The Improvement Was Progressive in Nature

Posted by urbandigs

Thu Jan 7th, 2010 02:56 PM

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!

false-consensus.jpgTo 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 peak
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
You 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!

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, 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.