Pricing in Downturn Risk May Lose A Dream Home

Noah - good post. You have stated throughout that deals will happen at all price points on the way down and on the way back up. I expect this is probably a seasonal uptick and despite my overall bullish stance on NY RE in the long term, we could still see some pain during the slower months.

I do feel some degree of vindication against the perma-bulls who predicted we would be down 50% by now - a deal just went to contract in my building down 6.5% from peak. Good properties in excellent neighborhoods at reasonable price points will move quickly, and I think the data continues to support this. And no, 25% from peak for a 1 or 2-bed property in a great neighborhood is not a reasonable price point.

that apartment looks real nice, so I would not be surprised to see it sell higher than what you say

now, I wouldn't pay that kind of money for this property if I could afford to bid on it, but hey thats me. wait a year and buy something similar for 2M

OT - guess you meant 'perma-bears'? Yes, nothing goes in straight line and there will be deals at every price. As for those who think we will drop 50%, that is a question of how bad our local economy gets and how this great city may change in terms of unemployment, empty retails, budget deficits, service cuts, higher taxes for businesses and consumers, homelessness, crime rate, schools, raising a family, and overall perception of quality of life in Manhattan.

These types of sociological changes impact a city, and its hard to turn that around. Thats the biggest fear and what usually brings a market from down 20 or 25% to down 40-50%. I HOPE THIS DOES NOT HAPPEN! I would like to see our residential markets reach equilibrium and adjust without the secondary damage to this city as a great place to live!

As for the deal in your bldg, I have to say great sale, or how do you do your calculations? Did you take into account floor premium (light/view factors), renovation premium (or discount), and market conditions discount for the analysis? Is it closed yet and public?

We could very well see -50% -- we are down significantly already, and the Government is engaged in shenanigans to prop up bank stocks so they can do 2ndary offerings and raise capital.

The NYC real estate market is tracking the health of the banking sector, so we could see further declines; or, there could be a bounce. It depends on the speed of bank earnings vs the speed of further writedowns.

I think a LOT of potential buyers are waiting on the sidelines to see whether we see tangible signs of inflation. That seems even more important than getting further price declines for buyers that plan to live in a place long term.

Noah:

Another great post, your point is well taken even by me (my wife insists I'm one of those perma-bears OT mentioned). My only thought is that with the increase in inventory (which, as far as I can tell, is mostly cookie-cutter), how many buyers are willing to risk further price declines? I can appreciate that a buyer would take that risk for a truly unusual space, but not for something fairly generic. This appears to be particularly true when you consider that there is still a large fundamental disconnect between rental rates and cost to own. Regards.

This post nails my situation. Last year we thought we'd be forced to buy in Inwood or Wash Heights. With this downturn, we are looking for a decent size 1/conv2 bedroom the UES. The prices are right in our range right now, the interest rates are good, the 8K tax credit looks nice and we do plan on staying for 10-12 years. The only thing holding us back is the 'catching a falling knife' theory. Any real-estate purchase would represent our primary investment. I am scared about buying a place, only to see the falling prices accelerate down. If we buy a place at $450K, will it drop to $400K in a year? That would represent $50K in equity that took us years to save up for. However, will interest rates go up? Will Obama renew the $8K tax credit? All these factors have our head spinning! With all that said, we won't wait past Jan 2010 to start putting in bids.

SRealist,

Is there really such a large discrepancy between rental rates and cost-to-own? What #s are you looking at?

A $600k unit at 5.25% fixed is about $2450 a month, plus maintenance (~$1000?). That's not so far from the rental price, all things considered, is it?

Noah or Jeff,

Any thoughts on high end mortgage modification?

I just came back from Phoenix and Scottsdale. I know they are not like NYC but there was talk about m.m. for high end condos, ranch houses, and mcmansions. Stuff that would normally cost $1-2 million was going for 50% off. And those homeowners (err...debt holders) who still held on were in somewhat...strained states.

"A $600k unit at 5.25% fixed is about $2450 a month, plus maintenance (~$1000?). That's not so far from the rental price, all things considered, is it?"

Hi Thisson. In fact it's even less than that because you get a tax deduction on your mortgage payment, as well as a portion of your maintenance.

in our situation (and our numbers are pretty close to teh example you are using), it was close to $1,000 per month off, which would bring your total cost of owning close to $2,500 per month.

Assuming no other expenses, you easily break-even on a run-rate basis compared to renting the same unit.

Noam,

i very much like your site. It's top notch.

However, this whole notion of trading real estate and a liquid market is really pushing it. Real estate is an illiquid market. Period. It was liquid for a few recent years but historically it is very illiquid.

I know you love trading stocks and bonds etc but Real Estate is not the same in my opinion.

batman - I couldnt agree more! That is why I have to put out stuff like this, because agent reports on 'HIGHER FOOT TRAFFIC' are misleading many to think this market is liquid again.

I said multiple times, that you can NOT day trade real estate, and you can not compare stocks to real estate. I dont believe this post counters that. This post accurately describes what I see out there right now.

batman - you bring up a good point so let me clear up further. YES, real estate is illiquid period unless it is a fantasy time like 2006-2007.

But there are levels of illiquidity that I can discuss openly. In my opinion, this market is way more liquid than it was only 4-8 months ago - still illquid but not anything like SEPT-DEC; people I think need to know this.

So, it does help to talk about just how illiquid the market is or isn't at any particular time. You cant offer daily updates because the market doesnt change daily - yet people need their fill. But if I notice a drastic shift in confidence or activity or other change, Ill write about it. But I agree with you!

Thanks, Marmotton.

Thisson and Marmotton,
Seems to me that your calculations of rent to own ratio are not taking into account closing costs and the various incidental costs of ownership, such as repairs. Plus, you have to consider the very likely probability of your investment (down payment) being interest free or worse for the foreseeable future.

anon - you should calc an opportunity cost for your downpayment + closing costs total in the analysis. Keep in mind tax deductions are great for homeowners, but the tax itself on owning is probably going to creep higher, not lower, over next few years as we have budget shortfalls.

It gets close if rents do not go down, but right now, they are and I think rents are down about 10-15%, after jumping about 50% since 2005 or so.

thanks for the comments. only in the hey day could you "day trade" real estate, now you need to find a place you like and bid appropriately and hope to live there.

i have never understood folks around my age (35) talking about making a fortune on their apartment. If prices go up and you are upwardly mobile (married, then have kids) you are always buying a bigger place and so the increase in prices actually hurts you more. very few (smart) people sold and then rented (although possible in nyc more than other places).

we rent and will look to buy in late 2009. I suspect prices will be lower than currently just because of the inventory overhang but not much lower.

Noah,

Thanks for the great post. It hits so close to home. I lost 2 great properties (1 last Fall and 1 this month) because I was not willing to pay 10% more. With the last property, I can't blame myself because I could not afford to pay more. In my situation, I had to price downside risk for 2 reasons (i) both apartments were estate sales that required a complete gut job (you can never predict with 100% certainty how much renovations will end up costing) and (ii) I will not get a lot for my apartment because I will have to sell in what I still feel is a fairly illiquid market. I know that this market is not as illiquid as last fall; however, I think this is true for a limited segment of the market (under $1 million is selling well and properties that are listed for less than 20-25% below peak will sell). The $2M-$3M market (the "trade-up market") is hurting because people can't trade up if they can't sell or believe they can't easily sell their starter home. Also, I think another reason to price downside risk is the expectation that with thousands of condo units expected to come onto the market later this year, inventory will be much worse and will put more downward pressure on prices. I do agree, however, that prices for truly unique, quality homes will not decline very much and if you find such a home, you should not lose the property by pricing downside risk in your bid. In my search, I have found many nice homes but not any "dream" homes.

Liquidity is not binary. There are, as Noah stated, degrees of liquidity. There is also high correlation between RE affordability and mortgage rates which in the medium term converge, period. Someone mentioned bank earnings as an indication of where RE prices will go. I totally disagree. Banks will not be earning much for the next couple of years - at least on a per share basis. A better metric may be the stock market because that is probably the most tangible source of wealth for Manhattan buyers and it would be a safe bet to say that folks aren't going to "feel" recovered in their portfolios for maybe another year. The bottom line is if one can afford to write a million dollar check today, why on earth would you put it into RE that at best will stay flat? The answer screams from the inventory levels. Folks aren't buying so the probability that one is overpaying at this point in time is huge. Noah, your example of this recent bid illustrates your integrity as a broker and how you save your clients from being underwater for the next 3 to 5 years.

Correct me if I am wrong but inventory levels are a leading indicator in NYC while quarterly sales reports are lagging? So until you see a meaningful drop in inventory levels, you can be rest assured that price activity will trend lower.

As long as the "low end" is defined as "Under 1 MM", I think it is a fairly safe guess that the market has not bottomed. If you need 20% down and 3x income, that is 200K cash and 265K income. How can that be the low end in a health real estate market?

Thisson and Marmotton:

Apologies, I hadn't been able to review your posts until now. To expand on Noah's point regarding the opportunity cost for your down payment: it's imperative to include a return for that investment. My personal approach in estimating what that rate should be is to assume that it's the same as the interest rate I'm being charged for my mortgage (many people would argue otherwise, and rightly so, but I believe it's the easiest number to generate). Then calculate the mortgage payment for the full purchase price of the apartment, i.e. 0% down payment (for the $600,000 apartment in your example, Excel shows it to be $3,312 per month at a 5.25% rate for 30 years). Add on maintenance and taxes and that's the number to compare rental cost to. There are many other ways (cap rates etc.) to compare, but this is one of the easiest.

Jan Hatzius of Goldman Sachs used essentially the same methodology a few months ago when he determined that the historical relationship between rental rates and cost to own for Manhattan real estate was out of step with its long-term historical trend (with cost to own much higher than to rent). Hatzius' conclusion was that Manhattan prices would have to fall between 35% and 44% from peak before the historical relationship is restored.

I've been on a few sites in the past where people argue vehemently about whether the tax benefit associated with owning should factor into the rent/own cost comparison. Personally, I don't think it should, because I think the appropriate business analysis would be to determine whether I could cover my monthly outlay if I had to rent out the place to someone else (in which case the tax benefit would be offset by the increase in my income from the rent). However, if you do not expect to ever have to rent your home and believe that all potential buyers for your home will also be able to take the tax deduction, then it's fair to include the tax benefit in your analysis.

I mentioned Jan Hatzius' analysis earlier, he used far more data than I have access to, and also made adjustments that I don't have the computing power to make on my puny computer. However, I've been going through individual listings on Streeteasy that offer homes for sale and also the same place for rent, and I have found many examples where properties are offered at rents that equate to approximately 50% of the cost to own (again, this is before the advantage of the tax deduction). Hatzius' analysis was based on old rental rate data. As Noah points out, rental rates are falling, exacerbating the disconnect between cost to rent and to own.

Regards.

SRealist - and to expand on the alternative return on equity, one could simply buy municipals and receive roughly the same tax benefit that the interest deduction provides you from your noose, ahem, mortgage I mean.

@OT
@Noah

Down 50% in NYC real estate only brings us back to the unbearable times of 2003. NYC is flat out unaffordable, prices aren't lower in manhattan in particular because owner's have more skin in the game and therefore less likely to walk away from their investments for losses greater than committed capital. If forced to model a theoretical value of NYC real estate values based on historical data points you will quickly find as a percentage of income prices remain unsustainable.

Great articles Noah - wish I found you earlier.

I recently made an offer for $510k for a home selling for $569k. Seller came back at $530k. Seller recently reduced asking from $620 (listed in 2008 then took property off market) to $569 (now).

My wife and I love this home but we believe there is enough inventory out there that we will find other homes to love. My point = I dont buy the dream home argument and is only useful in persuading first time home buyers to overspend.

LBJ,
At this point in time, I do not buy the "dream home" theory either. My opinion is that you should find 3-4 homes you can imagine living in, make a deal, then let emotion takeover from there, in that order. Regardless if it is a primary home or investment property, you are still sinking years worth of capital savings, therefore you need to think with your brain and crunch the numbers before you buy with your other head and get clunked on expected ROI, which nobody knows what to expect.

In Hoboken, there seems to be some type of equilibrium taking place. Unemployment and higher real estate taxes are expediting the seller mentality to lower prices, which get prospective buyers off the fence in seeing that in conjunction with the federal tax break.

Im a little late to this post, but just want to say that in Connecticut as well as NYC apparently, your observations are right on.Lots of fence sitters and bottom fishers trying to buy below where the market actually resides at the moment.Some things are moving ,particularly under $700K which is our starter market, but rental homes are full of the young, families who want to buy here (Fairfield County)but are waiting to be hit with the "its the Bottom!" sledgehammer. In the meantime, they low ball the hell out of everything wasting everyones time. We're also seeing some of the "lets try to cut out the buyers broker and get a price reduction out of the listing broker's commission ploy. Nice try.
We may be in Connecticut but we're not stupid.

Great information from Noah, as usual. Just to close the book on the example in this post, 155 Franklin St. #3S closed for $2.575MM on June 12th. The clearing price was 14% below final ask, 27.5% below original ask, 24.6% below Noah's estimated peak valuation as of mid-2007 and 15.6% below the price the owners paid in 2006.

In the end, the sellers were somewhat fortunate that Noah's client didn't hit their counter. They appear to have found a buyer who was willing to pay a bit more.

i have never understood folks around my age (35) talking about making a fortune on their apartment. If prices go up and you are upwardly mobile (married, then have kids) you are always buying a bigger place and so the increase in prices actually hurts you more. very few (smart) people sold and then rented (although possible in nyc more than other places).

I think another reason fees are not being paid and free months not offered is that prices have come down. Apartments are moving but part of the reason is that prices came down to a point at which they will move.