Valuing Manhattan Real Estate: Revisited

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.