Zombie Condos: The Falcons' Prey
A buddy of mine from an old New York City real estate family recently returned from a trip to Florida. He's been quite bearish on all things real estate having sold much of his family's multi-family portfolio in New York City over the last few years. He has kept busy since, helping others do financings across the country and has had a ringside seat to the unfolding debacle. He has been ahead of me most of the way through this in predicting massive commercial real estate losses and an eventual mass expunging of debt through the foreclosure and REO process. He called me today and said "have you heard about the Miami Falcons?" Now I'm a football fan, but not a fantasy aficionado. Surely I hadn't missed news about the Atlanta franchise relocating. "No" he said, it had nothing to do with football. "The Falcons are the only tenants in the penthouses of all the new empty luxury towers in north Miami Beach. They hang out on the roofs looking out at the nature preserve for rats to swoop down on."
Well I've been doing my own Falcon routine here in New York, working on a catalog of zombie condos that could potentially make good rental buildings if purchased from the bank financiers at the right prices. The theory being that any condo project that has not sold out and closed on a substantial number of their units as of today is in grave danger of becoming a zombie. A zombie being a condo, where some of the units have actually closed, but the condo developer is likely to default on their construction loan: the bank is likely to come in and take over the building and rent up the unsold units, finally selling the building to an investor, who would run it as a rental until such time as value could be maximized by selling the rest of the units.
The problem with partially sold condo projects today is threefold: first, many folks who have not closed on new condo purchases are trying to get out of contracts; second, many units won't appraise at the contracted value (and therefore will not be eligible for mortgage financing or will have to be re-negotiated by the sponsor) and lastly, with Fannie and Freddie no longer allowing conventional mortgages in condominium buildings in which less than 70% of the units have been sold, most lenders for jumbo loans have taken the same tack, essentially killing any projects in this position. I'm not finished with the project, but enough of the results are in to report back a couple of findings. To cut to the chase for those of you who don't want to geek out on the varied aspects of the data; there are not that many zombie condos lurking in Manhattan's future from the analysis I have done so far. However, those that do exist had high expectations for sell-out prices and significant amounts of leverage employed, such that however their situations are resolved....it's gonna leave a mark on someone's balance sheet.
With that, first some background on my methodology. I went back and got all the condo filings for Manhattan for the period June 2007 to June 2008. My thinking being that in order to market a condo you had to make your condo filing, and only a developer who had gotten their construction loan and was somewhat into the process, would spend the money and go through the trouble of filing their condo plan.
At the outset of my work I spoke with an attorney from one of the biggest New York law firms about the condo filing process....she judiciously requested to go nameless, which I am sure her very large and active clients will appreciate her for. I was told that while a sponsor must file their condominium offering plan in order to begin signing contracts, this does not in any way suggest that ground has or will ever be broken. On the other hand, a significant amount of construction may have taken place before a filing is made. Once 15% of the units have been sold, the plan can be declared effective, but it doesn't have to be until 80% of the units are sold.
So here are the early results. There were 182 residential condo filings made in Manhattan between June of 2007 and June of 2008 and recorded in the city's database system. These filings do not guarantee that the project was a new ground-up development as many were conversions from rental to condo, and many of the filings were not initial filings (the city's database is something of a blunt instrument and you can't really screen for initial filings). So while 182 sounds like a big number, not all of these were "brand new" projects. Additionally, the median number of units in these buildings was 16, and the average was 55. Notably, a few very large projects drag the average number up significantly.
Of the filings that were made over the period, price expectations were only included in 141 of them. This is likely because a good number of the filings were not the initial filings, but were supplemental filings; in some cases when prices were changed the expectations were included, in other cases where the filing was for other reasons, they were not. In any event the mean price per square foot expected was $1,134, with the median at $1,200, suggesting some very low-priced projects were skewing the average down. Now please understand that these filings were from all over Manhattan from Harlem to downtown. It is still interesting to note that the $1,000 per square foot threshold is increasingly being breached to the downside even in more desirable neighborhoods in Manhattan, according to recent reports.
Now for my purposes - targeting potential bank REO - the acquirers will be looking to value these projects as rentals. There are two issues here. I previously discussed the dire consequences for valuations that this perspective implies in my piece Zombie Condos: Day of the Charge-Off . Suffice it to say, that values of rental properties are way lower than condo project values and generally way lower than construction costs (that's why very few people can afford to build rental buildings in New York City). Secondarily, an acquirer is really going to look for a project with enough scale to make managing the asset economical. So only buildings with 40 or more units are really worth looking at (give or take.....don't anybody get mad, of course smaller guys who are willing to roll up their sleeves and manage the properties personally can go much lower). There were only 48 developments with this kind of scale. Of the 48 developments of scale, I narrowed the field further (actually Noah did the work for me here) by eliminating those where the New York City MLS system showed that more than 70% of the units had been closed. I also eliminated projects by the city's very largest developers, who I expect will not be forced to cough up their projects regardless of how underwater they currently appear.....to be sure, some may choose to "give back the keys" anyway, but I'm not assuming that. This process left 26 potential target properties. I was able to use the city's database to find out what the outstanding debt was on these properties. This requires a somewhat torturous odyssey through various mortgage filings. In my short experience looking through mortgage spreaders, blanket loans etc, etc., I believe that my data reflect the minimum debt on these properties and that in many cases the total debt may in fact be greater than what can be easily identified. Interestingly, the debt per square foot of residential space averaged $515, with a median level of $441, reflecting a few highly levered projects, dragging the overall average up.
Now I know of a few projects that are in progress, and are so far along that the structures will be finished, that did not fall into my screen of condo filings between June 2007 and June 2008. I am therefore going to bring my study of condo filings up to current day over the next few weeks. I will report if I find anything radically different. I am also going to study the zombies of Brooklyn, which I'll bet promises a lot more gore.
Guild Partners is working with real estate investors interested in distressed opportunities in New York City. We even have access to a new "Real Estate Falcon's Line of Credit" that can get building owners set up to make cash bids on opportunities that raise their heads without having to go to hard money lenders or wait for traditional bank credit approval processes. Let us know if you're a Falcon! (we prefer the graceful raptors to vultures anyway).
Comments (18)
Jeff-
Great research- as usual. Hope you find more opportunities in Brooklyn. I am not a real estate pro, but do have capital to invest. Please bear with my rough math -
Assuming you can rent out a 800sq foot 1br apt for $2500/month, common charges of $1000K , it gives investor pretax income of $18K per annum.
Now investment grade corp bonds are yielding 8-9%. Even unsubsidized debt these days costs 7-8%, so cap returns need to be at least that.
Assuming that investors will look for 7-8% yield, that equates to $250K ($320/sq foot) of buying power for the apartment. That is less than debt on these apartments. Do you see a one br condo selling for these numbers any time soon? It will take years. What am I missing? What cap rates do you think investors expect from residential real estate.
Thanks for your insights and please keep up the great work you are doing at this blog.
Posted by Valueseeker | April 15, 2009 10:45 AM
ValueSeeker,
I love your analysis. I really look at it from the landloird perspective. And you nail the point that as rental building investments, including a worthwhile return for your troubles...including rent up costs, etc. These buildings will have to be purchased from the banks at steep discounts to construction costs. I pencil in 7% as a cap rate for starters these days, but I think that is going to 8% as investors get more and more shell shocked by the commercial real estate implosion.
Posted by jeff | April 15, 2009 11:15 AM
Jeff,
Interesting, does your friend think its time to buy distressed Miami?
I have friends in the financial industry down there that keep tabs on things and I visit a few times a year. Our discussions lead us to think its still too early due to overhang of high property tax rates and unknown maintenance fees due to unfilled buildings. Oh blacklisted buildings for mortgages dont help.
Thanks.
Posted by iven | April 15, 2009 11:23 AM
Good work. Any thoughts on the Newport/Hoboken area right across the river in Jersey? The whole area seems to be more "ripe" for zombie condos that Manhattan. A lot of speculative building is still going on.
Posted by In Debt We Trust | April 15, 2009 1:44 PM
Iven - A couple of issues there. In terms of it being time to buy distressed real estate, you have to differentiate between buying a condo in a vacation area to use it/rent it/flip it in a place like Florida versus investing in income producing property in say New York City or Hoboken. In Florida as an individual buying a condo for an "investment" I can't give a lot of specific advice and my friend isn't in that game. I would comment that there is a huge amount of new supply, tourism is down and there is plenty of competition from hotels, so you would have to be willing to be a long-term holder. As far as buying entire income producing properties I think New York has some advantages over a place like Florida.....but it's all about price. Outside of New York City and some other unique markets, multi-family occupancy is horrific, much worse than many people would have expected. People figured that when housing crashed current tenants would continue to rent longer and those new homeowners were foreclosed on would go back to renting. What they didn't anticipate was the rentals of homes by short sale buyers and people leaving rental buildings or rooming together due to the bad economy/job losses. In short occupancy in multi-family assets has gone down, not up. Also condo buildings in many markets have been repositioned as rentals adding to supply. In many markets multi-family is in a world of hurt and in fact delinquencies on multi-family loans to building owners are running ahead of delinquencies on retail and office properties, believe it or not. New York City is a different story. It is a tight market in terms of supply, but the economic downturn has impacted Wall Street so severely, that demand has been crushed, so even here occupancies and rents are down. A small number (relatively) of zombie condos will come back as rentals and in some neighborhoods, where they are concentrated rents will get creamed (Williamsburgh) and maybe Hoboken, etc. However, the strong supply/demand balance (outside of the suppression by the poor economy) argues that as things normalize over the next few years, these assets will be well occupied and rent increases will again exceed inflation. Here it is also all about price though, if you can get in to a NYC multi-family property at a higher cap rate (based on real current NOI) than you could buy a property in Miami, I would go with New York City. Many would differ with me and say New York has peaked, will never be the same and is going into a downward spiral, while Florida will always attract retirees and folks from latin America....I'm not yet in that camp.
In Debt....I will try to get some more info on Hoboken, what i have heard peripherally is in keeping with your comments.
Posted by jeff | April 15, 2009 3:31 PM
Jeff - fantastic post. So the picture, while not rosy, isn't entirely doom/gloom for Manhattan projects. Certainly, there will be pockets of hurt, but it seems you are confident that the demand/supply math isn't totally out of whack as it is in FL and other areas that inflated primarily out of speculation (as opposed to NYC inflation which was caused primarily by massive income growth).
Look forward to seeing more of your research/thoughts on this topic.
Posted by OT | April 15, 2009 3:59 PM
Jeff,
Thank you. I took the PATH train to Newport /Pavonia about 2 weeks ago and walked around. The area seems to attract more of the younger professional working crowd and their families (lots of E. and S. Asian immigrants). Not sure what the occupancy rates are nowadays but the condo neighborhoods have a very transitional "feel" to it.
Posted by In Debt We Trust | April 15, 2009 4:57 PM
In Debt:
10 of the buildings in the 'Newport/Pavonia' area are rentals and only 2 are condos. It comes to 85% rental 15% condo and the condos tend to hold up better in value because the Newport developers (Lefrak) constrain the supply so tightly.
Walking south along the main drag of the Jersey City waterfront however, you can find lots of condo buildings which are in panic mode, slashing prices, inventing incentives and scrambling with lenders. Of course, the walk to the PATH from those buildings is farther, and hence the natural value should be lower reflecting the less convenient commute.
Good luck finding a great bargain!
Posted by Out there looking | April 15, 2009 6:59 PM
I'd love to hear about NJ as well. Ever since I visited a "fantastic apartment building" found in a "quiet location" near a "main street" a few years back (a hole in the wall, next to the train tracks, about 4 blocks from any main artery) my curiousity has been peaked. I'd really love to find out about East Rutherford's Xanadu and what implied impact that is supposed to have on the surrounding area. It's totally out of this website's domain but I can't seem to find reliable sources of information of the same caliber found here elsewhere on the internet. Personally that Hancock Tower deal in Boston made me envious.
Posted by MeekSheep | April 15, 2009 7:52 PM
Jeff, Thanks for the reply. Seems like cap rates still need to go up, or if you want to buy a home in florida or nyc for personal use alot of supply needs to work thru. Todays Bloomberg interview with Sam Zell was typical. The news summary ran it as a real-estate positive story, meanwhile as I watched the interview Sam's tone was very negative, stating that some large real-estate projects need to leave current hands who overestimated them. No transactions now, hes waiting for that sale and big markdown price. Interesting.
Posted by iven | April 15, 2009 8:38 PM
OT,
I would have to agree with you. New York is such a warped place due to zoning, rent control, etc. It is basically supply constrained in terms of free market rental product, but land prices and construction costs are so high that it generally has not made economic sense to build rental buildings except in economic downturns on land bought from the Indians. So its got that going for it. Condo prices rose to the point where it made sense to build (highest and best use) and the same thing happened to hotel room rates/hotels, they rose until it made sense to build. Being a pretty efficient market land prices rose along with these end markets, to the point where profits on building on the high priced land were largely contingent on continued rises in sell-out prices. Well sell out prices peaked and rolled over, land prices have crashed and half-built product is doomed to be revalued much lower as rental stock. But land is cheap again and will soon justify the building of projects that will begin selling in a couple of years.....smart, deep pocketed developers are at work banking land for future growth.....oh too be one of them. NYC is in no way analagous to Florida. We have a demand problem, the biggest worry is if quality of life declines/crime rises, further dampening demand, and if people were to flee the city as a result.....it's way too early to make that call in my mind, and yes we will be blucky to keep Mayor Bloomberg on to insure that this does not happen.
Posted by jeff | April 15, 2009 8:40 PM
Why didn't you include the largest developers, for example Extell. Yes they have deep pockets, but they also have the greatest inventory.
Posted by Anonymous | April 16, 2009 9:17 AM
The cap rate for condos should a little lower than corporate bond ylds because there should be an inflation protection premium built in. I would add 2-3% inflation premium to it.
Posted by Anonymous | April 16, 2009 4:32 PM
I think the larger spectre for Zombie Condos is in Brooklyn & Queens, specifically in Williamsburg and LIC...
Posted by Anonymous | April 17, 2009 9:33 AM
Jeff , For Condos constructed during 2006-2008 what was the typical leverage employed? Extell was required to post 40% equity for Aldyn on Riverside blvd. Where does this fall in terms of the norm of 06-08 in Manhattan?
Posted by Anonymous | May 3, 2009 8:21 AM
I have an off market deal that my client just aquired and is willing to re-sale to another investor if they will meet his price. If not, then he will hold onto it himself for investment. Prime real estate property. ONLY serious buyers may contact me at lisa@pinnacle-investments.net. It will require a conference call interview with the Seller and an NCND.
Posted by Lisa Francis | August 30, 2009 6:12 PM
I have an off market deal that my client just aquired and is willing to re-sale to another investor if they will meet his price. If not, then he will hold onto it himself for investment. Prime real estate property. ONLY serious buyers may contact me at lisa@pinnacle-investments.net. It will require a conference call interview with the Seller and an NCND.
Posted by Lisa Francis | August 30, 2009 6:12 PM
As a new player, I might need some game guides or information to enhance myself for real estate. Anyway thanks for great real estate blog.
Posted by Miami Beach Condos | May 27, 2010 1:03 AM