"At the time, it looked like a sound investment."
Clark McKinley, a spokesman for Calpers.
Some of us are still wondering whether mass hallucinations were at work during the bubble years, allowing so many to act so thoughtlessly on such a grand scale. Unfortunately, in many corners the delusions appear to be continuing, like the idea that capping government spending on a 17% sliver of the federal budget which includes only non-international, non-homeland security, non-human services, non-essential...blah blah blah blah blah categories, will actually help fix the nations ruined balance sheet? Next the White House will switch to generic toilet paper and call it an austerity program.
I keep being plagued by the idea, that after a period of reckless profligacy, lessons must be learned, prudence must be rediscovered and tough choices made and vigorously executed to heal the prior transgressions. Yet our society seems unable to actually tolerate even the most preliminary steps in this process, including fessing up to prior bonehead maneuvers.
Example number one being the statement made above by Calpers regarding its investment in the Stuyvesant Town/Peter Cooper Village buyout by Tishman Speyer. I hate to disagree with the world renowned stewards of capital at Calpers, but in my humble opinion this deal was patently absurd from the day it was first proposed. If I had a fedora I would pledge to eat it if Tishman Speyer was actually unaware of how ludicrous the deal was when they first proposed it. But alas despite the sponsor having precious little skin in the game, a fantastical deal price and an incredibly pompous assumption that the seller had no clue as to the upside still embedded in the property, a bunch of Stuy Town losers stepped up to fund this deal which will go down in history as one of the biggest and stupidest real estate deals of all time. Their names and approximate exposure are listed below, courtesy of the Wall Street Journal.
I know, I know, you can't believe it. Why would Tishman Speyer, heretofore an organization of sterling reputation, knowingly invest its hard earned dollars in a deal that was more than likely to fail from day one?
According to news reports the complex of 11,232 apartments was purchased for $5.4B, or $480,000 per unit. As a rule of thumb, savvy (meaning long-term profitable and surviving) investors in New York City rent-regulated buildings like to pay under $100,000 per unit. Granted deals at those prices are very hard to find and this rule of thumb applies more to Brooklyn, Queens, the Bronx or Morningside Heights, than to prime Manhattan locales south of 95th St. On the Island of Manhattan many would probably consider $200,000 a unit to be workable long-term, though not a "value investment" as you would need to eventually turn over all the apartments and do a condo conversion to really make out big. But these kinds of deals have been done pretty frequently.
Now the Stuy Town/Petter Cooper complex includes 80 acres of downtown property, an asset with long-term value for sure. But how likely is it that a massive block of airspace largely dedicated to rent controlled buildings would be upzoned in our lifetime...even in a Bloomberg administration.....not much. But let's just make the analysis a little more sophisticated as opposed to using loosey goosey local benchmarks (though you would be surprised how many transactions are done solely on the former).
I have heard people bat around various theories regarding the cap rate (net income/purchase price) paid for the Stuy Town/Peter Cooper Village complex. Some have said it was as low as 1%, From what concrete data I have been able to find in the media, the NOI on the properties was reportedly $112 million in 2006, which would put the cap rate at 2%. This in and of itself should have raised eyebrows among investors. For investors to accept a paltry 2% going in return on their investment, the return should have been considered absolutely rock solid under any imaginable economic scenario (say even a downturn like the early 1990s) and certainly there should have been a lot of potential upside, but let's dig further.
The return to equity expected in a real estate deal is equal to the cap rate less the cost of debt capital employed (mortgage constant) times the proportion of debt capital utilized. In this deal the capital stack supporting the $5.4B purchase price reportedly consisted of $3 billion of first lien debt, $1.4 billion of mezzanine financing and $1 billion of equity - or what would be termed an 80% LTV to the equity investor.
According to the Rent Guidlines Board's 2007 Mortgage Survey , the average new multi-family first mortgage in New York City during the year prior to the March 2007 survey was 6.27%. Now my guess is that considering the reputation/wealth of the sponsors, the underlying property, and the fact that this was large enough to be a CMBS deal (where rates and terms were typically better than the bank rates used in most NYC multi-family transactions), the Tishman group was able to get a mortgage on similar terms to the average Joe Blow real estate investor. I will also venture that the mezzanine market, which was hotly competitive at that time, was willing to take on the remaining debt for less than 200 basis points in additional yield. So lets call the mezz rate 8% (in the scheme of things it would have mattered precious little if it was 7% or 10%).
The weighted average cost of debt for this deal was likely somewhere around 6.5% - 7%. Applying the "Band of Investments" formula discussed above, results in a return to equity of less than 1%. So unless substantial upside to the NOI existed this was destined to be a loser of an investment. Now I'm not saying that there wasn't a history of significant upsides to the going in returns to equity on New York City real estate deals in the 1990s. There obviously was. But it was the minority of deals that were done with such extreme negative financial leverage I.E. if this deal had been done with all cash at least the participants would have been highly likely to get a 2% return (the cap rate) in most economic scenarios. Instead as we demonstrated, the application of leverage (at a cost well above the cap rate) massively diluted the going in return, requiring an even bigger upside to the existing net operating income and perfect economic conditions to make the deal work at all. Any knucklehead alive should know that this was a poor risk reward scenario. I won't insult Tishman Speyer by implying that they didn't realize this (Speyer guys, if you didn't know this please feel free to contact me for advice on your next deal...I'll charge a reasonable 1/2% of the purchase price as a flat fee - think of how much I could save you). In fact, it is highly likely that the Speyers put so little skin in the deal for precisely this reason. According to news reports, the Tishman Speyer investment fund put in $112 million or just 2.5% of the deal price, with the Speyers personally only putting in $56 million of this amount or about 1% of the deal.
For the record, Tishman Speyer was not the first or the only deal sponsor to look at the ridiculous financing parameters available in the market with no recourse to the borrower and say damn the pricing...let's do the deal. If it works out..... great!, if it dosn't we get most if not all of our money back and then some (through various fund management, property management and in some cases financing fees) and we just hand the keys back to the bank. The well publicized Riverton Apartments fiasco enjoyed many similar features of the Stuy Town deal.
So for all of those fiduciaries supposed to be investing money for teachers, firemen, the people of Singapore and God, shame on you. This was never a good deal for anyone but Tishman Speyer. The sponsor should have realized, however, that although the debt holders may have no monetary claim on them there is always recourse to your reputation in a deal as high profile as this one was.
Just as an aside, according to the underwriters method: Cap rate = LTV X Debt Coverage Ratio X Mortgage Constant - the highest LTV that the banks should have allowed for their first lien under the deal price, NOI and mortgage rates discussed above should have been about 20% to achieve a prudent 1.25x debt coverage ratio. So don't cry for them. They were underwriting to Tishman's optimistic pro formas...not reality and had nothing to gain if Tishman Speyer's business plan worked flawlessy. They were merely going to get their money back and some interest. They took equity risk for a bond return while allowing an imprudent debt coverage ratio. It's a good thing we tax payers have so much cash to spare to bail these bozos out.
A: When 1-Month Treasury yields turn negative it makes me wonder why investors are parking money for the very near term into vehicles that protect the full principal? Its generally a tell tale sign of risk aversion. As money pours into the short term protection of 1-Month Treasuries, yields once again fell to negative for the first time since March 2009. Something worth keeping an eye on although we can't read as much into it when the fed continues to maintain a zero interest rate overnight policy.
You can take a look at the chart to the right showing you the yields on 1-Month Treasury bills for the past year - noticing the move to -0.01%. According to Bloomberg, "U.S. One-Month Bill Rate Negative for First Time Since March":
“There’s some flight to quality with concern around sovereign risk around the globe, like Greece,” said Anshul Pradhan, an interest-rate strategist in New York at Barclays Plc, one of the 18 primary dealers that are required to bid at Treasury auctions. “Secondly, the bill universe is likely to shrink as the Treasury continues to term out debt, tilting the balance further toward demand.”Whether its fear of sovereign default, China's clamps on bank lending, a double dip, a move from accommodating stance by our Fed, Bernanke's renomination, the AIG/Geithner email debacle, etc.. who knows. What's clear is that money for the near term is coming out of riskier assets (after a search for yield for most of 2009) and into the safety of short term treasuries driving yields negative.
Greece’s 10-year bonds fell, pushing the premium investors demand to hold the securities instead of benchmark German bunds to the most since the inception of the euro, on concern the nation’s finances will worsen.
Bill rates turned negative for the first time and note and bond yields reached record lows at the end of 2008 as investors sought refuge in government securities after the collapse of Lehman Brothers Holdings Inc. and a freeze in global credit markets.
Treasury sold $10Bln in 4-week bills yesterday with investors only getting their principal investment back in return. Considering where we came from, when fear changes investor attitudes from chasing risk to simply getting their initial investment in full back, it's worth watching as an anti-risk trade might be setting up. This also tells me investors absolutely expect the fed to maintain a ZIRP policy. With a ZIRP policy in place, we can't read too much into short term yields turning negative but it still is something worth watching for in the near term as a risk aversion trade.
A: Interesting comments out from Morgan Stanley's European equity analyst Teun Draisma this morning regarding the future reality of tightening policy. The main point of the comments is that tighter policy will 'intensify' as 2010 rolls on, shaping up more like '1994 and 2004'.
From Business Insider, "Morgan Stanley: Sell Into Strength, The Tightening Has Begun":
Morgan Stanley analyst Teun Draisma:As tighter policy comes in, especially in the early stages, the talk will probably go something like this...'well, the fed is confident enough in the recovery that we can start to withdraw stimulative policy'. So the economic strength negates the tighter policy, and perhaps equities rally further. But it will be the pace and effectiveness of the exit strategy that I will keep my eyes on. How does Bernanke, if he is re-nominated, pull off a perfect withdrawal of all stimulative policy measures without disrupting the markets? And the real kicker, does Bernanke's Fed have control over how the markets react to this policy reversal? In other words, will the markets force their hand or overreact like they usually do - perhaps sending rates higher at a much faster pace than the fed would like to see?
Sell into strength, as authorities have switched from "all out stimulus" to "let's start some stimulus withdrawal". Tightening measures are coming in thick and fast around the world. We always thought that the start of tightening was not the first Fed rate hike, but could be many other things including higher taxes, less spending, more regulation, Chinese/Asian tightening, or Fed language change. Recent initiatives include Obama's banking initiatives, and several Asian tightening measures. In the next few months this theme is set to intensify, and we expect positive payrolls, a Fed language change, and the start of QE withdrawal. This willingness of authorities to move away from crisis mode is an important change and means that the tightening phase in the broad sense of the word has now started. Thus, indeed, 2010 is shaping up to be like 1994 and 2004, as we expected.
The start of tightening is hardly ever the end of the growth cycle, and normally the accompanying dip needs to be bought, but it typically is a serious double-digit dip lasting 2 quarters or more. The sector rotation has of course already started in October-2009 and is set to continue. As a result we move 2% from equities to bonds in our asset allocation, going to +5% cash, -2% UW equities, -3% UW bonds. We think short-term strength is quite possible, and we have not quite gotten an outright sell signal on our MTIs either, but the 6 month risk-reward of being long is worsening, and we recommend to sell into strength. Our 12 month MSCI Europe target of 1030 implies 6% downside.
Meanwhile. Goldman Sachs says, "It'll Be a Disaster If Bernanke Raises Rates", and calls for a 'gradual exit' from the current accommodative policy:
"On the surface, the backdrop for the Federal Open Market Committee meeting next week looks quite encouraging for members pressing the case for a gradual “exit” from the current accommodative stance.Interesting talk on the draining of over $1trln in excess reserves that banks are currently hoarding and receiving interest payments on. The real inflationists concern is that this money gets lent out, and multiplied by our fractional reserve banking system - something that is not happening at the moment! Keep an eye on how the fed handles that one.
We also are not sure that Fed officials will need to raise the discount rate in order to facilitate draining excess reserves. It is unclear whether—and if so when—they will actually decide to undertake such a drainage operation. Our own view is that the volume of excess reserves does not have important effects on the broad financial system and the economy, at least now that the payment of interest on reserves enables the FOMC to raise short-term interest rates without having to match the demand and supply of reserves. Moreover, even if Fed officials do introduce a term deposit facility that is priced attractively enough to mop up a significant share of the current $1 trillion excess, the rate on this facility would likely be well below 0.5% given the current slope of the yield curve. This would make arbitrage unattractive even without a higher discount rate.
The argument that a higher discount rate would be a signal that liquidity conditions have normalized is therefore similar to the phasing out of the other emergency facilities. But against this, it is important to consider the potential tightening in financial conditions if markets view such a step as a precursor to a hike in the funds rate. Especially at a time when the economy clearly needs all the monetary stimulus it can get, this risk should not be overlooked."
2010 will likely not disappoint in terms of volatility and surprises. It's always something from left field that nobody expects that comes out and changes the world as we knew it - its just timing it and predicting exactly what that will be that is a constant challenge! It is very possible that any double dip in our future is a direct result of the fed purposely tightening policy to control unintended inflationary consequences from the massive stimulus applied to stem the severe deflationary episode we just experienced. That, however, could be years away.
A: The volatility index surged about 56% in the past 3 days from 17.58 to 27.31 as markets reacted to what a future world of regulation and lending curbs may look like. As discussed three days ago in "Stimulus Withdrawal: Ain't It A Bitch!", China was a glimpse on Wednesday into how our markets would ultimately react when the 'juice' is talked about being taken away and the first forms of regulation are discussed. As usual, we got way too addicted to a world of free money, accounting gimmickry, liquidity facilities and stimulus packages. With selling volume surging, the dollar rally gathering steam and the VIX rising, I wonder if these are the beginning indicators of a dollar carry trade unwind?
Here is a quick look at the VIX over the past 6 months, focusing on the last 3 days with a spike of about 56% from mid-week; via Bloomberg:
The crazy thing is that people forget about the insane amount of stimulatory policies and programs that were taken to stem this severe episode of debt deflation. They just want their home prices to stabilize or rise, stocks to rise, and things to get better at any cost. The short term fix is what is wanted, without consideration for longer term consequences of such actions. That is what I want people to understand when they look at the equity markets these past few days.
As Jeff alluded to on Thursday, Obama's limits on prop trading in my opinion was the biggest driver, coupled with China's bank lending curbs, to drive the recent equity selloff. The Wall Street Journal reports, "Goldman Seen Hardest Hit By Prop-Trading Limit":
Goldman Sachs Group Inc. (GS) would be the hardest hit if White House proposals to limit so-called proprietary trading become law, analysts said Thursday.According to Reuters:
Morgan Stanley (MS), J.P. Morgan Chase & Co. (JPM), Bank of America Corp. (BAC) and Citigroup Inc. (C) also would be affected, the analysts added.
On a day when Goldman reported a full-year profit of more than $13 billion, President Barack Obama proposed that banks and financial institutions that contain banks should be banned from running proprietary trading operations unrelated to serving customers.
Obama also proposed that banks should not be able to own, invest in or sponsor hedge funds and private-equity funds. The announcement shocked some banking analysts, making them more concerned about regulatory risk in the industry. The proposal to ban the practice, known in the industry as prop trading, comes roughly a week after Obama unveiled plans to levee at least $90 billion in fees on the largest financial institutions. In the U.K., large bank bonuses are being taxed at 50%.
Prop trading accounts for 4.9 percent of revenue at Credit Suisse, 4.3 percent at Deutsche Bank, 4.2 percent at Barclays, 3.1 percent at Societe Generale and 1.4 percent at BNP Paribas, UBS analysts estimated.For Goldman, that percentage is significantly higher; a reported $4.5Bln of revenue was from prop trading in 2009, 10% of their total reported $45Bln in net revnue for the year. The WSJ article mentions that "prop trading could account for up to 20% of Goldman's revenue during a particularly successful quarter...". Ouch, that would hurt and the stock would have to re-adjust to that new reality if the proposal becomes law.
With the equity markets being the discounting mechanism that they are, this is the new world we have to get used to as stocks start to discount future realities. This includes higher rates, higher taxes, more regulation, expiration of liquidity programs, expiration of the fed's debt monetization experiment, and tougher capital constraints to curb lending and make sure this credit boom and bust doesn't happen again; at least for a while. Wall street will have to wait to see how this all plays out before inventing new and improved ways to work and play around the new regulation; something the street is very good at doing.
For now, expect continued volatility especially if the dollar does something nobody expects it to do: continue rising! Quietly, the greenback is at a 5-month high against the Euro and I wonder if this is the beginning of the carry trade unwind, as traders close out short term debt positions funded with cheap dollars? When a positive carry turns to a negative carry, crazy things can happen!
First and foremost, apologies... Haven't had much time in the past half a year or so to post anything. Much of it had to do with the refinancing boom of 2009 and me taking my mortgage career to the next level and switching lenders.
That said, it is nice to be back and I truly look forward to posting here on a regular basis and reading your feedback.
So lets backtrack a little bit and let me give you a little update as to what has happened in the mortgage market since my last post:
1. RATES: We are hovering around the 5.25% area for the 30 Year, 4.25% on the 5/1 and about 4.50% for the 7/1 Conforming products. The Jumbo 30 year is around the 5.75% range and the 5/1 JUMBO ARM's are in the high 4's.For 2010 many in the mortgage world are seeing the purchase business coming back and refinances dying off slowly. I concur with that outlook. I see a lot of inventory on the market and am starting to see a pickup in inquiries relating to pre-approvals.
2. LOAN LIMITS : Might be a bit of old news but the extended loan limits of '08 & '09 were extended to 2010. Take advantage of the High Balance Conforming $729,750 while you can.
3. NEW DEV FINANCING: Still require a 71% presale for New Construction before banks can step in to provide lending. FHA can sometimes go into a building for a spot approval and issue a 51% approval. Also some regional banks (Astoria, Emigrant, Apple) that don't sell the loans off their portfolios may have a lower threshold...This may go down to 51% once HUD declares Manhattan a non-declining market.
4. RESPA GUIDELINES: By far one of the most significant changes of 2009/2010 is the new RESPA regulation imposed by HUD. Basically it boils down to a completely brand new Good Faith Estimate that is supposedly easier to understand and shop around, as well as full disclosure of ALL fees and a limit by the government on banks charging various processing and underwriting fees.
The RESPA guidelines require full disclosure of lender, buyer, seller, and title fees. There is a tolerance of 10% by which certain individual fees can increase on the HUD-1 Settlement Statement (the piece of paper you get at closing listing ALL your fees), from the originally quoted GFE. The GFE can only be changed under very stringent circumstances or instances where it is out of the lender's control. For instance if the rate needed to be extended due to the seller not being able to set a closing on time, and as a result points needed to be charged for the rate extension.
5. LENDING RATES & 10YR TREASURY NOTE: From 2007 to 2009, it seemed that rates weren't affected as much as they were by the TNX or the 10 Year Treasury Note, and at one point in 2007 Noah wrote an article on the comparison of rates and the 10 Year. It showed very little correlation between both.
As a result, many lenders started following Mortgage Backed Securities and trusted it as a gauge for predicting where rates were going. Obviously I am not going to discount that the MBS is not an indicator of where rates are or where they are going, but in the past couple of months I do see some trends relating to mortgage rates and the 10 Year Note once again... Down to a point of where the yields drop and rates move down as well.
I am going to ask Noah to research the 10 Year vs. Mortgage rates and post up his findings here.
More updates to come next week!
Not long ago I wrote a piece entitled "New Yorkers...and the Rest of "The Rich Financiers" Under Attack" predicting that nascent movements to taxing Wall Street bonuses and even financial transactions were an indication of a growing backlash against the street that had potentially negative implications for the financial industry and New York City economy. Initially, not a lot of new movement came on this front, although the U.K. government did go through with its rather onerous tax on banker bonuses.
However, in just a few short weeks since that time, the CEOs of several of the largest banks/brokers were invited to Washington for a second proctological exam and the already controversial "Bank Tax" was proposed. I personally was privy to an anecdote which underscores the very real issues behind the attacks on Wall Street. A trader I know recently lost their job due to the closure of a significant Wall Street hedge fund, where illegal activities have been suggested. Contrary to any fears of radioactivity, this trader was almost instantly hired by a previously bailed out bank to trade for customers and run a proprietary trading book (doing both these activities at once seems problematical to me, but apparently not to many investment banks). The trader was given a large bonus guarantee, which I joked, must not have been reviewed by the pay czar. It gets better. When this trader arrived on the trading desk of this large previously bailed out institution, he discovered a total lack of risk management. To wit, when the desk lost money, the policy was to simply sack the youngest guy there - I am not making this up. My understanding is that the newly hired trader was viewed as a risk management guru for implementing risk management policies generally followed by legitimate hedge funds.
Meanwhile the banks have begun to report results for the fourth quarter and full year 2009. It probably doesn't help their case that Goldman clocked in this morning with a monster quarter putting up a headline number of $8.20 per share vs. street expectations of $5.20.
As if on cue, Bloomberg reports that at 11:40 today, the President will propose new rules to limit financial institutions proprietary trading operations. This after a meeting with Paul Volker, the revered ex-Federal Reserve Chairman I quoted in my original piece railing against the inadequate changes to the financial system made thus far post crisis. According to Bloomberg, the Senate seat lost by the Democrats in Massachusetts yesterday, has woken the President up to the fact that the populous could give a grape about paying for universal healthcare, but is currently much more concerned with the economy, jobs and punishing Wall Street for its roll in the downturn.
In case anyone wants to shrug off the potential impacts of restrictions on proprietary trading, I would note that in its quarter reported this morning Goldman's trading and principal investments netted the firm $6.41 billion versus the rather paltry sums of $1.64 billion from I-banking and $1.57 billion from asset management and securities services. (Note that Goldman, which does not need customer deposits to run its business is least susceptible to government imposed prop trading limitations.) Other banks that have reported results in the last couple of days have also revealed that a significant part of their profitability came from fixed income trading, which more than offset the woeful performances in such normal bank activities as lending to consumers, businesses and the real estate market.)
As in my last piece I won't get into a discussion of the economic validity of government intervention into the workings of banks or the financial markets or whether banks should be gambling with depositors money on their proprietary trading desks (or front-running their customers orders for that matter). My purpose here is only to warn you that the backlash is real, re-regulation is highly likely and it will not be good for Wall Street business levels, compensation, or employment. This will be a distinct negative for Manhattan real estate. WE ARE NOT GOING BACK TO 2006.
A: Hat tip Curbed. I keep hearing all about this Shake Shack and their amazing burgers but I am yet to try one. Its not because of lack of effort. On three occasions my wife and I walked the dogs to the much better dog run over on 81st and CPW and tried to get into Shake Shack for a quick takeout; the Carl Schurz dog run just doesn't match up for dog owners on the east side! On all three tries, the lines were way way out the door and we gave up. Doh! So, the hype is high and the food better be good because it's coming only 2 blocks from my apartment and Digs likes to eat his burgers!
According to the NY Times, they signed a 15-year lease and I'm dying to know what rate and incentives they got to ink that deal in this very attractive market for commercial tenants:
"Shake Shack has signed a 15-year lease at 182 East 86th Street, which is between Lexington and Third Avenues at the base of the 440-unit apartment building with circular balconies known as Park Lane Tower. Neither the landlord nor the lessee would reveal the negotiated price. The company’s owners expect to open within the year in the 3,200-square-foot retail space, which is reached via the 2,750-square-foot sunken plaza.It's funny because I always told my wife that this spot would be perfect for a Dairy Queen with an awning and picnic tables in the sunken space for outdoor dining...guess I wasn't too far off!
Mr. Garutti said the Shake Shack intended to make the plaza a place for patrons to have picnics. They will be able to place orders at the Shake Shack stand. There will also be seating inside, he said. Though the plaza extends through to 85th Street, it will be open only on the 86th Street side."
For me, I got used to the burgers at these 3 restaurants in the Upper East Side:
1. The Lexington Candy Shop Luncheon - pricey and very tight seating booths, but this old school candy shop has all the stuff to make any adult think they are a kid again. Even egg creams done the real way! For the burger, get the bacon cheeseburger with fried onions - you know, the ones that remind you of White Castle's bite size burgers but in a high quality way!
2. Gracie Mews Diner - Yes, an above average diner in my opinion also has some underrated burgers! I think its the apple smoked bacon that makes it soooo good..even if delivered!
3. Burger Heaven - Been here a few times with colleagues of mine to discuss the state of the Manhattan markets and what they are seeing in their business. The bacon cheeseburger deluxe hit the spot, but is not my top choice when that itch hits!
What are your favorite burger joints around the city??
A: When I talk about unintended consequences from policy actions taken to stem a severe episode of global debt deflation, I really am talking about what happens to markets when the brakes are slammed on and liquidity measures reversed. This can come in a variety of forms: higher rates, higher taxes, regulatory reform, tightening of accounting rules, the draining of liquidity by the fed via open market operations or restrictions on banks to curb lending. This is the world that lies ahead of us. But in today's world, the talk of the day continues to be the search for yield through an expanding dollar carry trade. Keeping our eyes open to the future, you can't help but notice what happens when this future reality hits home to a market half way around the world: China.
China led the markets with their stimulus and seem to be leading the markets with their tough talk to prevent another speculative asset bubble from forming. Already there are arguments regarding China's growth and whether or not it is manufactured and cooked. Between the doubling of highways, roads, ginormous empty skyscrapers via this 4-minute China property tour and the government sparked buildout of the empty city of Ordos (must watch that youtube news report; hat tip Mish's "China Faces Crash Scenario"), I wonder how long the party can last? Stimulus included $200Bln on a countrywide railway project and an additional $220Bln for public transportation..All the while Chinese banks lent $1.3 Trillion in new loans in the first 11 months of 2009 - talk about aggressive lending! Have we heard this story before??? Yet through all this, Yahoo Finance states..."By most measures, Chinese banks are among the world's healthiest at the moment. Not only are they flush with cash, but their bad loans, known as non-performing loans, stand at just 1.6 percent". Let's see how long that lasts for and how long bad loans can be hidden off balance sheet in complex vehicles and sold to trust companies.
If today is any indication of what might lie ahead for us when stimulus is withdrawn and liquidity measures reversed, we should take notice of what's happening in China.
The New York Times reports that "China to Slow Lending Amid Bubble Worries":
The Chinese authorities signaled Wednesday that bank lending would slow significantly this year and reportedly instructed some banks to curb loans — the latest in a series of moves designed to forestall inflation and stave off bubbles in the stock and property markets.Ok, so what would happen if our markets corrected 3% in a day? That would take the Dow Jones down about 325 points; something that people would notice! In the grand scheme of things, a 3% correction after a 62% surge from the lows is nothing. But when a 3% correction turns into a 15%-20% adjustment, all of a sudden eyes open up and confidence may rattle.
“This year we will continue to control the pace and demand of the credit supply,” Mr. Liu said at a conference in Hong Kong, The Associated Press reported. He added that regulators were paying special attention to loans for local government projects and real estate. All banks, he added, had been ordered to “heighten their vigilance against an impossible, embedded credit risk.”
Still, economists said that the Chinese policy makers’ signal was neither surprising nor dramatic and that it showed Beijing “tapping on the brakes,” rather than engineering a major policy reversal.
The purpose of talking about this is to understand how we have come so far, so fast after the world seemed to be on the brink of collapse only 10 months ago. Its quite amazing when you think about the shift we experienced from complete Armageddon to total reflation isn't it?
But when I see some buyers out there get nervous because lending rates rose from a record low of 4.75% in late November to 5.125% today, I get a bit concerned that we are nowhere near prepared for what may lie ahead. What happens when lending rates rise to 6%? Do mortgage refinancings and housing sales take a cliff dive? What happens to IRR (interest rate risk) for those holding loans fixed at lower rates? The FDIC already issued an Interest Rate Risk Advisory to banks just about two weeks ago - hmmm, now why would they do that?
The reason I call it unintended consequences is because it is an unavoidable side effect of having the 'juice' taken away from us! No one intends for it to happen that way but at the same time, a Zero Interest Rate Policy (ZIRP) and $800bln stimulus packages, and homeowner tax giveaways, and buying of agency debt and MBS by the fed and tweaked accounting rules are all temporary forces that will ultimately be reversed. We do know that much. The new world ahead will be one of implementation of an exit strategy and that includes taking the painful steps to drain liquidity, curb bank lending of hoarded excess reserves, raising rates, and removing all the programs designed to stimulate investments and consumer purchases. And of course we need to ultimately pay for all that we borrowed to stimulate our way out of this mess. Stimulus withdraw is a bitch and certainly not as fun for markets as stimulus announcements and expansions. I just worry that once again we have all become addicted to stimulus, free tax credits, very low rates, massive liquidity facilities and accounting changes to cover up bad loans and losses. At some point we will be on our own and have to fend for ourselves, without counting on big brother to bail us out or lower our rates. The question is when?
Sorry for the duplicate entry here, just very busy with clients and UD 2.0 - I know its repetitive but this blog, while becoming more of a part time job, sometimes has to be sacrificed when my time gets taken up with clients. This is a slight re-edit of my July 17, 2009 piece "Valuing Manhattan Real Estate" to reflect todays marketplace.
A: I often get asked how I approach my consulting for my buyer clients. I take it a bit differently than most brokers and like to take on the challenge of 'valuation/bidding strategy' over procurement of property - I find most of my buyers use me to find out what is really going on out there and where a particular product should trade if they are interested in bidding. Given the great strides in overcoming the lack of a MLS system here in Manhattan, consumers can now easily find the bulk of our inventory on their own using sites like Streeteasy.com or NYTimes.com. The Manhattan real estate market is a different animal than most markets outside our crazy little island here. It happens to be a very fast paced market with lots of variables affecting property value and a very diversified and deep buyer pool. Every broker has their own unique way of valuing Manhattan real estate when a client is interested in bidding - from sending simple data based excel tables on past comps to a more in depth property and current market analysis. Here is how I like to do it.
First, you have to have an idea of where this market is trading right NOW as opposed to say 6-months ago. Keeping a mental history of where trades seem to be occurring as time goes on ultimately turns into a gut instinct on where the market seems to be trading today compared to say 3 months, 6 months, or 12 months ago. Imagine if you followed INTEL stock daily for 2 years straight; you would know exactly where the stock is trading today and the relative improvement or decline the equity price experienced over time. Same concept, two very different markets. Manhattan real estate, while much faster paced than most markets across the country, will still be an illiquid and challenging marketplace to keep tabs on.
Believe it or not, most brokers I have dealt with seem to be a bit behind the curve when it comes to what the markets are doing today in relation to where we came from. Its not their fault, its just that they focus more on conducting their business and servicing their clients than to have a trading perspective on our marketplace; that is perfectly fine and to be expected!
Having an idea of where trades occurred from peak levels and how bids submitted changed over time is absolutely vital to consultations with my buyer clients. For me, its a constant challenge that I look forward to; I actually enjoy it! Knowing where you are in the grand scheme of things gives your clients a leg up to be ahead of the curve, not behind it.
Before you go further, it is important to disclose that I look at when a contract has been signed and NOT when a listing closes when doing a property valuation. Its more important to me to see where the deal occurred when that contract was fully executed - as closing may occur up to 2-4+ months later. We can go back in time to explain why this is important:
If you had a deal that was signed in AUG of 2008 yet closed in NOV 2008, analyzing based off the closing date may be misleading as this deal was signed BEFORE our market froze up in mid-September from Lehman's failure.So look at when the deal was signed, not closed, to determine how much down from peak the property should trade at! Then you need to tap into that gut instinct of where we are today and were we came from over time to figure out how much of a time adjustment to apply.
Understand a few things when it comes to this marketplace:
1) emotions DO play a role on both sides
2) confidence CAN rise and fall in different ways: either progressively over time or at the drop of a hat if a shock hits
3) in a fast paced market when inventory has experienced a notable decline, buyers may act irrationally when finding that perfect place
4) real estate is an illiquid marketplace and not a stock that can be easily bought and sold with little to no effort or costs
5) every buyer values views, natural sunlight, building amenities, monthly debt service obligations, layouts, school zones, location and renovations differently - try not to overestimate the number of people that you perceive as agreeing with your line of thinking; the false consensus effect
With that said, here are the 3 main elements (changes in market conditions, renovation adjustments, light/view adjustments) that I focus on for valuating real estate in Manhattan:
1. MARKET CONDITIONS PREMIUM/DISCOUNT - How has the market changed today compared to the past comparable sale and how does this affect valuation for a product my client wants to bid on? If you are bidding on APT 10A, chances are you will not have the luxury of a 9A sale a week ago to compare to. So, you must adjust for time and if you do, you must know what you are adjusting to.
Contrary to popular belief, I don't only look at the most recent sale to find a unit to use as a comparable for my analysis. Instead, I also like to find a SAME LINE sale or SAME ROOM sale that traded near peak to analyze and do a time adjustment. Some brokers will only look at sales in the most recent 4-6 months discounting anything older as irrelevent; not me. I have no problem looking at a very similar sale that traded near peak (say mid 2007) and then do a negative time adjustment based on where this price point seems to be trading today.
Since smaller units tend to trade at lower premiums than larger units, I like to compare apples to apples; for example, if a studio and 1BR were the last sales in the building and I need to analyze a Classic-6, Id rather go back a year or two and find a same line or another Classic-6 to use instead. I will just adjust for market conditions myself.
That's another thing, I try to compare units of the SAME LINE for valuation purposes. I mean, what is the exact formula for quantifying how much of a premium a Southwest open city exposure should get over say a fairly obstructed North only exposure if all other property features are very similar? I certainly don't know. A buyer will likely value the open Southwest exposure higher than the obstructed North exposure - just how much higher is what the challenge is.
Breaking down by price point, I use the model range of discounts that I often quote here on UrbanDigs to consult for my clients. While finding a very recent same line sale is extremely useful, its usually not available to me. Lately I have been finding that deals signed before Lehman, say between MAR-AUG of 2008, were trading about 3-5% or so off of peak levels - it was only after Lehman that our market froze up and experienced that sharp move down. Here is my most recent snapshot on today's market decline from peak, taking into account the slight progressive improvement from 10 months ago:
HIGH END ($5M+) - down aprox 20% - 30% from peak
HIGH/MIDDLE ($2M - $5M) - down aprox 20% - 27% from peak
MID END ($1M - $2M) - down aprox 18% to 25% from peak
LOWER END (Under $1M) - down aprox 13% - 20% from peak
If I see a perfect same line comp that was signed into contract in March 2009 and closed last June, I would probably expect bids to come in slightly higher today, perhaps 3%-8% based on price point and the quality of property features.
2. RENOVATION PREMIUM/DISCOUNT - You cant just assume that every apartment is in the same condition. So, we need to determine the quality of the comparable sale and how that compares to the unit we are analyzing. In general, anything in the internal system listed at FAIR, GOOD, or EXCELLENT probably needs updating - with FAIR likely being a gut renovation needed. Only if it says MINT or NEW do I assume that the place was in fully renovated condition - pictures play a nice role here if they are available. I often find myself browsing streeteasy.com to go back and check for myself the condition of the kitchens, bathrooms, floors, etc.. of units I determine useful for a comparable analysis. Since you cant just visit a past sold comparable that you are using, this is the next best thing.
Many people have different needs when it comes to renovations. Some buyers have no problem spending the bare minimum for a renovation, while others absolutely must have a kitchen that costs over $60,000 to update with high quality everything. For this analysis, you can't just make up numbers willingly to rationalize the property trading at a lower level. Instead, try to figure out how much money is needed to make the property in question comparable to a past sale worth analyzing.
3. LIGHT/VIEW PREMIUM/DISCOUNT (Per Floor Adjustment) - Tricky, and more art associated with this one. You must give a premium or a discount based on what floor the comparable being used was on in your analysis. If you are about to bid on 3A and you see that 22A sold a year ago, well then you have some adjustments to make.
The general rule of thumb that I use is about 10K-15K or so per floor for existing resales, but it gets a bit tricky because you need to use some art and the quality of the light/view for in this aspect of the valuation. You see, sometimes charming treetop views on the 3rd floor can be just as popular as open city views on the 10th floor that look over the mechanicals of neighboring rooftops - in which case a 105K premium for the 10th floor may not be warranted. Other times, the difference between the 6th floor and the 10th floor is the difference between looking at a building's rear fifteen feet away and having open city views. In this case, a 40K premium for the 10th floor may not be enough.
So you need to use some art here and figure out just how different is the light/view from one comparable to another. The bigger the difference, the higher the multiplier you should use. In Manhattan, buyers pay for flooded sunshine and park/river/city views. I would use a lower formula to compare the 3rd floor with say the 5th floor, in which both have similar views! When dealing with a property that has amazing views or is a dungeon, well you need to tweak the formula a bit to satisfy the demand of this picky yet willingly wealthy Manhattan buyer pool.
New developments tend to give a default 15K-25K premium per floor in asking prices, unless otherwise re-negotiated by the buyer prior to contract signing.
When using these 3 main elements, I usually come up with a nice range to anticipate where the unit being analyzed MAY trade at! I always provide ranges as nobody is perfect and markets are sometimes inefficient - after all, a perfect buyer with unlimited funds may show up at a sellers door anytime; although this happened more frequently in 2006 and 2007 then is happening now.
The items that play a lesser role include:
a) properly discounting first and second floor apartments that are generally harder to sell because buyers are concerned about security, noise, traffic walking by, etc..
b) layout; sometimes a layout can be a hard sell such as a railroad style apartment
c) monthly expenses; general range for f/t doorman building is $1.25/$1.70/sft or so given the additional same amenities offered from the building - anything above this range must be properly compromised for via a lower purchase price and anything above this range should get a slight premium due to affordability
You may wonder why LOCATION is not included. Well that is because I base my consulting on IN-BUILDING TRANSACTIONS where location is static! The key is to make the analysis as simple as possible without introducing more variables into the equation.
In my opinion, using neighboring comps is one way of saying, 'I cant find any useful comps to support this purchase price in the same building that you are buying into'. In-building same line comps are the best, hands down, to use for a property analysis. I only use neighboring/similar comps if there is insufficient data on in-building comps to conduct an analysis - and when I do, you better find the closest property and the building with the most similar set of amenities offered. Once you start changing the variables your valuation technique will get more and more flawed. Even comparing one line of a building to another line of the same building can be argued as flawed because of the difference in layout, level of natural sunlight, and exposures/view that comes from being in a different section of the building. I have seen buildings where the A-line trades at a significant discount to say the C-line simply because of the location and exposures/obstructions of each line.
So there you have it, my summed up method for valuing Manhattan real estate. The parts that can't be taught is the gut instinct that comes from viewing a property and seeing how it compares to hundreds of similar units I have seen over the past 5 years and keeping that mental history of where bids seem to be coming in over time. That's the art of the valuation process that comes with daily experience in the field over the years.
I'll let Fireman Ed take it away! Stuff some green down the chargers throats and lets face Indy on the road to Miami!!
Back to blogging after the Jets victory!
A: After going on appointments with six different clients over the past few weeks, the general consensus from these buyers are, 'I'm tired of leftovers, where is all the new stuff'? Funny when I don't say anything to clients as I focus on my business but observe similar statements from different buyers that don't know each other. My response would probably be, yes I can see the market the past 3-4 weeks as being one of slim pickings, or leftovers if you prefer, but be patient because new listings will be coming!
Every year in December we see the usual surge in listings removed from the marketplace for seasonal reasons. This time around saw the very same trend. My new data source shows around 1,100 existing listings or so removed from the marketplace in December alone - again, nothing abnormal here. Here's the rub: Active inventory was around 8,950 or so at the end of November and is lingering around 7,205 units right now. Factor in the 1,100+ listings removed over this time period and you see about 650-700 contracts that were signed and now off the market as well.
That pace of contracts signed is lower than prior months but fairly strong considering the usually slow month of December; with the holidays and all the lost time attorneys had a smaller window to get deals signed. Since, this pace has ticked up again as we got into the first few weeks of 2010. The continuation of deals being signed and listings removed for seasonal reasons brought inventory to the lower levels that we see today. I see Streeteasy.com shows about 3,163 listings IN CONTRACT right now for all of Manhattan (I have pending sales higher around the 4,224 level) - think about this pipeline of pending deals that will close in Q1; Ill discuss this in another post! This is why buyers feel that only the 'leftovers' remain after seeing more desirable properties get signed into contract over the past 2-5 months.
But not to fear, I already am starting to see new listings tick up and colleagues I talk to are telling me that they are going on multiple sales pitches that are expected to sign listing agreements shortly! This is about the time when I would advise new sellers to come to market or re-list after a brief time off if the property didn't sell before. As usual, pricing is the most important! With traffic levels solid and ready, willing and able buyers out there, new sellers should take advantage of the action while its here and resist the urge to price high and test the market. That strategy will only help your competition to sell faster and before yours! For the record, I see this market remaining active for another few months before slowing down again from market forces discussed in earlier articles (higher rates, higher taxes, carry trade unwind, wearing off of artificial stimulus/fed MBS purchases/tax credits, rising delinquencies, reversal of off balance sheet accounting/M2M rules, etc..)
As for buyers, if they are not frustrated by the slim pickings of quality property that is priced right then they are focusing on listings that have been on the market for 6+ months yet had not sold. The thinking here is to find sellers that missed the action because they were priced wrong and too high, but who now 'get it' and started to more aggressively lower their asking price. Perhaps those sellers are now tired of the selling process and ready to get it over with.
As for wall street bonuses, as I said in my October piece "Euphoria or Reality Over Upcoming Bonuses?":
What I don't hear are terms like: distribution of cash component vs stock options, deferred stock compensation, clawbacks, ROE shares deferred, toxic asset bonus fund (credit suisse in 2008), other government tax policy on future bonuses, etc..Those with guaranteed cash bonuses in their employment contracts, good for you but you are in the minority. The bonus season this year will be one of LESS CASH! Whether that means a lower cash component, deferred stock compensation, ROE shares deferred, future clawbacks, etc., we are yet to see and time will tell. One thing I can say is that for both co-ops and for lenders, bonuses are not treated the same way they used to be and provide for significantly less purchasing power than in years past!
In addition, you must keep in mind that this also could affect existing homeowners who counted on that cash bonus to maintain a certain lifestyle or high end property that was purchased near peak. Again, time will tell.
For now, be patient as I would expect inventory to rise the next few months as sellers (both new and re-listers) come back to the market hopefully at asking prices that are in line with where trades seem to be occurring. If I can make one more prediction, get ready for Q1 sales volume to show a surge of perhaps 100% when released in early April and compared to the very weak year earlier Q1 of 2009 - how will the media handle that one when it comes out???
A: Let's be clear on what the real issue is here with these option ARM's and other negative amortizing loan products taken out at the height of the credit boom. It's not so much the rate reset that is the concern right now, with LIBOR and other index's that rate's reset to much lower than they were when credit blew out. Rather, its the loan recast that should be the concern. Let's talk about this once again now that it seems to be making headlines for struggling borrowers across the nation. And let us not forget about the delinquencies in Prime, Jumbo, and Alt-A that seem to be gathering speed right now.
I wonder whether we really will be able to carry trade our way out of this mess given the artificial nature of what is driving asset classes across all markets right now! The search for yield while balancing risk is getting harder and harder. Between artificially low rates, a huge expiring debt monetization experiment, artificial stimulus plans stealing future growth, artificial incentives to homebuyers and builders, removal of mark-to-market rules, easing of off-balance sheet accounting rules, surging budget deficits and treasury issuance, etc.., just how solid is this foundation of growth built on? That has always been something I questioned.
The story today from CNBC is that "More Homeowners Struggling As Option ARMs Reset Higher":
Thousands of American homeowners are starting to see their monthly mortgage payments skyrocket, dealing a fresh blow to the already shaky housing recovery.Don't mis-interpret a discussion here on UrbanDigs on how the Manhattan market improved to mean I no longer have concerns about the foundation this reflation trade is built on! Long time readers of this site know my stance on the bigger macro issues facing us.
The widely feared reset of thousands of option adjustable-rate mortgages-where both interest and principal payments rise sharply-is already leaving many homeowners struggling to keep a roof over their head. Terms of the loan usually allowed the borrower to make low monthly payments initially-sometimes by just paying interest only.
But as the terms of those mortgages now readjust, homeowners are facing much higher mortgage payments at a time when the value of their house has plummeted and many are out of work. In some cases, homeowners who chose a very low starting interest rate have actually seen the overall amount of their mortgage increase-known as negative amoritization-putting them even deeper in debt.
Loan recasts are one of them. As I talked about almost a year ago in my "You Worry About ARM Resets, I'm Worried About Recasts!" piece:
While LIBOR and other indexes that are tied to Option ARM resets have come down greatly, its NOT the reset I worry about; its the RECAST! LOAN RECAST - when your loan is re-calculated with the new principal amount, to fully amortize within the previously agreed upon term; a.k.a, re-amortization of outstanding principal at the fully indexed rate. When the loan is recast, the payment required to fully amortize the loan over the remaining term becomes the new minimum payment, and the payment cap no longer applies.This took a seat on the backburner for many months while the headlines talked about reflation, rising stock prices globally, a turnaround in housing sales and prices across the nation, etc..But it never quite went away! We can hide all we want as the markets take an 'out of sight - out of mind' approach to things, but in the end the problem will resurface!
It's the NEW PRINCIPAL AMOUNT that is the worry here, because of all the borrowers out there choosing the negative amortizing monthly payment option that causes the original loan amount to rise over time! There are two main reasons why your Adjustable Rate Mortgage will re-cast:
1) the loan reaches it's balance cap
2) the first scheduled re-cast date, usually 5 years from origination
Think of all the borrowers, with Option Arms/NegAm/Cosi/Cofi/Pick-A-Pay loans, that chose to pay the bare minimum monthly payment in order to buy the house that otherwise they couldn't afford, and saw their original principal rise over time; and now the recast is near! You worry about the loan resets, I'm worried about the loan recasts!
According to a Sept 2009 report from Bloomberg,
"...About $134 billion of securitized “option” adjustable-rate mortgages will reset to higher payments over the next two years, worsening the performance of bonds backed by the debt, according to Fitch Ratings. Payment resets occur after five years or when the debt grows to a preset amount, typically 110 percent to 125 percent of the original principal. Recast payments are on average 63 percent higher than homeowners’ initial minimums, and can be more than double, Fitch said."Its all about when the tide changes folks. For much of 2009 after the March lows, both bad news and good news sparked higher highs and lower lows in equity prices and pretty much all asset classes. It continues until it doesn't anymore. Don't take your eyes off of rising Prime, Jumbo & Alt-A delinquencies which are really starting to gain some speed right now!
Just because you don't hear about much anymore, doesn't mean it isn't still lingering there!
A: An important discussion to recognize the progressive nature in which bids for Manhattan real estate has improved since the March lows. Putting aside the fact that every buyer values property features differently, we must also understand that this market does not operate in a vacuum. For some, rising interest rates over the past few weeks causes hesitation. For others, the loss of a few missed opportunities causes more aggressive bidding the next time something pops up. Its important to note just how complicated and how many factors play a role in how any one buyer decides to bid for any one property - and that buyers can and do sometimes get interested in the same place. Just because you feel a certain way, doesn't mean the rest of the buyers out there feel that way too!
To secure my bachelors of science degree in Psychology at Union College, I did my thesis on the False Consensus Effect - which is the tendency for people to project their way of thinking onto other people. I came up with my own experiment, got the money from PSY department to run it, and found that students participating indeed exercised a noticeable degree of false consensus when estimating how others think about their opinions for a series of situations. I find this false force to exist quite often when it comes to one's perception of the strength or weakness of our real estate market. If a broker has a slow few months, they tend to think the market as a whole is slow. If a buyer thinks higher rates and higher taxes brings their affordability down 5%, they tend to overestimate how every buyer thinks this way too. Its an interesting concept that I wanted to mention to begin this discussion, but now lets get onto the point.
At the height of fear, trades seemed to be occurring down from peak as follows based on price point - as discussed in my March 9th, 2009 piece "Understanding 'Liquidity', or Lack Thereof For Manhattan":
HIGH END ($5M+) - down aprox 25% - 40% from peakYou know I can't generalize for every property in Manhattan! We need to use some logic here and be cautious not to mis-interpret a statement like the one above from 10 months ago to mean that every product should trade X% below peak comparable sales - I put peak trades at contracts signed between early-fall of 2007. That is why I give ranges to the best of my abilities as to where I see bids coming in at the time of publishing. Every property is unique and valued differently, especially in this marketplace!
HIGH/MIDDLE ($2M - $5M) - down aprox 25% - 30% from peak
MID END ($1M - $2M) - down aprox 20% to 30% from peak
LOWER END (Under $1M) - down aprox 15% - 25% from peak
The above marks the limited trades that took place in a 1-2 month window at the height of fear. It didn't last long at all and only about 450-550 contracts were being signed a month during those fear trade months! That is well below our average and indicative of the plunge in sales volume at that time! One can argue that only 900-1,100 trades across this entire marketplace really took place at the height of fear - and who knows how many of those deals didn't go through because of inability to secure financing, buyer walk aways, and co-op board rejections. That's not many at all!
The reflation was slow to start and progressive in nature. It did not all occur at one point in time. Rather, it started in the lower end around May/June and trickled to the higher end over time. It was progressive in nature meaning the improvement in bids occurred as time went on, to where we are today!
Now, not to say that there is a 1:1 relationship between this real estate market and equity markets, but lets use the progressive rise in equities as an analogy --> as the S&P went from 676 in March TO 834 in April TO 900 in May TO 1,000 in August TO 1,065 in September TO 1,100 in November AND TO 1,135 today, the rise in confidence and equity prices was progressive taking us to where we are right now! It took ten months and a few minor downtrends in between to get to where are now! Some call it a bullshit move, an artificial move, a 'sucking in' process, a rebuilding of 'hope' process that will later destroy, whatever...it doesn't matter! It happened and its in the books.
That is how the improvement in bids since the March lows occurred in this market too. As I said, every property is unique and every buyer values views, light, building amenities, renovations, monthly expenses, location, layout, and other unique property features differently! So one product may very well trade slightly different than another product even though they are both full service prewar Classic 6s in the West 80s! I don't need to justify why one product trades a bit higher or lower than another with a specific market reason. Its the nature of real estate markets and this market does not operate in a vacuum. And I certainly don't need to justify why one broker may see a different market than what I am seeing. The key is to get as much information from as wide a pool of sources as possible to see whether what I am seeing is consistent with what others are seeing on a mass scale. Outside of that of course I won't always pinpoint the market perfectly!
So in my opinion how have bids improved and where do I see trades happening right now? To keep it consistent so you can imagine the improvement from the March lows, it would be something like this:
HIGH END ($5M+) - down aprox 20% - 30% from peak
HIGH/MIDDLE ($2M - $5M) - down aprox 20% - 27% from peak
MID END ($1M - $2M) - down aprox 18% to 25% from peak
LOWER END (Under $1M) - down aprox 13% - 20% from peak
I'm not saying deals are happening at peak levels and besides it takes two to tango so the seller needs to be on board with where bids are before any trade takes place! Clearly a seller is much less motivated to hit a low ball bid today than they were in March of 2009. Instead, what I am saying is that contracts being signed right now show a discount from peak that is not nearly as fierce as it was ten months ago - and that improvement was progressive with time. Properties with higher quality features and that are priced right are trading faster and seeing solid interest. Properties with cookie cutter features that are priced high are still taking time to trade or procure aggressive bids.
With that said, you can add in two clear wild cards that really differentiate today's market from the environment last March:
a) Much Lower Inventory - Total active inventory is down from about 11,100 units in March to about 7,111 units today! Yes, a 36% decline is a noticeable one and leads to emotional decisions by buyers that are frustrated with options available to them right now. Who knows, maybe a buyer missed multiple perfect properties along the way and when a desired product is found today, they are much more willing to get aggressive to go get it than they were back in March.
b) Confidence Shift from Fear to Reflation - Never discount the emotional element that affects both buyers and sellers when it comes to buying and selling real estate. The difference between the world ten months ago and the world today is significant. It doesn't matter about future headwinds (rates, taxes, carry trade unwind, less cash bonuses, stock selloff, etc.), whether you believe in it or not, and whether you think the rally is artificial in nature! Humans are irrational creatures! The markets certainly are NOT rational! Markets are not efficient, sentiment does matter, history usually repeats itself, and we tend to operate with a herd like mentality!
I really enjoyed Barry Ritholtz's piece on dissing the Chicago School of Economics; which assumes rational expectations and an efficient markets theory.
This market is a fast moving animal and many forces are at work, as proven by the last 18-24 months. In the meantime, as long as there is cash and improving confidence out there this market will continue to see demand; i.e. trades. We can always question how higher taxes, higher rates, less cash for bonuses, rising inventory and tighter lending may ultimately stifle this recovery. As it changes, I'll report on it the best I can and without bias - that's all I can do.
A: A quick update for you guys on the number of sales with Q4 reports out a few days ago. The chart below should clearly show you the adjustment we had and the recent surge in contracts signed that has pending sales awaiting closing at healthy levels. I would expect the next quarter to continue to see closings above the 2,000 mark as the pipeline deals clear; and represent a HUGE percentage increase over Q1-2009 sales volume when its released early April.
Here are Manhattan Total Sales broken down by quarter for Co-ops + Condos:
*Data courtesy of MillerSamuel.com/Data
MillerSamuel's Q4 Report adds:
There were 2,473 sales in the current quarter, up 8.4% from the 2,282 sales in the prior year quarter and up 10.9% from the prior quarter. This level of activity was more than twice the 1,195 sales seen in the first quarter of 2009, which had been lowest level of sales in nearly 15 years. The return to more normal historical levels of sales activity was also reflected in the decline in inventory levels.Now, recall the lagging nature of sales that I discussed yesterday! This is why when I wrote my Q3 Manhattan Quarterly Sales update I stated:
"With many deals still in the pipeline, we might be able to beat Q4 2008's number when that data is released January 2nd, 2010."And that we did! At least hopefully you know I am not making this real time update stuff up here on UrbanDigs.com! This represents the first year-over-year increase in total sales since the adjustment started after 7 consecutive quarters of declining y-o-y sales volume!
The surge in activity continued into year end, although not quite the pace we saw in June-Early Aug, so expect another quarter or so of solid closing data when Q1 sales are released in early April. Currently, I have pending sales around the 4,684 units level.
I'm on the record as being cautious on the stock market here, largely as a result of being lukewarm on the economy and real estate markets (both residential and commercial) during an anticipated long and drawn out rationalizing process. Since I have neither prescience nor precision in such matters, I'll sign on to Noah's potential 6-8% up move left in the stock market, with at least 15% downside and potentially a bunch more if things go the wrong way. However, I find it fairly easy to verbalize the bear case for the economy, stock market and real estate markets right now. I don't think Noah really left much unsaid regarding the grave threats to the economy and our pocketbooks over the next few years. In the interest of not being redundant and providing myself with a worthwhile exercise in scenario building, I'm going to talk about what could go right in 2010 from my perspective. I would even dare to say that with the risks that are extant today, if the potential positives I am going to discuss don't occur/continue in 2010, my long-term outlook would become quite negative.
Improved state budget deficits - there is no question that state budgets are a mess. California is currently begging Washington for a bailout. The Governator will give his final "State of the State Address" this week and talk about his ideas for closing a budget deficit estimated at over $20 billion. The state received $8 billion in stimulus money last year, which helped plug budget holes. It will need additional funds in 2010, or risk cutting services and more importantly state jobs. California as always is a microcosm of the country and as of mid-2009 estimates show that all states, ex North Dakota, faced 2010 budget deficits you can visualize here. The Christian Science Monitor recently published an article entitled "Which states are facing the worst budget deficits in 2010?" with New York and New Jersey prominently featured. According to the National Conference of State Legislatures "Ironically, a contributing factor to future state budget gaps is the end of federal stimulus funds provided by the American Recovery and Reinvestment Act (ARRA). Those additional funds supported state budgets in FY 2009 and, to an even greater extent, in FY 2010. That money recedes in FY 2011 and, when it is gone, will leave big holes in state budgets—what many state officials are calling the “cliff effect.”" However, despite 2010's issues and potential future shortfalls, income taxes, sales taxes and fees are the primary drivers of states' revenues and these should all begin to improve in 2010 if the economy continues in expansion mode. (Note that real estate taxes are generally the bedrock of municipal rather than state finances, but states and the federal government ultimately backstop municipal finances in many ways).
Exports - Manufacturing expanded at the fastest pace in more than 3 years in December according to the just reported ISM index. This has been driven in part by exports, which rose 2.6% in October for the sixth month in a row, as reported in early December. Note that exports are only about 13% of GDP, so this factor alone cannot carry the economy, but it does have salubrious effects on employment and represents an area of great potential growth in the future.
Inventory building - The inventory to sales ratio, which reached a low of 1.26 in mid-2008, rocketed to 1.45 by the end of 2008 as companies liquidated inventories in the face of an uncertain demand outlook. It has been on a steady decline during 2009 reaching 1.30x by October (last data available). As reported last month, inventories unexpectedly rose in October potentially signaling that the liquidation phase is over and that some stocks could begin to be rebuilt in 2010. Note that the current inventory to sales ratio is at the high end of the 2004 to 2008 range. It is also worthwhile mentioning that increasing prices for goods will tend to shrink this ratio without unit supply changing, if we have indeed escaped the clutches of the deflationary forces that were crushing prices for many commodities and finished goods last year.
Stimulus - A recent editorial by Paul Krugman in the New York Times goes through the timing of stimulus and puts the largest amounts of money entering the economy in Q1 and Q2 of 2010. You can see the data here (View image). Several economists, including Krugman, note, however, that the maximum year-to-year impact on the economy in terms of rate of change happened in Q3 2009. Although I am a 2nd derivative guy, I think in this case while the logic is correct it is missing an important piece of the real world behavioral picture. Many companies I have talked to delayed planned spending and/or saw states delay spending (that would have come to them) in order to see what kind of stimulus money would be awarded. In effect, the actual implementation of the stimulus program acted as a depressant to spending. Now the money is actually flowing in fairly large amounts, the economy is improving and everyone will feel better about loosening up the reins - the net impact being that stimulus, though delayed, will actually be reaching the economy in a significant way in early 2010.
Venture Capital - My personal opinion is that to save our nation's long-term future, Americans have to do what Americans do best, which is invent, or in today's case re-invent, ourselves. Our country has always been one of the most flexible, because of our capitalist structure (we can discuss flaws in the model and the need for safety rails at another date) and has always been a hotbed of new ideas and creative design. We have huge opportunities to improve productivity and the quality of life/standard of living for our entire nation if we can succeed in lower healthcare costs and improve our energy independence. A recent KPMG survey found an improving outlook on the part of venture capitalists, with 68% of respondents saying they expected total venture capital investment to increase in the year ahead, vs. last year when 74% saw a decline. This is indeed good news because new technology/business structures are going to be key to the long-term recovery of our nation. Interestingly, some of the investments made in energy efficiency technologies by big venture capital firms, a few years ago, are now getting to the commercialization stage and could actually have a reasonably large impact on the economy over the next decade. According to this fascinating New York Times article of a little over a year ago, venture firms have purposely kept several of these groundbreaking technologies and companies under wraps, so as not to invite competition. Additionally it would be karmacly correct in the context of Bernstein's Rules of Poetry of the Investment Universe for these technologies to begin having an impact on the economy soon.
Consumer Spending - According to the American Enterprise Institute, "During the three months ending in October, real consumer spending rose at a 2.6 percent annual rate while real disposable income rose at a 0.6 percent annual rate. Whether spending can continue to grow substantially in excess of income growth, and therefore draw down savings, remains one of the major uncertainties overhanging the U.S. economy as we move into 2010." One could argue, however, that disposable incomes have likely troughed and will soon begin to rise as hours worked begins to climb. While unemployment is 10% and wider measures of under-employment like U6 are > 17%, about 83% of the populous is still working and gaining more confidence in the sustainability of their income streams. Auto sales for December were 11.25 MM on a seasonally adjusted annual rate basis. While this is well off of the pre-crisis 16MM "normal" rate, it is also well above the 9MM rate at the trough and is driving a pick-up in related industries like steel production and transportation services. While year-end incentives played a role here, the fact that some of the citizenry is gaining enough confidence to step-up purchases of big ticket items is a big positive. On December 29 the International Council on Shopping Centers (ICSC) reported that U.S. retail sales grew a better than expected 2.3% during Christmas week, boosting the months' gain to 2%. The ICSC's chief economist Michael Niemira, was quoted by Business Week saying "We are in a retail recovery, but it's not going to be smooth sailing"; still he is looking for 2010 sales growth of 3.5%. You can find a graph of Gallup Poll data on U.S. consumer spending here(View image), that clearly shows a bottoming trend since mid '09. Consumer spending will obviously have to get much better in late 2010 to offset declining stimulus and housing incentives.
History - According to Deutsche Bank's economics team, "From the 1850s to present there have only been 3 instances in which the economy double-dipped (defined as the economy lapsing back into recession within a year of the previous recession ending): 1913, 1920 and 1981." I would note that in the most recent case, the Fed under Paul Volker was in the process of cranking up rates to kill inflation.
So there you have it. It actually took me much longer than usual to write this piece, because I wanted to give the glass-half-full scenario a fair vetting. Unconvinced? so am I, but lately the economic data has all skewed to the positive....until today's housing sales figures. I do believe that the economy will continue on its mild recovery track until something throws it off. Unfortunately, I think it all rests on the real estate markets and health of our banking system, which are still precarious and leave little room for error, while it is hard to see any big drivers from the list above to provide enough impetus for a healthy recovery. Have I missed any rays of light, or green shoots?....please feel free to add to the discussion.
A: You will often find discrepancies between what I say here on UrbanDigs.com and what you see in the quarterly reports issued by the major Manhattan brokerage firms. The reason is that these reports are lagging in nature; by quite a bit I might add. I'll explain below. What you need to know is that the next three quarterly reports will be compared to Q4-2008 to Q2-2009, and you get comparisons that will likely look pretty good as we get to that 3rd report. The downturn for Manhattan real estate was defined by Q4-2008 up until about the end of Q1-2009 or so. Since these reports are lagging it took a few quarters to really show up in the media - as early April were the first shocking Bloomberg reports of how hard our market was getting hit! So, you have to understand that this blog tells you what is happening real time and discusses changes as I see them occur in this marketplace; as opposed to lagging quarterly reports that amount to nothing more than a glance in the rear view mirror.
Take note to understand the lagging concept here with these quarterly reports, and use caution when interpreting the reports to mean this is what is going on right now in the Manhattan marketplace.
I look at when the contract is signed as the moment that captures the state of the market as of today; i.e. if we had contract signed data as it happens it would be as real time as you can possibly get as to where the bids are for properties. It's where the trade will take place! Now, in this market it takes about 2-4 months, sometimes longer, to go from contract signing to actual closing when the trade gets reported as public record. It is at this time the closed sale is calculated into the quarterly report and analyzed. Therefore, the Q4 report that is about to come out today for the Manhattan marketplace - which takes into account trades from OCT-DEC of 2009, are really a snapshot in time of the contracts that were signed from June through September 2009! Aha, the eureka moment. The downturn took 7 months to be captured by the mass media via the quarterly reports and the reflation I discuss now will likely take another 6-7 months to be captured by the lagging reports - so you have to wait to see what I said here in the past few months to get caught and reported on!
FLASHBACK: April 2nd, 2009 ---> "Manhattan Co-Op Prices Decline 22%, Most Since 1995 ":
Manhattan co-op prices dropped the most since 1995 and transactions for all apartments plummeted 48 percent in the first quarter from a year earlier as the recession and Wall Street unemployment cut demand.That was the first real report showing the adjustment Manhattan experienced starting about 6 1/2 months earlier; after Lehman failed and sparked a fear based selloff in all markets that came to a head in March of 2009. As for our markets, the failure of Lehman led to a disappearance of buyers that lasted about 7 months with the best deals taking place right at the tail end of that freeze-up. Since then, its been all about rising sales volume which led to the pricing out of fear, which sustained itself into a full blown reflation trade that seemed to have affected all asset classes. Right now the reports are capturing the beginning of the pricing out of fear part of the process.
The median price for co-operative apartments fell 22 percent to $587,500, according to a report today by New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate.
The report today, "Manhattan Apartment Prices Fall as New York Loses Finance Jobs":
Manhattan apartment prices fell for a third consecutive quarter as Wall Street job losses drained demand and the decline in co-op and condominium values reached 21 percent since the market peak.Future reports will slowly show the stabilization in prices and then ultimately show a slight rise in prices probably in Q2 or Q3's report that comes out later in 2010. I see it in the field and eventually it will come out.
The median price slid 10 percent to $810,000 in the fourth quarter from a year earlier, down from almost $1.03 million in 2008, New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said today. The number of sales jumped 8.4 percent to 2,473 as lower prices pushed transactions above the 10-year quarterly average.
In the last 6 months, I show:
ACTIVE INVENTORY ---> Down 27% to about 7,181 units
PENDING SALES --> Down 0.9% to about 4,724 units
LISTINGS REMOVED FROM MARKET --> Up 8.2% to about 11,118 units
The reason pending sales is down over the past 6 months is that the bulk of the action took place around June, July and August when we saw about 1,200-1,250 contracts signed a month - the so called pent up demand jumping in with much lower prices and a delayed seasonality effect from the freeze up period that consumed much of January, February, March, and early April. This was the time when fear started to get priced out of the marketplace.
When I say 'delayed seasonality' what I mean is that the adjustment down distorted the period of time that our marketplace is usually more active - and the seasonality effect got delayed and pushed forward. With the typical wall street bonus season seeing more action than summer months, 2009 became the year that lost its 'active' season as the market adjusted to a new, lower level. Once that comfort zone was hit, sales started to rise - and during the entire process we saw deals at every price.
Today, I see a market with much less inventory than only 10 months ago and noticeably improved bids and trades coming through. I am now seeing some multiple bidding situations in all price points as buyers get frustrated with the lack of good options that are priced right. When I say lack of 'good options' or quality product, I am talking about properties that have that desired mix of raw space, layout, renovations, natural sunlight, desired exposures, and open views in a building whose monthly carrying costs are not out of whack with the norms and whose asking price is not 'testing the market'.
I cannot deny the shift this market experienced over the past 10 months or so. It has been dramatic to say the least; the data says it all. Which brings us to what comes next? At first I questioned the sustainability of the pickup in activity, calling it a countertrend surge in action embedded in a longer term corrective process. Well, it turned out to be more than that. As a result, I have to adjust that phrase a bit as I see this market staying strong for another few months or so as long as inventory is as tight as it is and the reflation trade continues to bring willing & able buyers to the market. The main questions I have over the next few months are:
1) How will shadow inventory affect current active levels? We know many listings were removed, so how many are coming right back?
2) How will new listings add to inventory levels now that the market seems to be trading at improved levels?
3) How long will buyers' bids continue to improve to grab the property that is desired now that options seem to have declined? Will the reflation last forever? What happens when it reverses?
4) Will sell side optimism outpace the improvement in bids leading to another period of slow sales volume? At some point, I see this occurring as the reflation affected both buyers & sellers.
5) At what level will higher rates start to impact buyer's willingness to improve bids as affordability once again is taken into account. 5.5% lending rates? 6%? 7%? When do we even hit these kinds of lending rates?
Take it for what it is, a lagging report on a strengthening market since the March lows. It will take another two quarterly reports or so to see what has been discussed here as of late; so you make the call what you want to listen to. When the market changes, I'll report on it and I always try to keep commentary real time and unbiased. Lets continue to keep it real!
Happy New Year all!