Shock & Awe! - NOI Gets Bombed
Noah and I have been talking ad nauseam about the imminent threats to the New York City land market,
Unfortunately we were right and the world of "...New York is the capital of the universe, we never got overbuilt, they ain't making any more land on the island..." is now colliding with REALITY!
It's lights out. The shock came with the demise of Lehman Brothers and the subsequent stock market crash. But you are about to see the Awe. Or, as Brando says in Apocalypse Now, "The Horror....The Horror".
Just thumb through the latest issue of The Real Deal and you will see that most of the sales professionals in the real estate market have finally started to get real about their expectations. There is still a glass-half-full-mentality and downplaying of the bad news, but sprinkled in with the positive sound bites are some honest comments about the outlook. The denial is over. Here are a few select quotes on topics ranging from the outlook for the real estate brokerage business, to condo development, hotels, office and the retail markets:
Check this latest commentary by the top building broker in New York City in terms of volume - pay attention to the facts not the spin. If this is what the folks who are habitually positive are saying....guys like Noah and I - who have been warning for almost 18 months about the dangerous imbalances in world economies, markets and the New York City real estate market - can now go a step further and say the debacle we feared is now in progress.
BEWARE OF DECELERATION TRAUMA!
This week's Crain's New York Business features an article Stress and the city, subtitled "New York is gripped by fear. Are we headed back to the bad old days of the 1970s." Now I am by no means suggesting that we are heading back to the those days, but these fears are based on the realty of unemployment, declining business profits, declining real estate profits, declining tax revenue, declining services and a declining quality of life quality. We called the peak in NYC quality of life several months ago in a piece entitled Is The Bloom(berg) Off The Big Apple so for Urban Digs readers this not a new concept.
In my opinion the next 3 -5 months is going to see a huge step down in prices across the board in New York City real estate both commercial and residential to reflect the coming declines in personal income and Net Operating Income from owning real estate. Don't let anyone tell you otherwise. As a result of declining operating performance of real estate properties, the weak (over-levered) hands are going to either fold on there own or be forced to fold. A significant part of my business is financing commercial real estate and I can tell you that there is very little financing available and what is available is aimed at loaning to own or de-levering over-levered but high quality properties (if you have need for bridge or mezzanine financing or partner equity aimed at de-levering a property or getting to income stabilization we can help). Financing for construction is all but un-available and financing for acquiring properties is only available at very low leverage levels, largely for ultra-safe multi-family property and essentially only to those who don't need it. With a decline in the profitability of operating real estate just unfolding, few want to speculate on how bad it will get so providing debt will only be done with a large margin of safety in debt coverage (particularly in the case of the remaining portfolio lenders) and/or collateral value (particularly in the case of hard money lenders). Purchasers of equity in properties can't get much leverage to do it even if they wanted to and are demanding big discounts to provide their own margin of safety. Anyone doing a "market rate" transaction, just hasn't gotten the memo yet.
We are about to see the same series of events we have seen in other markets around the country that led the way down on the residential side. First comes delinquency, then foreclosure, then the bank gets in trouble and finally when the bankers are fired, new bankers come in and punt the properties. Transactions are driven by "foreclosure buyers" and if you are not a distressed seller, you are just out of luck. We are going to see this process unfold in New York City in a compressed time frame. You see in Florida and Nevada the delinquencies were happening before the actual economy turned down and joblessness started to soar. Banks had not marked to market away as much of their capital bases and world markets had not crashed, so when investors went to the banks looking to buy shaky loans at a discount the banks resisted. In New York City, only the small local portfolio lenders will be able to hold on to REO (real estate owned) and hope to parse it out over time. I am already hearing that one of NYC's premier local portfolio lenders is liquidating their bad construction loans.
RESISTANCE IS FUTILE
CMBS financed properties and large bank-held properties will be being puked widely by the second half of this year. The credit rating agency Fitch has identified 1,100 fixed-rate CMBS loans that need to refinance on or before June 30, 2009. They will likely be transferred to special servicing where the holders will be able to extend maturities, while praying for a miracle - and that's the bull case. Most of these loans were performing well and could have been refinanced in earlier times: however, with the credit crunch and economic downturn, no one wants to touch this stuff. The point being that even reasonable assets and deals will have trouble being refinanced; forget anything with issues (and issues will be widespread). When you talk about New York City and you look at vacancy rates soaring for office space and retail, hotel guest counts plunging and partially sold condos that have to go rental you are talking about major pressures on Net Operating Income of the properties and not just cap rate expansion (where investors are simply demanding higher returns on their money for existing cash flows because money has gotten more expensive). Now investors are going to demand higher returns on their money while factoring in declining cash flows and property prices. This is what causes the big markdown in prices in a market. It's a familiar cycle in the stock market. In a bull market, price earnings ratios sometimes compress due to fears of a slowdown or higher interest rates, and you get corrections. In a bear market, P/Es get compressed and the E (earnings) get slaughtered, thats why stocks get bombed out. We are about to see real bear market action in real estate. As a market that is discontinuous and doesn't trade daily or smoothly, you should understand that when Wiley Coyote realizes he has run off the cliff, the first step down is a doozy.
The stealth transmission mechanisms will turn higher vacancies into lower rents and lower transaction volumes into lower prices for residential units despite people's difficulty imagining how everything works in reverse after such a long bull market in real estate. When people lose their jobs some have to move in with other family members, they don't just become renters or move downscale....demand is destroyed.
Grab a bunker and some tinted glasses Manhattan project style!
Comments (25)
Allow me to share this piece of information about the state of affairs in the Dubai Real Estate market.
Well the Dubai real estate market was fueled by speculation that prices would rise, and the middle men kept jacking up the prices. This had to definately happen but the global financial crunch was pretty much responsible for striking the fear that was the final ingrediant into the hearts of Investors in the U.A.E.
Dubai is simply cash strapped, Abu Dhabi on the other hand is sitting on mountains of cash meaning Abu Dhabi investors are going to make a killing.
I have been following the Dubai Real Estate Market and the DFM since the last few years and i find the next few months to be extremely exciting..
Posted by Dubai Real Estate | January 8, 2009 8:44 AM
Dear Dubai,
So glad you are reading Urban Digs. I know a lot of cash rich investors who are licking their chops regarding NYC real estate. But they are also waiting very patiently for big discounts. I have a current deal where with a little help the developer could snatch victory from the jaws of defeat and return a very good return to a JV partner on a project that is > 90% completed, due to a very low basis cost in the project. But 80% of the investors I talk to don't want to get involved in a project they are not buying from the bank at a good discount from par value on the loan. In many cases this equates to 50% of project cost or less. OUCH! that's quite a markdown. My bet is that buyers of stabilized investment properties will soon be looking for large discounts as well, due to declining NOIs.
Posted by jeff | January 8, 2009 9:21 AM
great piece, Jeff.
So true, I am a broker and when I tell people I meet that prices will drop at minimum 50%, they tell me I'm a fool.
No, I'm no fool, nor are you. The psychological adjustment will be rough for sellers and brokers. But we are in for very hard and bleak times.
If you have a little cash, you'll be able to pick up condos which wer going for $1.8 for $700-800,000.
Posted by Anonymous | January 8, 2009 9:26 AM
Anonymous,
I have a piece coming out on why 50% down is actually a conceptually well founded number for the price adjustment considering that there will be property liquidations. Stay Tuned.
Posted by jeff | January 8, 2009 9:47 AM
$500 PSF is my bet as an average.
Posted by Fred | January 8, 2009 10:20 AM
"Grab a bunker and some tinted glasses", great visual. It surely will be interesting to look back at this post a year from now. Well said.
Posted by jim m | January 8, 2009 12:32 PM
Yup, Jeff and Fred, anonymous again.
$500PSF is right on target.
and Jeff, I'm saying that the crap on the market for say, $1.7, should ultimately sell for no more than say $800,000 maximum, maximum.
Posted by Anonymous | January 8, 2009 12:36 PM
I can't resist patting myself on the back, I discussed the reasons to support a 30%-50% price reduction from peak approximately 3 months ago on this site. I also mentioned that I thought the decline would be rapid. Nice job, Jeff, carefully thought out analysis. Looking forward to your next piece.
Posted by SRealist | January 8, 2009 1:59 PM
Down 50% is the new down 25%. Noah, when are you going to get on board with this?
Posted by monte | January 8, 2009 2:48 PM
well i do agree the prices will come down... i am wishing it will come down, i am waiting on the side lines.
but i'll believe it when i see it.. 50% drop... i hope and wish, but i haven't seen it yet. not in good areas of manhattan at least.
Posted by baileybee | January 8, 2009 3:03 PM
What does everyone think about prime mahattan? I'm talking about good quality high end condos in great locations in desirable neighborhoods.
Da da da da da ... I'm lov'in urbandigs.
Posted by PrimeHattan | January 8, 2009 3:09 PM
How can we profit on the short side given that NYC property will fall 50%? How do you structure an investment that will profit from it? Thanks.
Posted by iven | January 8, 2009 6:33 PM
Jeff, You wrote a few posts this year about the situation in Harlem. I wrote then (and still believe) that you were more optimistic about Harlem prices holding up than the facts warranted. Needles to say, the world has turned upside down since your last post on Harlem. In light of the predictions in some of the comments on this post about drops in the 50% range, what are your current thoughts about Harlem? Do you think condos asking 1.7 million there will be available for 700-800K, as some are predicted of properties elsewhere in the city?
Posted by cherrywood | January 8, 2009 6:38 PM
Jeff, You wrote a few posts this year about the situation in Harlem. I wrote then (and still believe) that you were more optimistic about Harlem prices holding up than the facts warranted. Needles to say, the world has turned upside down since your last post on Harlem. In light of the predictions in some of the comments on this post about drops in the 50% range, what are your current thoughts about Harlem? Do you think condos asking 1.7 million there will be available for 700-800K, as some are predicted of properties elsewhere in the city?
Posted by cherrywood | January 8, 2009 6:41 PM
50% down is where we need to go for the rent/own ratio to make sense. How long will this take? 3 years?
Posted by samnyc | January 8, 2009 8:43 PM
Question:
Is Wall Street to NYC as Automobile Mfg was to Detroit?
If Wall Street is being dismantled as we speak, might we expect downtown NYC to look like downtown Detroit in 10 years?
Seriously. I like to think I'm waiting on the sidelines (have been for a decade!), but that's a two-way street; if I still have a stable job when prices get affordable, i'm in; but if the 70s are coming back (been feeling a wierd ill-wind at the herald square subway station) the sidelines are the last stop on the way out of town. the next year will be interesting.
Posted by pessi-mist | January 8, 2009 10:00 PM
It is nice to see "mainstream" real estate observers starting to recognize the real estate collapse. But other sites, like www.patrick.net have already accurately predicted this since more than two years ago.
Posted by Man-Hatten | January 9, 2009 12:25 AM
iven - One way to profit fron the impending NYC real estate decline is to short SLG. An insider sold a big chunk of stock on December 30th.
Posted by cptulip | January 9, 2009 6:38 AM
One of the biggest lies about Manhattan real estate is that there is no place left to build. How about tear downs of tenement buildings, gas stations, parking lots etc....Plus we are a vertical city. I would posit that there are more places to build in Manhattan then in the 'burbs.
Posted by cfranch | January 9, 2009 8:24 AM
Man - Hatten - we have been talking about this in depth since mid 2007. And Patrick.net is a great site that has earned lots of credibility discussing the issues we face.
Its the eternal optimists and ones arguing against anything other than a normal recession who have been consistently dead wrong
Posted by Noah | January 9, 2009 8:36 AM
Cherrywood,
I was early in saying that Harlem, Brooklyn and Long Island City would be hit hard by the coming NYC real estate decline. I was mistakenly more sanguine on Manhattan proper, though less optimistic on downtown. I still think UWS and UES will hold up best, but was has changed in my mind is that the overall economy is tanking rapidly above and beyond the Wall Street damage. Despite rates coming down credit is still incredibly tight and most importantly....and really the reason behind this post...the commercial real estate debacle coming to NYC is about to blow another big hole in bank balance sheets. My comment about the 50% decline not being totally out of whack has to do with a piece I am going to publish today. I am on the record calling for a more mild 40% decline, which I think will hit the $700k to $3 million segment hardest and the emerging growth markets like Downtown, Harlem, Brooklyn etc. hardest.
Posted by jeff | January 9, 2009 8:57 AM
Great post. I could not agree more. One development I have been writing on is the coming migration of families from Manhattan to the suburbs. As quality of life continues to erode, those families with means will leave Manhattan for Westchester/Bergen County, thus putting a floor on prices there probably in early to mid 2010.
Remember, prices in Bergen county began to appreciably decline starting in 2006, so as of now, prices have come down approximately 30% off peak. However, unlike Manhattan, these towns were not over built, so there is not a ridiculous amount of inventory, nor is there a thriving rental market for comparable living units. To be sure, negative economic dynamics in Manhattan will effect the suburbs, but again, the suburbs have been declining for years.
Posted by mh23 | January 9, 2009 9:58 AM
@mh23,
Families in NYC have to either shell out big bucks for a 2BR apartment once their second child arrives (when they tend to be young and least able to support such huge purchases) or move to the suburbs.
There is downward pressure on NYC wages. And many of us will likely be hammered by Obama's tax the "rich" strategy, especially when combined with NYC/NYS tax increases to plug budget deficits.
The next 2 years will be ugly.
Posted by Thisson | January 9, 2009 12:07 PM
New York is a great place. But I hope this issue won't affect its "class". I mean, I love New york and I often go there for a New York dating excursion. But now, I can't really imagine New York city market devastated.
Posted by alex | February 18, 2010 9:26 PM
Interesting real estate blog and I will do some research to learn more – keep the good work
Posted by Aventura Houses | April 24, 2010 2:03 AM