Noah's 2009 Predictions

A: Lets keep the tradition going and I apologize in advance for the length of this, hopefully you can find 5 min to read it all. Here were last years predictions for 2008, published December 27th, 2007; if you haven't read it yet and are new to this blog, please try to read it before continuing so you can see where I was right, and where I was wrong. I recall when I published those statements about 12 months ago, many accused me of trying to take down Manhattan real estate, and of being too doom & gloom so 'either I should blog and be gloomy, or I should be positive and sell real estate', emails. Just goes to show both the positive sentiment & denial in place at the time, when everyone thought the fed's rate cut fueled equity rallies were signaling hope. Anyway, we are at now now, stocks fell 40% or so, oil down 65% or so, housing deteriorating to depression-era trends, Manhattan's downturn came on fast.....so what's next? It's a game right, so I'll play and keep the same format as last year so we can go back and analyze later on.

NATIONAL HOUSING - Building on last years 'end of 2008' prediction, I think the worst is almost over for the rate of declines for housing markets across the nation. I think the 'L' shaped cycle will be close to the bottom of that 'L', by the end of 2009, leading to a few years of muddling around. Real estate is local and properties vary greatly, so to generalize here is to really tie any prediction to the health of the overall economy and general confidence. Lets not forget that it is all about the buyers when it comes to any local housing market!

I expect the rate of deterioration for most markets to slow as 2009 gets into the 2nd half, causing some major media sites to at least rationally discuss a stabilization in very hard hit markets. Hindsight will probably show a 40%-60% peak to trough correction in many markets when all is said and done (w/ distressed and foreclosed properties overshooting to the downside), so predicting this exact number now must have a wide range to it; we are not at the bottom yet but when we realize a bottom is in place, the market will already be recovering.

Buy side psychology for most conservative investors that have not purchased yet, but plan to, leads to a desire to buy an asset that is appreciating; or at least not depreciating at spectacular and uncertain rates. What I mean is, in general most conservative investors choose not to buy a depreciating asset unless the 'buy' decision is very one sided. Right now I think the mid sized private investors are buying up the majority of distressed/foreclosed assets so the question becomes, when will the general masses start buying:

a) they WANT to buy real estate again
b) feel CONFIDENT enough to buy real estate
c) can AFFORD to buy real estate again
d) can SECURE FINANCING to buy real estate again

It is likely that two out of the above 4 dynamics come into place during the course of 2009. I doubt all four will. The healing process after this housing collapse will be slow and most markets will in hindsight see an 'L' shaped adjustment in prices, with the bottom of the 'L' muddled for a few years. During this time sales volume will still likely be low, putting the most pain on those sellers that have a time pressure to move the property. However, it is very possible that the course of 2009 sees the highest level of fierce sell side competition in many local markets during this adjustment phase. I'm not saying this means a new bull market, it doesn't. I'm simply saying that the most distressed markets, with the most sell side competition, with the highest level of overall fear, may be nearing its peak of their local down cycle. From a risk/reward standpoint, if the property is income producing, in good shape, and in a solid town, well it could prove to be a solid investment. If anything, be a mini expert on your local market and keep tabs on the fierceness of sell side competition, for signs of opportunity.

I expect most markets to see average declines of another 8%-12% during the course of 2009, as the credit crisis finishes its wrath of doom.

MANHATTAN RESIDENTIAL REAL ESTATE - First off, when reading the new articles (trust me, there will be plenty of them now that downturn started) that come out calling for a bottom in Manhattan RE market, ask yourself if that same source discussed in advance the current downturn we are in now; chances are they never saw it coming. To defend a bottom or to call for a recovery based on assumptions that have not occurred yet, is quite silly. If they didn't see it coming to begin with, how can you rationalize a recovery with no fundamentals to back you up? There will be a time for a recovery, but for now, lets KEEP IT REAL!

Interesting to look back to my 2008 predictions for this one:

"As wall street falls, so will confidence and demand on the buy side for Manhattan real estate products. At the same time, we will see more types of sellers contribute to inventory builds toward the end of 2008; speculators, foreign buyers flipping, second home's selling, and struggling buyers who bought a bit more than they can chew or whose job security has changed to the negative. While we won't see a crash by any means, I think sellers will find that its a bit harder than they thought to move their property above last years comparable sales."

I certainly didn't expect the illiquidity to hit until 2009, so that was a bit of a shock as the fall of wall street occurred so fast; that is why I didn't expect the downturn to hit full gear in 2008! Nevertheless, the market became very illiquid around mid SEPT, with the fall of Lehman & gov't rescue of AIG. Here is the deal, buyer confidence started to decline around AUG 2007, so by JUNE/JULY of 2008 I started to notice 'Low Ball Bids & Cold Feet'; the market really slowed when it became so illiquid starting around mid September, with a noticeable buyers strike.

On to 2009, I expect this market to remain very illiquid. Its mid December now that I write this, and it will be published at year end, right before the so called 'bonus season' hits. Umm, not this year! As I stated early 2008, the 2009 bonus season is the one to worry about now that wall street is all but dead. Expect bonuses to be down about 50%, and this is not counting those that won't receive any bonus or got fired before they could receive a bonus. Retention bonuses & top performing PMs will be the most common bonuses, and I just don't see that money rushing back into the Manhattan residential housing marketplace; that is if the recipient doesn't own a home already.

I expect 2009 to be a dark year for Manhattan's real economy. The after effects of the credit crisis and the death of wall street will really hit home in 2009 as consumers tighten their belts; especially at the higher end. We will see massive job losses in the financial sector as forced mergers close and I think frugality will consume most of us that live here. The combination of:

a) job losses from financial sector and ultimately from real economy (retail, restaurants, etc.) in Manhattan
b) negative wealth effect from stock selloff
c) frugal mentality
d) deteriorating buy side confidence
e) lack of speculative buying
f) lack of foreign buying as credit crisis hits their local economies
g) continued tight lending standards
h) media enhancing the slowdown as reporters 'report' on lagging price data and low sales volume

...will continue to dampen buy side demand. Bids will come but the market will likely remain illiquid, and as a result I think the adjustment will continue to occur. For those arguing that supply plays a more vital role in this market, just look what happens when bids stop coming in! It's all about the buyers; always was, and always will be. It doesn't matter if there are 8,000/9,000/10,000 listings on the open market, your property is worth only what someone is both willing and able to pay at any given time.

For a real time guess on where we are right now, I put the deals being done right now down around 15%-25% from peak levels (peak being deals signed into contract in early/mid 2007). The large range is a result of the variable quality of product here in Manhattan + the fact that the downturn started earlier than most would like to admit. If we are down 10-15% since September, then I would say we were down 5-10% already before Lehman failed and AIG was rescued!

Cookie cutter and un-renovated properties, with few exceptional sell side features will be hard sells in an illiquid market and the seller is likely to eventually bite and 'hit the bid' received just to move the property. Chasing the curve and increasing sell side competition eventually hits seller mentality; it's just a matter of when they reach that breaking point and want to move the property. Unfortunately, many sellers who have been on the market for 4+ months already, likely received an earlier bid at or near their current asking price, but didn't accept it because of when the bid was received and how far from ask it might have been at that time.

For sell side, I expect 2009 to see rising inventory as both desired and forced re-sales hit the open market and buy side demand stays dampened. For the 4Q of 2008, I would not be surprised to find out that sales volume was down 40%-50% or more from previous year's level. I expect 2009 to reveal who is swimming naked, who is overexposed, who is over-leveraged, and who was a speculative investor that just took on too much riding the Manhattan gravy train; illiquidity brings this out - when the money stops flowing in and selling ain't so easy anymore. Clearly anyone that stuck to the statement that 'Manhattan real estate never goes down' & 'Buy Manhattan now or be priced out forever', has been proven very very wrong. Manhattan's real estate market is a market just like any other and as such is not immune to macro economic forces. If anything, 2008 has proven that being on top of your macro game would have kept you ahead of the curve in terms of the current slowdown now upon us.

With that said, everything has a price and this adjustment is all about price discovery. We are in that illiquid part of the process where price discovery ultimately surprises us, yet only the guys that transact and appraise the property know where the deal was done; UNTIL IT CLOSES. After the closing takes place, the world discovers the price and issues in the next level of price discovery that will set the new benchmark for comps and pricing analysis. The downturn is defined.

The key to 2009 will be the severity of:

1) job losses
2) illiquidity of the marketplace

..on buy side confidence. If we see job losses exceed even the worst of expectations, and buy side demand deteriorates further, this market could get even more illiquid and fierce sell side competition will likely arise. Once this happens, its fairly difficult to reverse course without any fundamental reason to draw buyers back to the market in mass. That fundamental reason usually is noticeably lower prices. Higher property taxes to fill budget gaps are also likely to play a role in this adjustment.

In short, if we are down 15%-25% right now from peak, I would expect 2009 to continue this downtrend and likely see prices fall another 10%-15% on top of where we are right now, by years end. That would make the range between 25%-40%, a wide one yes, but one certainly possible for this type of residential market with such a wide range of quality of product. The reason lies in the vast difference in product features including:

a) location
b) park/river views
c) outdoor space
d) prewar style - fireplace

etc., just to name a few. High quality products will retain value a bit better during the down cycle, than properties with no light, no view, plain layout, and just OK location. However, the high end is more susceptible to an illiquid marketplace due to the nature of this downturn and the kinds of jobs lost with the death of wall street. All in all though, no product type will be immune to this downturn. How fast a property must be moved will become central to 2009's level of sell side competition. If 2009 is the year that sees the distress really come out, then we should expect at least some level of fierce sell side competition as the cycle progresses here in Manhattan. After all this is a wall street city facing a wall street centered crisis.

Taking a step back for a moment, we are in the initial snap down from peak right now, and this is the fastest and most furious phase of the bubble correction (when the bids just seem to disappear, so to speak). By Fall of 2009 I would expect the majority of the furious initial adjustment to be complete and price drops thereafter to slow in pace and be more dependent on the level of desperation of the seller. Just like nobody could tell exactly where the top would be, nobody will be able to tell if we ultimately overshoot on the downside either.

As we near 'fair value' or what buyers perceive as 'fair value' for Manhattan properties, we will see sales volume start to stabilize; in the end I expect more of an 'L' shaped adjustment in prices. Right now we are trying to find that base of the 'L'. I don't buy into a quick 'V' shaped adjustment & recovery because of the nature of this recession and uncertain level of regulation coming to the credit markets. I often ask myself, what fundamentals are near that will drive real buyers back into this marketplace en masse, willing to pay a time premium again based on comps. Right now the only silver lining I can find is in ultra low interest rates as a result of fed meddling; and (a) I think this is temporary and not without its risks that I get into below, and (b) I don't think this overpowers the negative fundamentals causing buyers to remain sidelined and sellers forced to move property. You can't force buyers to buy and you can't force lenders to lend. As long as this market remains illiquid on the buy side, a negative time value is likely to be placed on open market properties and loan appraisals; which in essence, defines the down cycle.

My concerns beyond this lie in the perceived quality of life and the actual quality of life here in Manhattan, as the side effects of budget gaps ultimately result in service cuts and higher taxes. These effects that are perceived by families w/ kids, speculative investors, current homeowners, foreign demand, future buyers, etc.. won't be clear until 2010 or 2011.

THE FED - Well, there is no more room left to cut rates. The fed will be forced to engage in more lending facilities and quantitative easing from this point out to address the crisis/slowdown. Expect it to possibly expand to home builders, commercial, credit cards, student loans, auto loans, etc., as everyone looks for a piece of the TARP pie. I really wonder whether a very big bank will have to be nationalized or not; Citigroup being the biggest question mark. For 2009, here is what I expect:

1) Second round of TARP will be used like the first, most going to inject capital directly into the major banks. The remainder, say $75Bln-$100Bln, may be saved to help other sectors, smaller banks, big developers, autos, homebuilders, and whoever else they decide to be worthy of taxpayer rescue.

2) Obama's fiscal stimulus will be near $1Trln, and will focus on jobs, infrastructure, homeowner relief, foreclosure relief, some pork, and who else knows what sector they feel like including. As with most gov't packages, we must question how efficiently funds are applied, used, and when the goals of the program are actually achieved. Will it take 6 months, 12, 18? In the meantime, how deep does the recession get?

3) TARP II or RTC like program to directly take on distressed assets from the big banks? As the first $700Bln goes to recapitalize, and the next phase has the fed focused on getting the system interested in taking on riskier assets by driving up treasuries, the final phase may be to rid the balance sheets of the spreading toxic assets. Lets be real, as the problem spreads to alt-a, prime, helocs, credit cards, auto loans, lbos, option arms, etc.., more and more assets are becoming toxic as deflation continues. The final phase may be to just transfer these toxic assets from the banks to an RTC like vehicle. I'm not for gov't intervention, just telling you what I think is possible. Maybe this program is another $700Bln, who knows.

Ben wants to inflate, and is famous for his 'printing press' speech. The real question is how deep the quantitative easing becomes, and how much uumph they pump directly into the system. As this money goes in the front door, the shadow banking system is seeing the destruction of assets through the back. So, looking at a chart of the adjusted monetary base surge is kind of misleading. The 18 credit facilities were more to liquefy the markets so they remained operational.

I will keep an eye on the slowdown in velocity of money, adjusted monetary base, and reserves held by depository institutions throughout 2009 to see how this unprecedented fed actions hit the money supply, how often money is used within the system, and for banks reserves. There are no free lunches, and ultimately the fed will have to wane the system off these measures!

Will 2009 be the year for this? Hmm, hard to tell, certainly not the first half of 2009. For now, it seems large purchases of mortgages and treasuries are in the works. But by the end of 2009 we may see the fed pull back the reins on some of the lending facilities. I wonder how the system will react?

Back to 2009, what is interesting to me is when the markets may start pricing in future rate hikes and removal of credit facilities. In short, how long does the fed keep rates between 0% - 0.25%? I would expect for at least most of 2009 as macro data is lagging and will continue to deteriorate as an after effect of this credit tsunami. As long as unemployment is rising, and the job losses mounting, the fed will remain in 'stimulate' mode. If they hike significantly earlier then the lagging unemployment's peak, well, Volcker probably smells something he doesn't like!

STOCK MARKETS - Exactly one year ago I predicted a negative year for stocks and it turned out I was way too optimistic! With markets down about 35% or so for the calendar year, we have to wonder whether the market has discounted the current deflationary environment. We also need to wonder how all the fiscal and monetary stimulus will ultimately help to reflate the stock market.

Given such a huge move down already, I'm not as bearish on stocks as I would normally be for 2009. However, I do expect a few more rounds of forced selling amid hedge fund redemptions and more deleveraging before all is set and done. Lets not forget about all the securities on review for downgrade, and the lagging nature of Moodys and S&P to downgrade the credit rating of corporations. This will most likely occur during the first half of 2009. I think 2009 will see many HF's close their doors and who knows how many more "Madoff Scams" there are out there yet to reveal themselves; the cockroach theory usually proves correct in times like these. Making a call today on where we may be at the end of 2009 is so tough, given the highly volatile markets and the huge selloff we had already. But this is a game and I'll play.

I expect stocks to have a rough first half, but perhaps find a bottom sometime before mid year. Whether we muddle around for a while, who knows, but by mid year I would say most of the volatility will be over and it will be slow and boring for a year or two afterward as we deal with the stubbornly lagging macro headwinds and main street pain of this crisis. It will seem like the economic data doesn't get any better and most analysts will look for a silver lining in a 'slowing down of the bad data', for signs of stability.

All in all, I would expect us to end 2009 slightly negative again, because I would think that any rounds of forced selling will overpower any rounds of rallying later in the year. But, time is what we need and I am getting less and less bearish as this cycle plays out. Just keep in mind one very important thing:

Those buying stocks because P/E valuations seem cheap as stock prices plunged, watch out for the 'E' in 'P/E'! Sure, stocks may look cheap now based on already lowered analyst expectations for future profits, but one thing is for sure and that is we have NOT seen the full effect on corporate profits from this very severe and drawn out credit crisis. I fear that real earnings in the future may be significantly lower than already lowered analyst expectations, and that means the valuations that appear cheap today, really aren't!

JOBS - The dark days of job losses are here and I think Manhattan is in the early stages of our local slowdown. Expect ugly jobs reports from Manhattan firms for the first half of 2009, especially as forced merger deals close and headcount is reduced.

As Manhattan handles its own slowdown, the combination of tight credit, frugality & tough business conditions are likely to spread to retail businesses leading to further job losses as the year goes on. I'm not too excited about 2009 from a jobs standpoint and this is the sad after effect of the death of wall street. Nobody's job is safe and there will be victims here.

If Manhattan real estate continues to be pressured, consumers in this city, especially the big spenders, will feel less wealth and that negative wealth effect is likely to cause frugality to set in. As a nation of spenders and credit, saving is not the best dynamic for businesses. If frugality sets in as Jeff & I expect it to as this process plays out, many of Manhattan's businesses will see a noticeable drop in demand for their products/services. Nobody likes a slowdown, and this cycle is no different. But lets keep it real here and understand that this is my opinion on what I see for 2009. Trust me, I hope I am proven wrong in hindsight!

INFLATION - We are fighting a deflationary spiral right now and the fed/treasury are throwing everything they have to stop it! Time will tell how successful they are. While markets will do what markets want to do, it's proven to be very difficult to control market forces by intervention. While the powers that be try to inflate, I think most of 2009 will show deflation continuing. The question is the back end of this cycle and if inflation will rear its ugly head as a result of super aggressive fiscal and monetary stimulus. I think that is a late 2010 - 2011 problem, at the earliest. Expect 2009 to show the after effects of this deflationary environment.

While treasuries prove to be the safest bet in times of deflation, I think the treasury market is in the 'silliness' stage of a bubble. How long it lasts and how big it inflates to is anyone's guess, but I do think when the party stops we could very well see a sharp and fast surge in rates. However, I would not put the treasury bubble in the same category as the tech bubble of the late 90s or oil bubble of 2007/2008. It may last much longer than these bubbles did before rolling over. Looking ahead, the question is how this ultimately affects borrowing costs just as the economy tries to recover from this crisis. It could be a big unintended consequence of polices taken to combat this deflationary spiral.

DISCLAIMER - I'm not always right, I am no messiah, and I never ever claim to be! UrbanDigs.com, since the very beginning, has been a way for me to 'speak out' on how I feel about the macro economy and the Manhattan residential real estate marketplace. I tell it how I see it, and nothing more. My true background is with a momentum style of equity trading as I was a NASDAQ equities trader with Tradescape from 1998-2004 and have been following the markets since 1990. I learned a lot along the way and I feel I have a much deeper understanding now, than I did 10 years ago when I started trading professionally, but that does NOT mean you should make any investment decisions based on what I say here! Talk to your financial adviser for that. As for buying or selling real estate here in Manhattan, no one can time the market perfectly and you should always take into account your unique financial situation and needs. So, if you are thinking of buying now, consider your job security, liquid assets, salary, timeline to own, and whether you can afford a product that meets your needs rather than day trade housing and waiting for the perfect entry point! Real estate investment decisions are very personal and everyone's situation is unique. With that said, I welcome any comments regarding what I said above!!

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