Residential Construction Expected to Plummet 81%

A: The numbers just do not make sense to start new projects, especially with the recent changes in the abatement grants from the city. This is a healthy consequence after a boom and is part of the purging of excess process. Over time, the markets will heal themselves and the numbers will start to make sense again. Don't mis-interpret the headline to think the cleansing process didn't start yet - it did! This is evidence of it and a good sign.

Crain's reports that, "NYC construction spending to drop 20% this year":

Led by a sharp decline in private-sector building, overall construction spending is expected to plunge 20% this year to $25.8 billion, according to a study released Wednesday by the New York Building Congress.

The recession has strangled demand for new residential buildings while the credit crunch has severed traditional lines of financing. The number of residential units constructed this year is expected to plummet 81% to just 6,300 units, while the amount spent is projected to sink 44% to $3.5 billion.

Meanwhile, spending on non-residential private construction, which includes buildings such as office towers and institutional projects such as museums, is predicted to slump 38% to $6.9 billion. It is expected to tumble further in the next two years.

With rents down, unemployment still on the rise, and prices in the process of finding a comfort zone to trade in, new construction plans are falling. Add in that financing for major projects is not anywhere as easy and cheap as it used to be, and the numbers just don't work. This is prudent decision making in a recessionary environment. Banks are hesitant to lend and developers are hesitant to build.

In regards to the 421-A and other tax abatement/exemption programs, the city utilized such tools to incentivize developers to build vacant or underutilized lots across the city. It became a subsidy to the developers of luxury new developments. In the boom years, especially in 2006 & 2007, the abatement became the focal point of justifying ever increasing asking prices. All of a sudden, paying $1,500, $1,700, or $2,000/sft was not only OK but buyers rationalized that it made sense with the lower carrying costs. It got so dangerous that I publicly warned would be buyers out there of the potential pitfalls back in June of 2006 - "Don't Be Fooled: 421A Tax Exemption" and again in a NY Post article in April 2007 (man, did I get shit for that from the brokerage community):

Don't get me wrong, new developments are a great product and perfect for those who can afford them. But for those seeking an investment play, its hard to rationalize the price per square foot + higher closing costs on some of these developments considering they will get more expensive to carry every two years for the next 10 or 15 years.

The monthly expenses (maintenance + real estate taxes) of a particular property are directly correlated with the affordability of the apartment at re-sale. Therefore, a property with higher monthly expenses must lower their ultimate asking price to compensate for affordability or else it will never sell. On the flip side, a property with very low monthly expenses can get away with a higher asking price on the open market.

When the price is right, the abatement is a wonderful bonus for the new owner. Its when the price gets out of whack and the abatement used to justify the higher price, that I called into question.

While the temporarily low monthly expenses were used to justify the surging price per square foot during the boom years, over time the cost to carry the unit would systematically increase. The 421-A is a 10 year abatement where every two years 20% of the untaxed portion becomes taxed. There are 5 adjustments until mature taxes are implemented. When the market was in the euphoria stage in 2006 and 2007, buyers were too focused on the ever increasing prices and willing to ignore this risk to get on board the asset boom. The thinking was the party would never end. Nothing you can do about it now. It is what it is. Sure, the new development should trade at a premium and the lower costs to carry should warrant a slight effect on the transaction price. But in the height of the boom, this was taken to the extreme and the markets, as they always do, ultimately corrected itself. What began as a program to stave off the tough times in the 70s and the need for more affordable housing in the 80s, became a tool for developers to make record breaking transactions. There is no shortage of luxury condos in Manhattan today, that is for sure. Maybe a shortage of affordable luxury condos, but that is a different story.

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