300,000 or so on this transaction from beginning to end.

The adjustment has begun and I have a feeling we will be seeing noticeably more new development resales come to the market. Not all will aggressively cut their asking prices, as most buyers-turned-sellers will try to test the market and recover some transaction expenses in the deal. It is only when desperation hits and the property MUST be sold fast, that the aggressive reductions begin. Seller psychology is a strong force and things like denial & price anchoring tend to take over their minds at first. Nobody wants to hear that the market has weakened or worse, that the market has become illiquid. Nobody wants to hear that they may have to take a loss on the property. Nobody wants to hear at what price will result in a quick sale. My mother sold her house on LI after 11 months at a 25% discount to where the house was selling for in late 2005. It took here 7 months to realize the reality of the situation, at which point, it became a process of finding out where 'true value' actually was. In declining markets, this process is painful, emotional, and feels like it will never end.

The market does what the market wants and nothing I say here will change that. I just tell it like I see it, regardless of how that may affect my own personal business. Right now, we are in the process of finding out what the market feels is a proper valuation for an apartment in a market with clear near term challenges. And nothing I say here will change this or enhance this process. In other words, me writing this article is not the reason any apartment is not selling for a higher price!

My advice to sellers:

a) fight denial and recognize that the market has changed; this is the first step
b) do NOT anchor to peak prices; this will be counter-productive
c) do NOT believe any broker that promises you an extraordinary price because they are the best and they know how to market a property the 'right way' to get 10% more profit than other brokers. In the end, buyers dictate the value of your property and it is only worth what someone is willing to pay, NOT what a broker working on commission trying to get that exclusive listing agreement signed says its worth
d) price ahead of the curve; rather than test the market and play catch up via reductions as inventory rises and the local economy deteriorates further
e) only YOU know how quickly you must sell, so do yourself a favor and anticipate a longer time on market if you start at a higher price. The last thing you want is to put yourself in a position where the property must be sold within 1-2 weeks, because you tested the market first and wasted valuable time that you could not afford

If you have to sell, you have to sell. Period. Hopefully you have enough equity in the property so as to cushion the blow to your originally expectations on what your place is worth. Every seller, including me when I sold my place, thinks their place is worth top dollar because of the renovation work you did and because of the memories experience in your home. Buyer's do not care about your memories, they rarely love every single renovation you did and often have plans to change the place to their own taste, and are very savvy about what is going on right now in the world. The greater fool theory should not be counted on to save you and procure a deal above peak levels. Its a slowdown, it has to happen, and there is nothing wrong with discussing it openly. Adapt accordingly and don't fall for any dirty tricks.

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