Condos More Clearly Showing Manhattan Real Estate Excess
A: The condo market will more clearly show the pain/excess that this market experienced for obvious reasons. In a market like Manhattan where 70% of the housing stock is co-op, you don't expect there to be high levels of speculation that often marks the top of an asset bubble. After all, the island of Manhattan certainly didn't experience a development boom to the extent that say a Miami did. But we did see a development boom and we did see a credit and housing bubble deflate - in the end, no market was spared. So what is Manhattan in store for? Well for one, the basic structure of the majority of our housing stock will help to blanket the depth of pain that may be felt by those that purchased near peak and have lately become distressed sellers. Its impossible to quantify this real time so I really don't know how many sellers out there absolutely must move property, and fast. As you know, co-ops have a much more stringent process of approval that has since got even tougher. As a result, condominiums will likely show the sharper rate of decline as the first wave down fully reveals the excess this market experienced.
Co-ops differ from condos in legal structure, by-laws, and to whom the product may be right for. For example, an investor/speculator or even a buyer that intends to use leverage to buy as much house as they can afford is much better off buying a condo rather than shares in a corporation with a strict approval process and restrictive by-laws for use. In short, co-ops don't want too many investors in their building or buyers that don't meet financial guidelines set by the board. Coops can also reject without providing a reason. Condos do not have such restrictions and enjoy a 'waiver of right of first refusal' system that allows the board to either let the deal through or to be matched by the building and its reserve funds - usually that does not happen as the hit to the reserve fund will negatively impact the financial stability of the building.
These days, co-ops seem to be getting stricter in regards to:
a) the quality of the buyer that seeks to buy shares into the corporation
b) the quality of employment - all of a sudden working in the financial industry is a higher risk
c) quality of salary - too much reliance on past bonuses will be looked at negatively
d) price of the transaction - coop boards are beginning to monitor the price level of deals, especially deals done in the months of March and April that may have been influenced by fear or severe desperation. The building can reject a purchase application without providing a reason, so don't underestimate the boards willingness to 'act as the market' and attempt to set a price floor on deals they deem as too low that in their eyes would adversely affect shareholder value on future deals and refinances.
Back in March, at the height of the fear, I wrote about whether or not coop boards wold try to influence deals in my piece, "Price Flooring? Will Boards Try To Stop Price Discovery":
"I have been hearing stories lately about co-op boards rejecting purchase applications because they think the price is too low and may adversely affect future valuations for existing shareholders. I for one do not dismiss such rumors that quickly because of their source, past experience I have had with co-op boards, and colleagues of mine who I know and trust. Since the co-op board is comprised of, wait for it...., co-op shareholders, there is a vested interest in seeing price appreciation go through and avoiding what may be considered aggressive price deterioration because a shareholder must liquidate their shares.The very idea that coop boards 'act as the market' makes the hairs on my back stand up. Yet, you will see it happen and it is happening. The blanket of protection lies in the freedom of a private corporations elected board to reject without providing a reason. Your only recourse is if you can somehow prove that discrimination played a role in the rejection and that is a hard thing to achieve.
My two cents? You can NOT place limitations on the open market - and that includes price flooring policies! If a seller is distressed, and must sell below a price floor, what will happen to shareholders' maintenance when the unit owner goes into default? It will rise, and that will negatively affect all shareholders and market value of all units with the now higher carrying charges. The co-op board has no business trying to control sales prices. The market will do what the market wants to do, and meddling with open market transactions to 'protect shareholder interests' will do more harm than good."
So, for condos the question is can the buyer secure a loan. For co-ops, the question(s) are can the buyer secure financing + will the buyer and the deal pass the board!
The reasons you will see sharper adjustments in the condo market, rather than the coop market, include:
1) Investor Friendly / Less Invasive / More Lenient Financing - condos trade at a premium to co-ops because of the investor friendly structure, less restrictive policies, ease of use, less invasive approval process, more lenient financing policies, and real property nature of the product. You own your apartment and not shares in a corporation with a proprietary lease to live in the unit. As a result there is a larger audience, what I refer to as 'buyer pool', that are interested in buying condos and can afford to buy condos with less money down and less money in the bank required. Condo transaction fees on the buy side are also quite higher than co-ops, especially when financing 80% or more. Higher values and higher transaction fees could mean what went up faster might also fall faster when buy side demand dries up as it did in Q42008 - Q12009.
When it comes to speculation, excess, use of leverage/debt to get in on the game, look no further than the condo market that was more exposed than restrictive co-ops at the height of the boom.
2) Development/Conversion Boom - the development/conversion boom is where you see the clearest signs of the euphoria reached at the height of the credit/housing bubble. The priciest deals in Manhattan, excluding prime existing co-op products on the best blocks, were for new developments and conversions that offered luxury products in a luxury setting. Paying $1,500/sft+ became normal in 2007 - especially for foreigners that just wanted IN on the party. It's hard to get that type of premium for a co-op unless it was on Madison/5th Avenue or Central Park West.
So, those who bought into new devs and conversions (especially investors/speculators looking for a quick buck as the market boomed) may have over-extended themselves and are seeing their equity deflate and their debts getting cumbersome. Combine individual distress with a pressured market and you will see sharp downward pressure on the final deal price if the market is allowed to act without outside interference. Because its a condo, the board can either let the deal through (assuming the buyer/pet is not a convicted felon) and waive the right of first refusal OR match the deal and dip into building funds to buy the property; and that usually will not happen! In short, condos offer buyers and sellers more freedom and flexibility and that in turn allows the product to be marketed to a wider buyer pool.
3) Nature of this Crisis - The excess was in the high end and the boom was marked by very expensive new developments and conversions. Peak buyers of these products that have to sell will find it hard not to take a significant hit as the buyer pool for $3M+ properties is no where near what it was 2 years ago.
4) No Outside Interference - Barring a very unusual situation, most condos deal will go through to closing as long as the buyer can secure financing as needed. The fact that there is no aggressive review by the board in terms of buyer quality and deal level means the data will more closely reflect the sharp wave down that we experienced
Look no further than some of the quarterly reports from our biggest brokerage firms to see this 'condo clarity' effect in action:
CORCORAN Q2 MARKET REPORT:
DOUGLAS ELLIMAN Q2 MARKET REPORT:
If I look at the Corcoran Luxury co-op data above, one may wonder if the market really is down only 8% compared to the same quarter in 2008; yet the 32% adjustment for condos more accurately reveals how the high end got hit. The Plaza unit that just sold for 40% below its original sponsor price (granted it was gifted to the New York-Presbyterian Fund and then resold) exemplifies the excess in the high end perfectly.
The high end / new dev boom artificially inflated the data on the upside and will likely artificially deflate the data on the downside as this cycle plays out. You will probably see another pressured report in Q3, only to tick up in Q4 when its released in JAN 2010 reflecting the lagging nature of our marketplace and the recent pricing OUT of fear that will ultimately show deals happening at 'less worse' levels than those earlier this year. Year over year analysis will continue to be pressured until we reach Q2 or Q3 2010 or so; which will be compared to reports that showed the biggest adjustments downward. Interesting times indeed.
Posted by David UWS
Fri Jul 31st, 2009 01:23 PM
Yes, It certainly looks as though prices in the city will continue their downward momentum for a few years to come. Sure am glad I wasn't listening to the silly brokers when I moved here a couple of years ago. One actually called me 'completely insane' for wanting to rent for a while!
Posted by john-buyer
Fri Jul 31st, 2009 01:37 PM
Noah,
Do you think the full effect of the development boom has been removed from those broker reports yet? I feel like we still have deals in the pipeline that were signed closer to the peak.
Also, how does this effect the sell side? Are you seeing Co-op sellers 'anchor' themselves to these reports that show less deterioration for Co-ops?
Thanks for the blog and keep it up!
Posted by Jay
Fri Jul 31st, 2009 02:22 PM
The only thing that happens when a board rejects a deal as being "too low" is the value of the units in the building go down because the board is made up of idiots!
Posted by Noah
Fri Jul 31st, 2009 03:06 PM
John-buyer - hmm, tough question to answer. Last quarters report saw a big wave down so I would think the majority of new dev pipeline deals are past us; but certainly we still have some coming just not enough to statistically alter reports going forward the way they were altered in 2008 and Q1 2009.
As for 2nd question, I left halstead and dont work for any sellers right now but YES, I would think sellers in general are looking for any and all reasons (coop deterioration, stock rally, pickup in contracts signed, less worse data, etc.) to get a bit more anchored to previous higher prices. Of course its self defeating as the market will always dictate price and if the seller prices wrong, they will not get any traffic or strong bids. Good questions.
Posted by Noah
Fri Jul 31st, 2009 03:10 PM
Jay - couldnt agree more that when boards play the role of 'market', the negatives far outweigh the positives for shareholders. Although the board will adamantly argue against that. In building politics certainly plays a role, especially if/when a board member or former board member with continued influence tries to sell when a lower comparable deal is put forth for approval.
Posted by linda
Fri Jul 31st, 2009 04:26 PM
Its not that easy to just say a deal was rejected over price alone because everybody tries to get away with more money after the deal at the expense of the coop. Shady deals happen everywhere. Sellers may work a side deal and get cash separately or orchestrate a lower price so that a lower flip tax is owed. The board has a right to protect their interests and their shareholders if they suspect something.
I own a coop and would be very disheartened to learn that a deal is rejected over price alone for a qualified buyer. This is even more the case if the deal is near where the market happens to be. If the seller is distressed, going into foreclosure or defaulting on maintenance would be more damaging to shareholders than letting the deal go through at the market price at that period of time.
Posted by Noah
Fri Jul 31st, 2009 06:16 PM
well the fact is that the board will NEVER give a reason for the rejection. they will implicate themselves and open up to a potential lawsuit. its just not worth it for them. if a board wants to play the role of market, they both can and will and not give any reason for the rejection.
but yes, shady deals do happen and when I wrote the price flooring piece in March, a commenter broought up the same items you mention and rightfully so.
and I agree 100% on your last point, better to let the deal happen then to deal with a foreclosure in your building, the stigma that will stay there for a while and likely affect future near term deals, and/or worse have the shareholder default making other shareholders maint go up to make up for any shortfall if not other funds are available to make up the difference
Posted by sechel
Fri Jul 31st, 2009 09:02 PM
Noah,
Any info on Sponsors not doing a first year budget that is truly representative of the buildings long term needs as suggested in the services of the building(building engineer,concierge,day care, etc). I read an offering plan where some of the services are gifted by the sponsor for the first 12 months making the common charges appear lower than they would've been. Same building omitted an engineer even though similar buildings in the area have one. What standards ensure the budget is realistic?
Posted by Sechel
Fri Jul 31st, 2009 09:05 PM
Noah,
Any info on sponsors not doing a good first year budget? For example not including a full staff such as an engineer or gifting some first year amenities and excluding them from common charges(i.e. concierge and child care)
Posted by In Debt We Trust
Sat Aug 1st, 2009 03:40 PM
If you guys think housing is headed higher, stick with Lowe's (ticker: LOW). 2x top at 22.
Posted by Diana
Sat Aug 1st, 2009 09:02 PM
Noah, good points as always. Let me just add a one more:
Well-established NYC co-ops, much more than condos, will tend to have boards made up of "permanent residents." As in, they bought in the 90s, 80s, 70s, even 60s, this is their lifetime home, and they are never going to sell. In my opinion (and i live in one) this really changes how they view transactions in their building. For example, they are likely to impose high flip taxes, because since they are never going to sell, they are never going to pay the flip tax. They are also not likely to mind foreclosure, because a co-op has priority over any bank (remember those recognition agreements you signed when you bought? In them the bank recognized the superior interest of the co-op, hence the name). A foreclosure in their building means 1) co-op will get paid in full by the time it eventually sells, so no worries, and 2) insider opportunity, because these people have seen the market go up, they've seen the market go down, but they've also seen NYC become a consistently better place to live. If you weren't willing to leave in 1981, and you've been here ever since, believe me, you're not willing to leave now. I'll bet if there are any foreclosures in NYC coops you'll see a fair number of the buyers being people on the board or friends of the board.
But I don't expect a lot of them, for precisely this reason.
Posted by sechel
Mon Aug 3rd, 2009 01:30 PM
Noah,
Condos will fee the pain more than coops.
Coops had tougher lending standards, money is ore long term in coops, and the buyers were less speculative(the young wall street crowd went condo). All this will mean coops went up less and they'll go down less. I believe condos experienced a greater velocity of transactions and will continue to do so, so they'll over-represent in terms of what we hear about nyc real estate.
Posted by sechel
Mon Aug 3rd, 2009 01:30 PM
Noah,
Condos will fee the pain more than coops.
Coops had tougher lending standards, money is ore long term in coops, and the buyers were less speculative(the young wall street crowd went condo). All this will mean coops went up less and they'll go down less. I believe condos experienced a greater velocity of transactions and will continue to do so, so they'll over-represent in terms of what we hear about nyc real estate.
Posted by Robert
Mon Aug 3rd, 2009 02:00 PM
The interest of the coop board seems to be in conflict with the seller. A seller wants to have the transaction approved. But boards may just simply choose to disapprove all sale transactions. In an extreme scenario, what would legally prevent a board from saying that all sales happening right now is reflective of a fearful market and are therefore not fair market value? They will then proceed to disapprove all sales. These grandees in the board are rich, old-time residents anyway with no interest in selling their units. What will the poor seller do?
Posted by haberdasher043
Mon Aug 3rd, 2009 03:05 PM
I don't think Noah is saying that an equity rally up is correlated to real estate going up. I think he hits the nail on the head in saying that an upward stock market rally can affect psychology. I agree with this totally. I think there is a disconnect in Manhattan definitely in that sellers are not willing to give up apartments at a discount if they don't have to. I have an apartment I gut renovated which I unfortunately purchased at a peak, if I were to put it on the market now because I had to move out of state say or I wanted to downsize but there wasn't an urgency to it in that I don't have to sell but I'd really like to sell, there's no way I would give in to the current market pricing and low bids buyers are putting out there. I think that there are sellers who are getting some gains in portfolios that took serious losses and they are definitely not going to sell at deep discounts if they don't have to. I think there is alot on the market where people don't have to sell but with the panic that went on they might want to sell. Alot of what I am seeing insofar as neighbors I have selling is they are hoping they can sell what they're in so they can buy more for their money. So they don't have to sell but if they can get their price they will and hopefully make a trade for more for their money. I really don't see Manhattan going down any further. In my building alone there were 9 listings over the past 7 months that all of a sudden disappeared this month, they were either sold or in the case of 2 of the apartments, the sellers felt better about the economy and didn't want in their words "to give the apartments away." I think there is a huge misconception that Manhattan is having a fire sale and that's just wrong. People here will give up a 2nd home, luxe vacations and private school before they give up their real estate at steep discounts IF THEY DON'T HAVE TO. Also NYC is a job mecca, it's where jobs are created and people need places to live who work here. I think doomsday is just way over exaggerated in the scope of things and I think that psychology of an equity rally will create a dichotomy between seller and buyer and sellers will not continue to take low ball bids - optimism is in the air.
Posted by Roseville real estate agent
Tue Aug 4th, 2009 07:44 AM
he condo market will more clearly show the pain/excess that this market experienced for obvious reasons. In a market like Manhattan where 70% of the housing stock is co-op, you don't expect there to be high levels of speculation.
Posted by Houses in Miami
Fri May 28th, 2010 01:23 AM
Thanks for the update!!! Wow, awesome real estate blog.