No Inflation in Manhattan Office / Mixed-Use Markets
A: Hyperinflationists' need to explain their logic to me when it comes to the mixed use and office market in Manhattan. News that came out a few weeks ago from from Massey Knakal and yesterday from CB Richard Ellis, reminds us of the deflationary environment that has hit all segments of the Manhattan property market. Hit especially hard was luxury residential high end, mixed use, and office markets. Due to the nature of the downturn, the lower end price points have not been as affected. Its hard to argue that hyperinflation is just around the corner when your dollars can buy twice as much mixed use & office space as it could only 18 months ago. There will be a time to talk about the unintended dangers of uber-stimulative policy, but for now that policy is in place as a desperate attempt to stop a deflationary spiral.
If you get into an argument about how inflation or hyperinflation is very near, just remind them of what is actually going on out there and the increase in purchasing power of their dollars as a result of deflationary pressures on our housing markets.
Case in point, Massey Knakal's report from a few weeks ago discusses how "Manhattan Mixed-Use Property Values Fall by Half":
A buyer could get twice as much mixed-use space in Manhattan in the first half of 2009 than in the same period a year earlier, according to a new citywide mid-year report from commercial sales firm Massey Knakal Realty Services. The prices for mixed-use properties fell 53 percent to $535 per square foot from $1,135 per square foot in the first half of 2008, the firm's data show.Here is the Massey Knakal 1H2009 report and a quick check on cap rates that are being pressured by lower rents:
Company Chairman Robert Knakal said he expected prices would continue to fall even as the numbers of transactions increased. "Even with a significant increase in volume, we expect prices to continue to drop as fundamentals deteriorate, caused by continuing increases in unemployment,” he said in a statement.
Sales in the first six months of the year in Manhattan, in all categories of buildings priced higher than $500,000, were down 82 percent to $1.9 billion, from $11 billion in 2008, and $30.8 billion in 2007, the firm reported. The transaction volume fell 74 percent from the first half of 2008 to 95 sales, totaling 122 buildings.
As for the office market, Bloomberg reports "Manhattan Office Sales Ground to Halt in First Half":
Manhattan office sales came to a near standstill in the first half, with less than one-tenth the average number of transactions seen during the same period in the previous five years, CB Richard Ellis Group Inc. said.1/10th the volume compared to the same period average over the past 5 years. Ouch! Securitizations for CMBS is still not functioning properly forcing the fed to extend the TALF program by 3-6 months for newly issued CMBS. The program was set to expire DEC 31st as $165Bln in commercial mortgages come due this year. Under the TALF program, the fed 'lends to investors to purchase new asset-backed securities as well as commercial real-estate debt'.
Three office buildings valued at more than $30 million sold from January to June, down from an average of 32 in the first six months of the prior five years, said the Los Angeles-based firm, the largest publicly traded commercial real estate broker.
Buyers and sellers are far apart on bids while low interest rates on existing loans mean many sellers can afford to wait, CB Richard Ellis said. “When the CMBS market shut down, that really shut off the financing mechanism that allowed a lot of these large transactions to get done,” said CBRE’s Enoch Lawrence, senior vice president of capital markets in New York.
In the near term, most property sales will be forced by distressed financial conditions, CB Richard Ellis said.
CMBS issuance has been virtually non-existent for about a year now after peaking in early to mid 2007 - the height of the credit bubble. Since charts sometimes tell the whole picture, take a look at Commercial MBS Issuance By Type via the Atlanta Fed:
Calculated Risk says it all when he states..."The increase in cap rates suggests more than half off the peak prices of a few years ago - and probably even more since rents have fallen too (reducing operating income) and vacancy rates are rising sharply (pressuring rents more)."
Does this look like inflation or deflation to you guys? With the fierceness of the destruction, you can't expect the pace of these levels of decline to continue. Naturally, the market will react to an overshoot on the downside that will cause many to mis-interpret this equalization as a new trend supporting sustainable upside in prices. Falling 53% and then rising 5% is the market adjusting to a dislocation - overshoots to the downside are common in these scenarios.
After all, we saw it in our residential marketplace as prices overshot to the downside in FEB-MARCH, and then naturally rebounded slightly as buyers got comfortable again in the months of MAY-present - in essence, pricing OUT Armageddon. It would be silly to use the 'slight rebound' from this overshoot as a bullish argument to support a new bull market ahead. I should also add that as bad as this looks and as painful as the cycle is to consumers and our banking system, it is healthy, it had to happen, and lower prices and lower rents will ultimately stabilize the markets. It is for these reasons that one must be 'less bearish' today than 18 months ago when the excess was not yet purged from our marketplace.
Posted by lr10021
Wed Aug 19th, 2009 11:02 AM
Noah,
I think you are being a bit to real estate centric here. If the definition of deflation is falling prices, we definitely have deflation of asset classes such as real estate, equities, and inflation of asset classes such as metals, commodoties, etc.
The point is that when you start using words like inflation and deflation, rarely do assets which trade off an earnings valuation come to mind. Of course if your NOI is lower the asset will fall in price, but is it deflation that is causing the drop in the NOI? Probably not. Actually, I would argue that Manhattan residential cap rates are so low, due to Inflationary costs associated with their expenses, primarily mtc / common charges or taxes as much as they are due to the overall supply/demand of the rental and sales markets. In many cases, we have had the monthly carrying cost of an apartment go up two fold in a matter of less than 10 years, when during that same period, rental prices have not done so.
Inflation and Deflation are measured in the minds of most Americans as how far can my dollar go on a day to day basis.
Just because it buys more bricks does not necessarily mean that the dollar is deflating in relative terms. I would argue that most of the deals that are getting done today in the commercial arena have just about the same chance of succeeding at closing as they did prior to the downfall. For all this "distress" in real estate prices, there is just as much "distress" in the operating environment of real estate, and therefore does it necessarily point to deflation, or just a change of strategy of the purchaser. I would argue the latter.
When Americans talk about inflation and deflation, what they really mean is how much am I paying for taxes, a cup of coffee, a subway ride, utility costs, gas, and a hamburger. And it is hard to argue that any of these items have not seeing massive inflation in the past few years. Just about the only thing I know of that has seen real deflation is costs of things made in China, such as clothes and toys. And that has it's negative implications too. I am not sure how our government measures inflation but my guess is that they are missing the point in a big way.
Posted by Noah
Wed Aug 19th, 2009 11:55 AM
very good point. However, where does credit fit into the picture when discussing inflation vs deflation? You are right that you cant define inflation or deflation just by looking at one asset class: in this post, housing.
The point of the post was really in response to an argument I had the other day with some co-workers that hyperinflation is right around the corner. Many of my posts are triggered by real life experiences that I then make a discussion around.
There is a camp out there that truly believes hyperinflation, or at the very least, runaway inflation is very near. To me, that argument is just nuts because they are looking at what the fed is doing and ignoring everything else. Mainly, that deflation is negating any artificial inflationary forces created by the fed and printed money is
a) being sterilized by paying interest on excess reserves
b) not being lent out and being hoarded in excess reserves, thereby not producing the multiplier effect that our fractional reserve system is designed to do
c) not keeping pace with the destruction of wealth from the credit implosion in the shadow banking system
I often argued here that as we experience housing deflation, we are going to see commodity inflation. I still believe this to be so, although not to the extent as mid 2008 when oil prices went beserk. But you will see inflation in the form of the essentials: food, energy, metals, commodoties, taxes, rates, health care, subway tokens, or other area that has to do with cities and states raising money to cover loss of tax revenues collected.
Your dollar does buy more bricks, and those that argue about hyperinflation or runaway inflation are inter-relating that to real estate or to support rapidly rising prices as their dollar gets crushed. I say, where do you see evidence of this? The exact opposite is true, in a big time way. When I talk to people about this, I would argue real estate is front & center in their minds and whether to buy now on a reflation trade or as a hedge against the coming hyperinflation - I wrote a piece on that a ways back:
http://www.urbandigs.com/2009/03/is_inflation_good_for_manhatta.html
As you closed your comment, I couldnt agree more, the govt tends to overestimate inflation in bust times and understate inflation in boom times. Hmm, how does the cost of living metric of our Social Security system play a role here? If inflation was shown as it really was, would Social Security pressures increase significantly? I think so. Not something we need to deal with now. Lets kick that can down the road another 25 years and deal with it then.
Thanks for great comment!
Posted by lr10021
Wed Aug 19th, 2009 12:34 PM
Hi Noah,
I see where you are coming from and have tried to explain this matter to buyers/sellers several times but it's a tough concept for most to grasp. Let me try.
Inflation/Hyperinflation with regards to real estate prices have nothing to do with Manhattan or it's greater area. Here is why:
Lets say you build a $105,000 house that costs $45,000 in materials, $45,000 for labor, $5000 for land, and the builder makes a profit of $10,000. After 10 years of healthy inflation (3%) your neighbor builds the same home but now the materials cost $70,000 and the labor costs also go up to $70,000, the land goes to $6,000 and the builder now wants to profit $12,000. So in essence that same house costs $158,000 to build. Assuming that the demand is there and so is population, there would be upwards momentum on the $105,000 house to the $158,000 area. All due to inflation! That's pretty good right?
BUT now let's switch to Manhattan. Most people will tell you, hard and soft costs to replace the average condominum in Manhattan run about $300 per square foot. However new construction prices average $1100 per square foot! So where is the $900 per square foot???? In the air, land, and the profit margin. So no matter how much inflation or hyperinflation we have, we need to increase the replacement cost by $800 per square foot or almost 300% before we start feeling the inflation effects of real estate here in Manhattan!!!!
So to sum up -- inflation as it pertains to real estate mainly pertains to replacement cost, and will have an effect on the low value areas first. Perhaps that is why we see some stabilization at price points in Florida which are now equal to or below replacement costs? You want to protect your dollars - try Albany NY where you can buy property for $50 per square foot and replacement costs about three times that!
Whereas in high priced areas such as Manhattan, inflation and even hyperinflation generally kills prices as investors stay away due to the higher cost of credit and reduced cap rates as a result of higher operating costs.
Posted by Fred
Wed Aug 19th, 2009 04:39 PM
Isn't it debt deflation that really matters? I bet Fortress thinks 38 cents on the dollar is fair market value for Sheffield57 given the amount of risk and lack of financing.
Posted by In Debt We Trust
Wed Aug 19th, 2009 05:10 PM
We are in deflation but on POMO days the markets experience asset inflation - you know it when you see stocks and bonds both up at the same time.
scroll down to the chart: pomo $billions per day.
http://www.chrismartenson.com/martensoninsider/martenson-insider-fed-pomo-activity-and-stock-market
Posted by Noah
Wed Aug 19th, 2009 05:42 PM
IDWT - yea, word around town is the primary dealers have nicely freshly minted monies to play with.
I guess better to gamble with stocks than to lend to a consumer with deteriorating credit.
POMO bought 2.6Bln today, but nothing yesterday when market rose and they bought 7Bln on Monday when market tanked. So not really a 1-1 relationship. Im sure it plays some type of role and I think economic data could easily surprise to upside with stimulus and cash for clunkers programs and ramping up of production of cars. Crazy, but I think the market is discounting the stimulative effects. Of course its temporary and of course there will be consequences later on. But who cares about later, we will deal with that, well, later.
See Buffets op ed today?
http://www.nytimes.com/2009/08/19/opinion/19buffett.html?ref=opinion
Posted by I HATE THE FED
Thu Aug 20th, 2009 10:17 AM
hyperinflation is right around the corner. Go to a grocery store moron.
Posted by Noah
Thu Aug 20th, 2009 10:48 AM
another hyperinflationist getting emotional. Hey, I hear you about the fed their mis management of policy and boom bust engineered cycles. But we do not have hyperinflation. In fact around me, grocery products are a bit more expensive but nothing that would show hyperinflation. But if you read my stuff, you will know that I stated inflation will show up in food, energy, metals, health care, other commodities, rates, taxes, etc.. right when growth is sub par squeezing balance sheets.
But if hyperinflation were really here, credit would not be contracting and real estate prices would be flying. Or does your version of hyperinflation exclude those two?