Manhattan Q2 Report Thoughts

A: Due to the lagging nature of these quarterly reports, nothing disclosed here is a surprise; at least not if your reading UrbanDigs.com! The biggest mistake one can do is to read one of these quarterly reports, and just assume this is exactly what is going on right now! The thing is, the market today is significantly more active than what this report suggests because Armageddon has been priced OUT of this marketplace over the past 7-9 weeks or so - something not reflected in this report. When you hear, 'sales volume plunges 50% from year earlier', you may immediately assume today's market is completely dead - not so. So, make sure you understand this lag and acknowledge that this market did equalize from the frozen months of OCT - MARCH. The bulk of the pickup in activity occurred between mid-April to end of June - as confidence rose with the equity rally and a wave down in prices. The telling aspect of this report lies in the y-o-y price declines reported by price point - something that I reported to you as early as March 9th, ironically the day the stock market hit its most recent lows. At least I feel good that my reporting to you guys is both accurate and timely. I will do my best to continue this front line reporting mixed with macro economic thoughts going forward as there is always something to talk about when it comes to Manhattan real estate.

Lets discuss price first, and then move onto sales volume. In early March, right at the height of the fear and the top of the severe illiquidity since Lehman's collapse, I wrote a piece called "Understanding 'Liquidity', or Lack Thereof For Manhattan" to describe what I was seeing out in our marketplace - note, this is before the equity rally and shift in psychology from Armageddon to Reflation that occurred (whether you like it or not or buy into the sustainability of it or not):

Right now the market seems illiquid because the bid-ask spread is too wide creating a disconnect; meaning that either sellers are still in denial about the price drop of their asset (current market value) OR buyers are too cautious to bid more aggressively for the asset.

This is really a high end recession in the Manhattan real estate market, that is rippling through to the lower price points. That is the best I can describe it. If I were to divide Manhattan into a few categories and where deals seem to be happening now, it would be something like:

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

Remember, we will have to go through Armageddon price discovery first, before we see the slightly higher deals that took place over the course of the 7-9 week confidence/reflation shift. We are seeing the beginning of this now, but expect it to last a few more quarters on the pricing side.

Fast forward to today and Bloomberg reports on Manhattan's Q2 Report, "Manhattan Apartment Prices Drop as Lehman Effect Hits Home":

Manhattan apartment prices dropped for the first time since 2002 in the second quarter as the collapse of Lehman Brothers Holdings Inc. and Bear Stearns Cos. caught up to property owners in the nation’s most expensive urban market.

The median price fell 18.5 percent from a year earlier to $835,700, New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said today. The number of sales plunged by half, the most since Miller Samuel began keeping data in 1989.

The price of studio apartments declined 16 percent from a year ago to a median of $405,000, according to Miller Samuel. One-bedrooms dropped 17 percent to $650,000 and two-bedrooms fell 23 percent to $1.27 million. Three-bedroom units fell 37 percent to $2.35 million and four-bedrooms plummeted 47 percent to a median of $3.92 million.

Notice that last paragraph that discusses the structured effect of this slowdown on each price point and compare that to what I reported to you guys in early March! You want to keep it real, keep it here!

Now, lets move on to sales volume. As most brokers used this latest equity rally and countertrend pickup in activity to call for a bottom or recovery, you must use caution when analyzing month-to-month trend changes in a seasonal market. Instead, you should compare data on a year-over-year basis or seasonally adjust the data.

In May, I did a piece discussing this exact topic and showed you a graph going back 10 years that looked at NUMBER OF SALES by quarter - in an attempt to analyze how the first half of 2009 would compare to previous first halves of the year over the last 10 years. While brokers discuss the pickup in action on a month to month basis, which is true, the bigger picture tells a different story and todays Q2 report confirms this. I estimated that number of sales for Q2 would come in around 1,700 - 1,800 or so, which would put the first half of 2009 as 'the most sluggish in the past 10 years'. The report notes that y-o-y sales volume plunged 50% - and Q2 2008 sales totaled about 3100. That would mean Q2 sales came in lower than my estimate and closer to 1,550 or so. I cant find an exact number in the report, but will do a separate piece on this in a few days - clarifying the bigger picture.

Now, what this report doesn't reflect is the last 7-9 weeks of action that occurred. Whether you like it or not, whether you are a perma bear or perma bull, we must be able to accurately discuss what is happening out there, without bias or agenda, BUT take into account what we just went through and how the macro economy may or may not affect our market in near term. I expect the countertrend pickup in activity to level off soon, and this market to slow down a bit as we enter the normally slower summer months - seasonality at play, nothing more.

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Quick Manhattan Snapshot: Market Pricing OUT Fear

A: I have been too busy to blog lately, which is nice of course, but wanted to give a quick snapshot of what I see out there - take it as such, a quick snapshot of what I see out there. Basically what has happened over the course of the past 2-3 months is an acceleration of activity from the March lows, as this market priced OUT Armageddon. Strange to hear it that way, but basically that is what I see happening. I see deals happening at slightly higher levels today than only 3-4 months ago because of the shift in both buy and sell side confidence - leaving out whether this shift is warranted or not. Does that mean a new sustainable bull market, of course not. It means we went through some extreme times, and the market is adjusting and equalizing. While every price point has been affected by this crisis and trading in their own unique ranges down from peak, it seems transactions taking place over the past 7-9 weeks are not as pressured, or 'fear based', as those that took place in February and early March when fear was highest. The shift in psychology from fear to reflation/confidence is responsible; and a 40% equity rally from the lows + a wave down in prices helped that shift to occur. Looking at inventory trends, you can see this shift rather clearly. Don't forget though, the fear months will close first - so we will have to wait 2-3 months to see the 'less pressured' deals I am referring to here.

Contracts continued to be signed and you may have noticed some listings on your radar exit the active marketplace. Combine this activity with listings taken off the market for seasonal reasons, and you see a notable reduction of active inventory over the past 2 months. Take a look at Manhattan Active Inventory trends both before and after the March lows and know that there was a bit of a lag for the confidence and action to get going - mid April to mid June were noticeably active and the trend started to reflect this in early May:

Now, you must keep in mind where we came from and understand that very few trends go in straight lines forever. There are blips, bumps, corrections, retracements, and countertrend surges - all in the way natural markets behave. To ignore the increase in inventory and only concentrate on the last 2-3 months to build a sustainable bullish argument, is flawed. Always look at where you came from. Nevertheless, this market seems to me to continue to be active and I can see this trend continuing for a bit longer before we head into the normally slower summer months! Time will tell how this summer compares to previous ones, considering how different this year has become - I am referring to a wave down in prices that most thought impossible only a year ago.

Here is the trend in contracts signed, at a lag of course, that is displayed as a weekly average so to avoid the spikiness that comes from little to no data updates over the weekend. You could clearly see the pickup in activity that was discussed here months ago:

I would expect confidence to continue to mirror the equity market and major headlines moving forward, on top of seasonal changes in activity for the 2nd half of the year. Should you see a deep correction in stock prices, expect to see activity dry up again for our local marketplace. On the flip side, should stocks continue the rally and surge, sellers will be less motivated to hit a low ball bid (unique financial circumstances aside) and I'm sure brokers will continue to benefit from a ready, willing and able buyer pool - lets see how sellers, appraisers, underwriters, and co-op boards react. Predicting a shocking event or a systemic risk at this point in time, seems dangerous given the path taken by the fed and government. This is evident in the fall of the VIX to its lowest levels since Lehman's collapse - a lower VIX means fear is subsiding and traders view this as a contrary indicator (a low vix may mean complaceny sets in, while a high vix may mean fear is peaking). How long it lasts is another story as the markets seem to be pricing in a V-recovery and not a deep, prolonged, or W-double dip recession possibility - will the market be disappointed if data doesn't come in to support this?

For those trying to Price In Downturn Risk right now, you are probably finding it harder than you previously thought; especially if you were seriously bidding in the fear months of February and early March! When fear was high then, pricing in future downturn risk was easier to get away with as sellers desperately hit bids after 4 months of severe illiquidity / stocks falling to lows / and systemic risk high. But today, with the market pricing out Armageddon and total collapse, I'm sure you will see deals happen at higher levels than what units in contract 2-3 months already are closing at now from the fear months - the lag of property transactions at work. Strange and interesting to see how Armageddon discovery comes first and whether buyers will consider those deals outliers or the new baseline for future bids. Don't forget, that while the buyer dictates the value of any property at any given point in time, it is the seller that must sign off on it. Therefore, you can't discount the psychology changes that came on the sell side as well as the buy side, as traffic heated up and bids started to come in at stronger levels. For me, I still focus on the buy side as a gauge to current marketplace health. With that said, let me be perfectly clear that this market is not a frenzy like it was in early 2007 and deals continue to be had at the noted range discounts discussed here previously for each price point - albeit closer to the lower end of that range now that Armageddon seems to be priced out of transactions.

Interesting times indeed and remember, don't look in the rear view mirror if you want to look ahead. And don't analyze a seasonal market by focusing on month to month changes! When Q2 data comes out in the next few days, expect a significant tick UP in contracts signed from Q1 to Q2 but a drop in closed number of sales on a year over year basis! Because of the lagging nature of our markets from contract signing to closing, we could see a rather bullish Q3 sales number down the road - reflecting the active market from mid April to present! Its the sustainability of this activity that I call into question and as we get deeper into the summer, I would expect things to quite down a bit again in line with the seasonal nature of our marketplace.

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Jonathan Miller Podcast w/ Noah Rosenblatt

A: I had the pleasure to be a guest on Jonathan Miller's Housing Helix Podcasts earlier this week that is now published. This is the first of a few appearances I'm told, so hopefully I get another invite back in the future! This interview was mostly about me, as a person and entrepreneur (thats right, I have been technically self-employed since I graduated college), and how urbandigs got started, about how I got into trading, a little about my first website venture (www.hotspothaven.com), a little about national housing markets, a little about how change is a coming to our local marketplace, a little about the fed and its money printing policies, and a little bit about the natural order of markets. We stayed away from the future of UrbanDigs 2.0 and the current state of the Manhattan marketplace, sorry, but hopefully very soon I will be invited back with no attachments to any employing brokerage to discuss these things in great detail. Anyway, I hope you enjoy and check out the bottom of this post to see what UrbanDigs was originally going to be!

DID YOU KNOW?

Did you know that UrbanDigs.com originally was designed and modeled in early 2004 to be a replacement for the NY Times Search Directory? I bet you didnt! Originally, my goal for UrbanDigs - before I got my re sales license in June 2004 - was to become the new and improved MLS system for NYC real estate! I had the designs all made out but startup costs were too high and I couldnt get anyone to give me money to launch it. You can see the mid 2005 dates on the image below, as this design was like the 5th revision to the idea that started about a year earlier. Here is the model of what UrbanDigs originally was to become, before I decided to make it a blog and did my first post later in 2005 - notice the model derived from the hotspothaven.com search engine design (view larger image)!

Funny isnt it!

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Prime Jumbo MBS Downgrades From 1998?

A: Hat tip to Calculated Risk for bringing this one out to people's attention. Umm, one would think that the real questionable prime jumbo loans (at the height of the credit boom) were issued between 2005-2007 or so, before the securitization market decided to go the way of the dodo bird. To hear that we are getting downgrades on '102 classes from 33 U.S. prime jumbo residential mortgage-backed securities that were issued from 1998 to 2004', makes me wonder how deep this problem goes. Where were these guys marked? Oh what a tangled web we weave.

You may wonder why some of the holders as far back as 1998 may be defaulting if they saw the equity of their home skyrocket with the housing boom. Well, the answer to that would be MEW. How much did the homeowner cash out during the boom, and how did the subsequent fall in prices kill the LTV ratio for the homeowner? We all know how people used their homes as an ATM machine for at least 3-4 years, big time! Now the house is worth less, yet the debts remain. Couple that with this severe slowdown and rise in unemployment and pressure has been building on these once 'high quality' borrowers.

Prime Jumbo and the rest of the stuff sitting lord knows where on the banks balance sheets (helocs, credit cards, lbo's, commercial mbs, etc..), are all part of my concerns over a 2nd wave of writedowns, capital raising, activation of the planned toxic junk-disposal programs, etc..Just be prepared thats all. The banks raised a lot of money with this equity rally, and got some earnings behind them from Q1. This could help capital ratios and TCE for a bit longer. But ultimately we will have to face the music on the higher quality debt classes and other types of debt that are still sitting there, rotting away.

From Marketwatch.com, "S&P downgrades prime jumbo mortgage securities":

S&P said it lowered ratings on 102 classes from 33 U.S. prime jumbo residential mortgage-backed securities that were issued from 1998 to 2004. The rating agency also affirmed ratings on 669 classes from 32 of the downgraded deals, as well as 34 other deals.

"The downgrades reflect our opinion that projected credit support for the affected classes is insufficient to maintain the previous ratings, given our current projected losses," S&P said in a statement.

Prime mortgages were originally thought to be less vulnerable to housing cycles. Home loans offered before 2005 -- when the lending binge really took off -- were also considered more solid. But the rapid increase in unemployment has undermined these assumptions.

Careful about that complacency thing setting in that this credit crisis is over.

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Nenner: Deflation Now, Inflation Later

A: Charles Nenner is out today with a call that the deflationary episode is not yet over, and still has to run its course. Meanwhile, he discusses how inflation will kick in down the road (18 months) and continue in an 'upcycle' for about 30 years. I have to admit, I am in a very similar camp as Nenner in terms of another wave of deflationary pressures before the true inflation cycle begins.

Charles Nenner, founder of the Charles Nenner Research Center, discusses on Yahoo Ticker:

Renowned for his cycle work, Nenner sees deflation remaining dominant until year-end and inflation not picking up for another 18 months. But that will be the start of a 30-year (yes, year) upcycle for inflation says Nenner, who spent 12 years as a market-timing consultant for Goldman Sachs. Nenner believes the "deflation trade" is about to reassert itself in the short-term, meaning strength in the dollar and Treasuries, and weakness commodities and equities, as we'll discuss in more detail in a forthcoming segment.

For those who believe the dollar is doomed, Nenner notes "all currencies are bad." In other words, currency trading will be a game of relative bets vs. a one-way trade against the greenback, as so many expect.

Nenner did discuss the deflation 'scare' in late 2007. Here is a question for you:

Q: If the fed continues with a Zero Interest Rate Policy, stimulus everywhere both monetary and fiscal, tons of credit facilities and programs to recapitalize the banks, bailouts galore, and pure QE money printing to the tune of trillions of greenbacks out of thin air, then WHY oh WHY won't there be hyperinflation, or at least inflation in our immediate future?

This is a question many people ask me, as if I am omnipotent or something. I'm not. But I do have my views on this topic, like most people. Fact is, YES, the fed is printing trillions of dollars and stimulating like mad, and you can see the surge in the adjusted monetary base - but that surge is mainly sitting idle in excess reserves. Thats the thing. Our fractional reserve system of banking, with its money multiplying debt creation effects, is not operating normally and very rightfully so.

If you have trouble grasping this concept, that the newly created money is not entering 'the system' so to speak, think of it this way: the money that Helicopter Ben is printing and dropping from the air is caught in an updraft and circling high above us! Its not hitting ground where we all pick it up and go willy nilly spending it. This is evident in the plunge in the velocity of money, that I discussed back in January. Fact is credit is contracting, HELOCs are being cut, loans are harder to get as underwriting standards have tightened, the shadow banking system saw hundreds of billions of lost wealth, trillions of lost wealth from housing and stock market collapse - does any of this sound inflationary to you? No.

The main reasons why the feds printing and stimulus wont produce hard core inflation right off the bat, include:

1) The deflationary episode we are in will negate any inflationary effects for as long as the system takes to delever, restructure, handle bankruptcies and failures, write down toxic assets, and destruction of bad debts through defaults - this is ongoing and WAVE 2 still lies ahead of us

2) The feds hundreds of billions of money printing is sitting idle in excess reserves and not being lent out - this is what is keeping the multiplier effect of our fractional reserve system muted. Recall that the fed requested and received authority to pay interest on excess reserves last September, and since that approval came in, boooooom, excess reserves started to surge. The reason the fed did this was to sterilize their stimulus and money printing policies so that the banks had an incentive to keep that money sitting idle instead of putting it to work through new loan creation that could have sent the system overboard in terms of credit creation and inflation. Plus, the fed knew the banks needed to recapitalize and still had loan losses and toxic assets improperly marked that needed to be taken care of.

Recall Jeff's statement on excess reserves in January: "My guess is that these excess reserves will be melted away as banks absorb losses on delinquent loans and as marked down securities see their income streams actually collapse."

3) Credit is contracting! Mish is all over this and a believer that money supply contract/expansion and credit contraction and expansion play a major role in the definition of inflation. In short, you cant have hyperinflation if credit is contracting! I tend to agree 100%!

4) Destruction of credit is greater than money creation - think of Printer Ben pouring hundreds of billions of newly created dollars onto the ground, except, there is a huge hole in this ground that represents the destruction of hundreds of billions in credit. This money is not piling up on the ground, ready for people to take, because it is falling into the big hole, not to be seen!

These are the main reasons why I dont see inflation as a threat right now, or even in 2010. Yes, we are seeing a stimulus induced reflation trade that people are building foundations of hope on. Not me. I am still cautious, will continue to ask questions about the stuff sitting on balance sheets (off and on) and the accounting tricks that allowed things to get covered over, and I am less bearish than I was in late 2007 before the process really got going. At least now it is happening and we felt a great deal of pain already, which tells me we are on our way to get through this mess that our system created! But, its hard to solve a debt deflation problem with more debt and accounting tricks. Hence my caution.

Sudden Debt has a great piece out discussing how the boom during the past decade was really a 'debt fueled' unsustainable growth period:

This blog's position has always been that the US economy's performance post-2000 has been due to ever-increasing assumption of debt, particularly by households to finance real estate purchases and personal consumption. I don't think anyone can dispute this any more: just look at the chart below. Debt kept accelerating while GDP remained "stuck" at around 5% annually (these are nominal figures). In the end, the debt boom created its own bust and dragged down the entire economy. Cement shoes come to mind...

We are now deep in a debt-bust crisis and it is the first time since at least 1953 that household debt is decreasing in absolute numbers, year on year.

Interesting stuff. My stance has been deflationary since early 2008, and prior to that I used statements such as 'housing deflation + commodity inflation' to discuss the pressures facing our national economy. I still expect another wave of deflationary forces before this cycle is done that will be triggered by pressures from cmbs, helocs, prime, jumbo prime, credit cards, lbo's, types of holdings. I am not sue when this will hit, or if it will be as severe as the first wave that we went through, but I think it's something that needs to come and go for us to get through this cycle. This is not your ordinary recession and there are no free lunches. Any inflation that does show up at first will be in the form of higher food, energy, metals, commodities, health care, types of costs. Basically the stuff we need to live will see the first wave of inflation and it will be the form of inflation that squeezes consumers wallets and pressures corporate margins, at first. The policy makers will have to shift their policy to combat this form of inflation and that means higher rates. The cycle's endgame in full effect. Of course this has not happened yet and is only my opinion on the topic. Because of the nature of what we experienced, how the world has changed, I do not see inflation sending house prices surging. But it should kick in at some point down the road to help stabilize the downfall. I think Nenner might be on to something here.

A touchy topic I know, and one I would love to hear your thoughts on.

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Market Has Been Active; Where Deals Are Happening

(Christine Toes here)

Consistent with the pickup discussed here, I have also seen a huge pickup in my business in the last 4-7 weeks & Noah asked me to share where the deals are actually getting done - as that clearly is the most real time information I can provide to you. To give you a frame of reference, before September 2008, I used to do a consistent 1 - 2 sales per month (and a lot of rentals). Last fall and early spring were pretty abysmal, I did about 4 sales in 6 months. In the last two weeks of May, I had 4 signed contracts. For June, I have 4 signed contracts, 1 contract out that might be signed by early next week, and 1 offer that was just accepted.

Where are these deals happening, who is buying & why are they buying now?

West 100s - just over $2M. (Over ask) An extremely similar apt in the building sold for $3M in June 2008. So this is a 33% drop over last year. This seems pretty consistent with what other brokers are seeing in the higher end market. There was a bidding war, both buyers were all cash. Best deal in the neighborhood, Central Park Views, approx $1,000/sq ft., which was a 2004 price for this building. Pied a terre. Buyers first Manhattan purchase. Legal field. Would say that this was a "value" buyer.

Village straight studio - Approx $315K (Slightly below last ask). Came on market in Feb for approx $350K. Price reduction to $325K when my buyer jumped on it - this is about the least expensive studio you can get in the Village in an elevator building. Apt needs work. Similar apt sold in late 2005 for this price. In 2008 this would probably have sold for about $375K, so this is approx a 15% drop. First time buyer who is currently renting and thought it made more sense for her to buy at these prices and interest rates. Web Designer. Qualifies for first time buyers homeowners credit. Would say this was a "location" buyer.

Gramercy alcove studio - Approx $375K (Slightly below last ask). This is a 2005-2006 price for this building. 2008 prices were approx $420K. This is approx an 11% decrease. First time buyer who has been looking for 9 months for the absolute best deal out there. Architect.

Upper East Side alcove studio, unrenovated. Approx $360K (ask). Bidding war (had offers over ask but buyers not as qualified). Retired couple. Primary residence. "Value" buyer (building has very low maintenance).

Village one bedroom. On market since August. Approx 25% off original ask (determined at close to height of market). First time buyers. $600K-$700K price point, apt has outdoor space. Construction & marketing fields. "Location" buyers.

Approx $400K condo. Brooklyn new development offering 10% off asking prices but no other concessions. First time buyer who saw everything else in Brooklyn and LIC, determined this was best value - not that many condos in this price point that are a good quality/location. There was also only one line of apts w/ the exposure that he liked & this was the only apt in that line in his budget, so he had an incentive to buy earlier than he probably would have liked. Concern about whether they will sell enough units to get a competitive mortgage rate but building's preferred lender is lending at just .25 more than current rate so buyer decided the risk was worth the potential reward. Internet field. Qualifies for first time buyers homeowners credit.

Brooklyn prewar conversion. $500K-$575K price range, 2 bedroom. Small, pre-war building. Prices reduced by 20% from last year. First time buyer. Internet field. Qualifies for first time buyers homeowners credit. Charm/value were most important to this buyer.

Upper West Side prewar conversion. When they were determining original offering prices for this apt, they were going to list at over $3M. Buyers paying approx 35% less for an apt that is being customized to their specs (which developers never used to do). Buyers felt that net costs of purchasing were less than what they would be paying in rent, wanted to build equity + take advantage of low rates. Looked at over 35 apts including every new development & condo conversion on the UWS. Made several very low offers before determining where best "deal" was. These buyers spent months searching for value, quality, charm & location. Finance and health care sectors.

Village one bedroom, $700K-$800K range. Hard to determine where pricing would have been last year, largely non-owner occupied building. Financing is difficult. Very unique product (pre-war, outdoor space). Multiple bids including two cash offers. Internet field.

Murray Hill studio, $400K price range. Last year's comps suggest a 10% price reduction. Even though this wasn't a huge discount to last year's pricing, there were multiple offers. As a lover of pre-war buildings, I think the apt held its value because of the charm factor, which is what attracted my buyers. Pied a terre buyers.

It seems that lots of the "creative types" are getting into the market now. Lots of first time buyers who have been renting and waiting for some type of relief after years of price appreciation. Some of these buyers have been looking for months and painstakingly looking for the "perfect" apartment. Buyers really have been picky & patient, as Noah wrote about a while ago! Others have had lifestyle changes or have rental leases expiring and figure that this is the right time for them to buy.

Naturally, I've got my fingers crossed that this trend continues, but if rates increase further...or stocks turn around...or this crisis proves to have a 2nd wave, well, we may have to deal with some slower pockets again.

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Reuters Talks Hit To Manhattan RE

A: Manhattan's bullet proof armor is starting to show some weaknesses as the main stream media starts to pick up on the lagging nature of our adjustment! That's one big thing with real estate, its very lagging! So, stay tuned to sites like UD for real time reports, but be prepared that what you read here may not show up in reports for a good one to two quarters! Plus, the media may pounce on lagging data and Armageddon discovery giving a misleading picture of the current health of our markets. As I noted before, we need to get through the Armageddon price discovery first before we see just how much of a stabilization occurred with the 40% equity rally and the media induced 'green shoots' reflation mentality for buyers. Just as the media enhanced the move up, it may have the same effect during the correction process.

Reuters discusses, "Is the housing bust about to take Manhattan?":

New York City real estate prices are looking increasingly shaky as instability in two of the city's sexier submarkets -- second homes in the Hamptons, and new condos in Manhattan -- register the latest signs of a housing downturn.

Back in town, the number of sales in new developments dropped a whopping 71 percent in April from a year earlier as condo developers enmeshed in complicated financing arrangements have been slow to slash prices even as the market corrected all around them, Kim said.

When the rest of the country was watching new neighborhoods begin to disintegrate into foreclosure ghost towns in 2007-2008, Manhattan landlords would still publicize new buildings by hosting parties featuring pop stars, sushi and girls twirling hula hoops in a bid to convert still-airborne Wall Street bonuses into down payments.

Today, that bonus pool has dried up amid job and compensation cuts in the financial services sector that drives the city's economy. The elite in the real estate industry had once hoped Manhattan could escape relatively unhurt as other housing markets suffered. But the collapses of financial powerhouses such as Lehman and Bear Stearns destroyed such thinking.

Oh, it was much more than just the elite that argued why Manhattan was immune to any slowdown, how the foreigners would always save us, how the weak dollar would always make us attractive to outsiders, and how supply could never grow for this market limited to a measly island! Amazing how things change when people realize that markets will do what markets want to do, and they usually follow the macro fundamentals. It gets tricky and ugly when you start dealing with unsustainable gains due to temporary credit bubbles that are blown up by the lovely engineers at the federal reserve! Of course, this crisis went much deeper than just the fed and every bank wanted in on the credit bubble that earned billions in fees from an originate-package-sell securitization model - giving a loan to anybody with a pulse. Well the party was fun until everyone was drunk and the music stopped! It always does.

Back to Manhattan. Whether you believe it or not, this market started to trend down in Spring 2008 or so as the first signs of how bad this credit crisis finally sunk in - even though at the time, many still believed the fed rescue of Bear Stearns avoided all systemic risk and that the worst was over. Boy were they wrong. I wrote about the change in psychology on the buy side in detail in my July 7th piece, "Low Ball Bids & Cold Feet". I couldn't get more specific than that folks! Putting yourself back into time & place, most brokers assumed that if it didn't happen in Manhattan by that time, well, it just wouldn't happen! Hopefully many learned a lesson that nobody is bigger than the markets and that nothing goes up in straight line forever!

So what has happened? Well, the first wave down occurred after Lehman failed and sales volume plummeted for about 5-6 months - say from mid SEPT to early MARCH. That was when bids were hit and people began to realize something has changed in this local marketplace. Inventory rose, sales volume dove, and to move property you had to offer quite a discount from peak trades to entice a buyer to put their hard earned money to work at a time that was far from certain! Its all about the buyers and buyer confidence, always has, and always will be. If you focus on the sell side or supply only, you may be missing something. For example, if you looked at inventory levels 7 weeks ago you would have noticed that we were near our highs and assumed that the market was dead. But that was not the case at all and in fact buyers started to sign deals in droves as the equity rally, reflation trade, and first wave down complete combined forces to add certainty to buy side psychology in the asset. In short, buyers got way more confident putting their money to work. Today, you see the net result of this action as the lagging nature of contracts signed finally made their way into inventory numbers - giving us a drop of about 6-7% or so in the past 30 days. This is a combination of sellers removing unsold inventory for the summer + the accelerated pace of activity following the first wave down to a comfort zone.

Before we get excited, know that we have to go through the discovery period of those difficult months + we need to go through the 'taking out' of the new dev effect on Manhattan price data. The latter is something I will discuss in more detail later - but dont forget, what comes in will ultimately come out and we already went through the positive effects of all those new dev closings, now we will get to see pure existing resale reports without the uumph that defined most of 2007 and 2008 data. That is why I wrote, "Why Manhattan Price DATA Will Stay Strong in 2008", last April:

How could prices rise as sales volume slows and inventory rises? The reason is because the prices component is NOT registered until after the deal closes; some 1-3 months generally from contract signing! For new development deals, a contract can be signed over a year in advance of the closing. Which leads me to tell everyone that 2008 will see the closings of thousands of new development units that were signed into contract in 2007!

QUESTION: How will the prices paid, especially the price per square foot paid, ultimately affect future quarterly price reports for Manhattan?

ANSWER: Positively! As new dev deals close, it will help to offset any weakness that may be occurring in the current existing resale marketplace causing a misleading and mysterious report that probably will not be in line with the sales volume & inventory trends at the time!

Soon we will get Q2 data and I expect a solid uptick from Q1, which the brokers, streeteasy commenters, and media will of course base new bullish arguments around that the bottom is in and that all is well moving forward. But the real juicy analysis will be to compare Q2 of 2009 to past Q2's, on a year-over-year basis. Real estate is seasonal, and as such the data must be seasonally adjusted OR compared y-o-y to cancel out month to month noise that may be misleading. But, people will no doubt take advantage, which is fine and part of the natural order of markets. In the end, the markets will still do what they want regardless of anybody's banter.

There will be a time to discuss a sustainable recovery both for our local economy and our local real estate marketplace; for now, I am less bearish now that the process has started but I think we still have some issues we must face and I discussed them plenty on UD - including unintended consequences from actions taken to stem this nasty crisis. When things do improve, we will see a big time exit strategy from the fed and regulation both on wall street and on the banking system to make sure a parabolic credit boom never happens again; at least for a decade or two until we forget and need a way to make more money. For now, there will be deals at every price during the adjustment and nothing goes in a straight line. Real estate tends to be like a tanker, taking time to stabilize and turn around. So, focus on the things that make for good decision making and don't buy just because you think prices will surge 20% in a year! A home is becoming just that again, a place to live and not a ATM machine that can be speculated on for 100% appreciation in 3 years time - although you will ultimately see nice returns for vulture investors that are gobbling up foreclosed properties in very hard hit markets for 30 cents on the dollar. Markets working as they should.

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Rogers: Currency Crisis Ahead

A: This was so entertaining to watch today. Lets try to have an intelligent discussion on this topic, a topic that I have touched on here a few times already - including my thoughts on the excessive printing and the gold trade. Jim Rogers on CNBC late this afternoon battled it out with Cantor Fitzgerald CEO Howard Lutnick, and it was great. Watch both videos as this is uber important for endgame to this crisis and involves all of us and can ultimately affect Manhattan real estate!

"They are printing so much money, I have no shorts on...stocks can go to 20,000 or 30,000, but of course it would be worthless money...commodities will be the best place to be. The US dollar is a terribly flawed currency." - Jim Rogers

The above video is the beginning of the fun. The real action started when Larry Kudlow and Howard Lutnick chimed in about the treasury bond outlook. It was awesome! Basically Kudlow agreed with Rogers that treasuries are a great short, and will rollover causing higher rates for all of us as a result of fed actions, policy, and government borrowings to stem this crisis. Lutnick argued that Rogers is about '4 years early' on that trade and that the commercial real estate problem and the leveraged buyout problem (2006 deals) is far worse than anyone right now is willing to admit. Lutnick believes this to be a 2011 and 2012 problem, causing major problems for banks and the economy - as a result the flight to safety will CONSTRAIN the treasury market from rolling over as the 'fear factor' kicks in again. When Rogers asked why investors would buy trillions of government bonds over the next few years, Lutnick responded...'because you get your money back'. Kudlow responded by saying.."why anyone would want to buy treasury bonds right now is utterly beyond me!"

It was awesome. Here is the real action:

Lutnick's argument about treasury bonds being constrained by what I described as WAVE 2 of this crisis, is very interesting. I'm not sure I buy it, but its interesting. Lutnick says this will hit us in 2-3 years, I thought it would be earlier.

Your thoughts? Who is right - Kudlow/Rogers or Lutnick?

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Keeping It Real - Less Bearish

A: People seem to forget that about 8 months ago I started to change my tone a bit now that the adjustment process started. It was back in November that I made my first statement about being "less bearish", and wrote..."This might surprise many, but I am a bit less bearish than I was 12 months ago when we were near peak levels...Today, a noticeable adjustment has occurred and the pendulum has clearly swung in favor of buyers". Recall that when I made that statement, this market was still frozen from the shock of the Lehman bankruptcy and government rescue of AIG. What took us so long to roll over still confuses me, but markets have a tendency of surprising us sometimes. Longtime UD readers know how bearish I was in late 2007 when equities were near record levels and trades in Manhattan were at peak levels. So to hear me start to talk about being "less bearish", should tell you something. I will always strive to keep it real, even if the market behaves in a way that is inconsistent with my general feelings about macro fundamentals and the new, less sexy world we are in. Ultimately, the markets are bigger than any of us!

That wasn't the only time I talked about being less bearish OR that a pickup in activity has occurred in our local marketplace. Here, take a look:

FEB 3rd - "I'm less bearish today because the process is happening, as a year and half ago I was way more more bearish than I am today. And as time goes on, I will probably become even less bearish."

April 2nd - "I'm way less bearish today than I was 12 months ago now that the process has started and equities have adjusted. All I know is that the process is taking place at great speeds, and I would not be surprised to see the bulk of the adjustment complete by this time next year."

April 16th - "Its hard to argue these forces although I am way less bearish today than I was only a year ago on Manhattan real estate because the process is happening. It must happen. It will happen. And we will get through it! This leads me to believe that at some point in the next few quarters you will see a bunch of quality Classic 6s, 7s, and 8s, looking mighty attractive!"

May 19th - "I was quite bearish for very real reasons 18 months ago, and now I am way less bearish than I was because the process started; but we still have a ways to go before a solid foundation can be built to sustain a recovery. Right now, I would update my 'muddled L' recovery to look more like a muted 'W' recovery with the final growth spurt a big question mark and more of a muddled stabilization for a while. It seems Keynesian stimulus will have its moment, although it will be temporary."

Enough of that, as you should get the point. But I took it further. I started to discuss the pickup in action from the frozen 4th quarter as early as late January, but was too unsure to call it anything other than a relative anecdotal pickup from a very frozen 4th quarter. Real estate is seasonal, and when we compare the first half of 2009 to previous first halves you will likely see the number of sales on the sluggish side. Month to month pickups can be misleading.

Moving on. As buyer interest gathered steam, I decided to call it a 'countertrend pickup in activity embedded in a longer term correction process', and I will stand by that call even today. I even went as far to devote a post to the surge in contracts being signed about two weeks ago, asking people whether they are noticing their Streeteasy saved searches going into contract.

But there is a big difference between a countertrend pickup in activity embedded in a longer term correction and a new, sustainable recovery for Manhattan home prices. This is where you will see me differ from others. Deals still seem to be happening in the comfort zone reached after the first wave down - a move down almost all brokers and executives either didnt see coming or thought impossible (my E 87th property went into contract over ask after being priced about 30% below peak levels - proof that markets dictate price, not brokers)! If anything, accuse me of being extremely bearish on Manhattan real estate in late 2007 and being less bearish starting in late 2008 when the adjustment occurred.

Fact is, there are many bids coming in and there are plenty of deals being signed. The pace of deals happening seems to be accelerating with the ongoing rally in equities - in other words, most of the action has occurred in the last 6-8 weeks or so. Inventory is coming in as a result right as we enter a time when new listings tend to decline with sales volume for the slower summer months - except sales volume isn't declining, its accelerating. Take a look at a chart comparing new listings to a weekly average of contracts signed and you can see what I mean (courtesy of UD charts):

In my opinion, the boost in buy side confidence is due to a few factors that I will list in order of what I feel is priority:

1) first wave down to comfort zone - definitely the most important. Tiered structure of correction due to nature of this recession with sharpest adjustment in high end and slightest adjustment in studio market

2) equity rally - the S&P is up about 40% in the past 12 weeks and that is boosting confidence; remember, the stock market is the stars and the most widely used gauge as to the overall health of our economy. The banks raised a ton of money, and the fed engineered the system to make banks profits soar. But a) will it last and b) what about higher quality debt classes still on and off balance sheets?

3) reflation trade - rates, stocks, commodities are all rising at the same time as a reflation trade is in place from massive fiscal/monetary stimulus. Many like to be in real estate to protect them from massive inflation and a devaluation of our currency. Time will tell if wage inflation and job growth occurs as onset of inflation hits.

4) rates - the combination of lower prices, confidence boost from equity rally, reflation trade, and possibility of higher rates is making many feel more comfortable to pull trigger to lock in price and low borrowing costs. Its very possible the next wave down is a result of another round of severe illiquidity because lending rates are significantly higher than what we got used to over the past 5-6 years.

Know that markets do not move in a straight line and there will be deals at every price. Real estate in general is very illiquid and even with the big uptick in action, some units are having trouble selling. And the most important thing people need to realize, is that deals are happening in the range that I discussed previously! It's not like you are seeing a sudden surge in the aggressiveness of bids with deals happening closer to peak levels. So don't mis-interpret this piece. We reached a comfort zone, prices came down, and because of the 4 forces I just discussed, confidence is up and bids are coming in! Its as if the wall street bonus season that is supposed to be active (we forget that this time of year is the busiest time of year for us), is on a 2 month delay. Rather than being JAN - MAY, its like the action really was from MARCH - present, and ongoing. I would not be surprised to see this action last a bit longer than normal, and continue until the end of June.

But make no mistake about it, this economy is still hurting big time, macro fundamentals are still pressured, and if the stock market decides to sell off again you will see the recent boost in buyer confidence slip away for a while until equilibrium is once again achieved by natural market forces. No one can predict exact bottoms and real estate is a very individual decision. There will be a time to talk about a sustainable recovery based on positive fundamentals, but for now, the best I can get myself to do is be less bearish than I was at peak. Whether or not another wave down comes is something I cant conclusively answer, but my gut is telling me we will have one. Plus, we are about to get some price discovery about where high end deals are happening at, and I think that will surprise many! Given the surge in activity from the dead 4th quarter, perhaps some deals are happening at the lower end of the pyramid range I discussed here before for each price point. Time will tell. For now, I still worry about higher rates, higher taxes, rising unemployment and other unintended consequences that come from a major earthquake like the crisis we just went through. Its hard not to expect a few aftershocks!

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We Never Learn

A: And this will ultimately lead to more problems later on. I read this in the NY Dear John section this morning, right before I head out for work.

Via NY Post:

DEAR JOHN: I purchased my first home, a condo, for $384,000 in September. I have a mortgage of $332,000 through Wells Fargo and Fannie Mae. At the time of the purchase, my monthly income was $4,000. Since then I have lost a job and a got a new one which pays me $2,600 monthly.

My mortgage is $2,116 a month and maintenance is $194.31.

So I figured I would call Wells to see if I qualify for this "so-called" government relief program. They told me that I did not qualify -- for the loan modification program. And they told me I couldn't even refinance because I don't have enough equity.

The current mortgage is a 7-year fixed at 5.75 percent interest only. I really need to change to a regular 30-year fixed at a lower rate.

If I don't qualify for any help, who does? Do they really want me to default? As of now I haven't missed or been late on a payment. Who gets the help? J.F.

Forget John's response, my reply would have been...'why the heck did you buy a place you could not afford with an annual income of $48,000'?

This woman puts 15% down, or $52,000, and takes out a $332,000 loan while taking home only $4,000 a month in gross income! Forget for a moment that you have to pay income taxes, sure slightly less with deductions, and you have to have money to eat and survive. And what about other debt obligations - credit cards? It doesn't mention anything but certainly I think its safe to assume this buyer has some credit card debt to service?

But, lets assume the best and say she has no other debts and is of great credit! Still, this woman bought a place way above her means, and now she is wondering whether the bank 'really wants her to default'; as if its the banks fault! Its the banks fault for lending, its the person's fault for buying.

DEBT/INCOME RATIO - to calculate d/i ratio, you simply divide your total monthly debt service obligations by your gross monthly take home pay. Generally speaking, banks like to see a d/i ratio of 28% or less. This went completely out the window during the parabolic credit years of 2003-2007, when the party stopped. I was under the impression that natural market forces whipped the banks into shape, where exotic loans went extinct and underwriting standards naturally tightened. In short, I thought the banks realized that they need to start lending to people who are worthy and stop giving people a loan that cant afford one! I was wrong and the same shit is happening now, probably because there is pressure on banks to lend to stop the natural market forces from purging the excess from the system that is ultimately painful to banks. We have become a society that bails out everyone, so why stop making money when you have good ole Uncle Same to bail you out?

Back to the story. This woman made 4,000 a month, or 48K a year, and decided to buy a $384,000 house. Lets do some math. Her monthly nut is $2,116 and a monthly maintenance of $194, totaling $2,310 to service her ownership costs, and this is an INTEREST ONLY loan (hey, at least its not negatively amortizing)!

2,310 / 4,000 = 58% debt/income ratio

ARE YOU F**KING KIDDING ME!! How in the world did Wells Fargo allow this loan to go through? Have we learned nothing? Of course, macro fundamentals kicked in and this woman lost her job. Luckily, she found a new one and now makes $2,600 a month. Her debt obligations on the house alone, forget other possible debts, now takes up roughly 89% of her take home pay! Uncle Sam can forget tax collections on this woman, because her decision to buy just put her smack dab into the money pit! Now her home has lost equity, and Wells decided against refinancing her or modifying her loan to make it easier to maintain! Why would they anyway?

This woman made a very bad decision, bought a house she could NOT afford even with her 4,000 a month original job, and Wells gave a loan that should NEVER have been approved! We fail to learn from the mistakes that got us into this mess, and its probably because politicians are putting pressure on banks to lend to stop housing from falling further and keep the system going! When will we learn! How many more thousands of people are in this same situation?

One element of deciding whether or not you can afford a home, is by calculating what your debt/income ratio will be. Only you can tell how secure your job is and in this economy, nothing is certain. Debt/income ratio should at the very least, come in under 33%, or 1/3 of your take home pay. I prefer to see it under 28%. But you have to calculate in your total living costs of the purchase and your minimum payments on other debts.

This woman clearly didnt care, and probably just wanted to buy anyway - maybe she liked the granite countertops or marble bathroom. I bet a comparable rental would have been $1K/mth - $1,200/mth max. Now she will pay the price. Wells should not have granted the loan, and the market should have STOPPED this person from buying a home naturally. Yet, that didnt occur. Now, we have one more person that will likely eat up all her savings to service her living costs and max out other avenues of available credit, before defaulting. Good job America! Keep on truckin!

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Stage 10 Starting Already? Expect Fed To Step Up

A: It seems there are rising concerns in the treasury market, marking what I referred to as Stage 10 of this crisis and part of endgame. From a trader standpoint, I define endgame as the final phase of a bigger situation; the end result of actions taken to deal with some sort of event or economic anomaly. There are no free lunches and many, including I, argue that there will be unintended consequences that will come from everything the fed/treasury has done to stem this crisis. I'm sure the fed is watching, but I would not expect them to announce any increase in planned treasury purchases until their next rate decision meeting.

Is the treasury market signaling growth ahead? No, and I think PIMCO's CEO Mohammed El-Erian hit it perfectly yesterday:

"Your getting a lot of warning signs about this massive move we had in the 10YR yields, from 2.90% a month ago to 3.50% today, and that's not for good reasons, its for bad reasons. The market is starting to price in the enormous issuance and the fact that the treasury will have to lengthen its average maturity, when it comes to its debt. Secondly, the ratings news last week was worsened. And thirdly, importantly, people are starting to worry about potential inflation. They are starting to worry that the emergency liquidity is not going to b drained on a timely basis, because of political issues. The market is saying this is a very delicate time, and that it is very important that it is navigated well bot by policy makers and by investors."

Spot on. Higher rates could very well be the 'new normal' that we will have to get used to and it is entirely possible that we have already experienced the lowest lending rates we will see in the next decade. This is an unintended consequence of policy actions taken to stem this crisis. In my opinion, this is NOT the treasury market signaling future growth via a sharp economic recovery. Any inflation we see to start, will not be the kind that is associated with higher wages and higher asset prices - a symptom of an overheating economy. Rather, to start, I believe inflation will show up mostly in food, energy, metals, health care, etc., the stuff that shrinks profit margins and squeezes consumers wallets. The question is, what does our fed do next to combat this problem and how does that play a role in crimping growth? And for how long?

Hyperinflationists are screaming that real estate is the place to go to protect yourself from the ginormous piles of money the fed is printing that will eventual send inflation to the roof. I am not in this camp and would rather be in gold to protect against a possibility like this.

Here are my reasons:

1) Deflation will negate some Inflation - people seem to forget that we are experiencing deflation right now, and the damage has been done. Asset vales have fallen, trillions in securitized mortgage bonds losses, stock portfolios have been murdered, unemployment is soaring, debts are rising, bankruptcies are surging, and in general most people have seen a significant hit to their total net worth over the past few years whether it be from equities, falling home values, loss of job, or other form of distress associated with this slowdown. People are saving again and getting frugal after being whacked by a 2x4 by housing market forces. The initial wave of inflation will cancel out the deflation we are currently experiencing, and for all I know this stage may be occurring right now.

2) Government will understate inflation to protect Social Security - people seem to forget the govt's tendency to understate inflation when it seems to be rising and overstating inflation when it seems to be falling. Should inflation become the hyper variety, the cost of living formula for Social Security would have to be adjusted sending higher checks to recipients and putting massive pressure on the new date that the fund will be depleted. Hard to see the gov't releasing inflation data that causes such mass problems on this front, but thats just me.

3) Rates will surge if hyperinflation ensues - umm, if hyperinflation ensues, lending rates will surge. Can you imagine how affordability will be affected if a 30YR mortgage rate is 9% or 10% or higher? It happened before, and those that say it can never happen again, well, I hope your right. But in this new world, unintended consequences may include higher rates for all of us. The question is, how high, and how does the economy/consumers adapt? Do not forget that ZIRP is still in full effect and we only have higher to go from here as the fed figures out an exit strategy.

4) Housing needs credit to boom to see prices skyrocket - umm, we just experienced a parabolic credit bubble that went bust. Among other factors, this played a HUGE role in the housing bubble and bust. We are at now now, just experienced this, and now watching our banks getting nursed back to health. We are about to see regulation come in to make sure this excess doesn't happen again. With underwriting standards much tighter and regulatory watchdogs coming, I don't see a repeat of 2003-2007, when money was just handed out to anybody with a pulse and exotic loan products allowing anyone to buy something way above their means. People seem to forget that we are in store for a new, less sexy normal, and instead they look at housing as a stock that can easily rebound ('V' recovery) after a substantial fall! Me, I think we are adjusting to where we should be had no bubble ever occurred. The problem is a bubble did occur and markets have a tendency of overshooting to the downside as equilibrium is ultimately reached. Many people will never look at housing, in terms of the asset class, the same again!

5) Wage inflation needs to occur to see prices rise - probably the most important element in terms of a housing recover. In order for housing to not only stabilize, but to recover and start seeing price increases, you need to see consumers earning more and a stronger jobs market. Now, yes, I think we are in the peak of the monthly job losses right now that will show declining losses going forward as the cycle plays out, but remember that an economy the size of ours should add about 150,000 jobs a month. We are far from that and right now we have millions unemployed. So lets not kid ourselves that wage inflation is a big concern right now. If people aren't earning, and current homeowners lost a ton of equity, where is the purchasing power going to come from to sustain general price appreciation? Yes, you will see savvy deals being done and money being made out of distressed purchases, but certainly nothing in terms of sustainable general increases across the nations local markets.

6) Destruction of wealth in shadow banking system negates most of the fed's money printing - probably the most important element here when looking at the fed's printing. The banks losses were astronomical, and they are the ones that are the biggest beneficiary of all the feds stimulus/printing. People tend to think the feds money printing is just entering the system, and all those dollars chasing too few goods will cause hyperinflation. But the deflationary destruction that hit the shadow banking system, is GREATER than the stimulus/printing the fed has done. So, imagine 2 stacks of money. Under one of these stacks is a deep money pit where the pile of cash falls into. Under the other is no hole at all. Our situation is the first of these scenarios, with most of the money filling the voids left by deflation in the shadow banking system - and not entering the system, at least not yet.

7) Money is being hoarded in excess reserves, which pays interest to banks, instead of flooding the system - (view image at St. Louis Fed) there was a reason the fed started paying interest on excess reserves back in SEPT of last year! Right when that announcement came, the banks started hoarding cash in excess reserves. This was one way the fed sterilized its actions so that money didn't flood the economy. The real question is what happens if/when this money does enter the system via bank loans, bringing the fractional reserve multiplier effect back into full force. This is one thing the fed will have to deal with later on. I would NOT be surprised at all to see the fed raise minimum capital requirements as part of their exit strategy to contain inflationary pressures of massive lending of newly printed dollars.

8) Too much money chasing too few properties? - many define inflation as too much money chasing too few goods. Well, if we are going to see housing fly because of hyperinflation, how does the fact that we have tons of oversupply fit into that equation? Do we expect future supply to stop coming in and future demand to just keep picking up? Lets be real here. The consumer is deleveraging now and this process can last a while to purge the excess and repair balance sheets! Plus, its not like sellers of homes today have so much equity built up that they have a whole new arsenal of buying power - in fact, the opposite occurred and homeowners equity is plunging. Looking at where we came from, we just experienced a parabolic credit / housing boom that saw over investment, overcapacity, overbuilding, whatever you want to call it. We have too much supply! I don't see a housing shortage in the future but I do see a peak in months of supply either being hit already or being very close, especially as short sales and foreclosure sales continue to surge as part of the natural order of markets. We are yet to see the high end jumbo prime problems really hit full force, and I defined this as part of the 'Wave 2' that is ahead of us:

WAVE 2 (yet to come) - perhaps sparked by commercial, prime, jumbo, HELOCs, credit card writedowns. How quickly we forget that the IMF recently upped their total global credit writedowns estimate to $4.1Trln - this assumes total US writedowns of $2.7Trln, up $500Bln from previous estimate (view image).

Hyper-inflation is NOT a good thing! Was the 70s good? Yet I hear people arguing with such emotion, that housing will surge if hyper-inflation kicks in. I just don't see it and I explained why. Why anyone would want hyperinflation is beyond me. Buy a property because you are ready to buy a property and need a home, can afford to buy the property, your job is secure, because your an investor and the numbers make sense, because you are happy with the deal you are getting, etc.; not because you fear hyperinflation. Nevertheless, the voices are out there.

Ben had difficult choices to make: either one, face a modern day repeat of the Great Depression or two, inflate our way out of it and worry later about letting the genie out of the bottle. He picked the latter. Only history will decide what road was the better one to have taken. We are, however, on a path to rising inflation at a time when incomes are not growing and unemployment is high - for now, deflation is still the battle with signs that Ben's inflating is working. Hyperinflation, if it comes, will wipe people of their cash. The cost of living will go through the roof. Business margins will be diminished and may businesses will fail. Unemployment will therefore see increased pressures. This can contribute to the escalating delinquencies in housing, credit cards, car loans, etc.. Banks, however, will benefit from spreads but hurt in potential future losses. Yields in the term markets will be so high and short term rates so low that banks will make a fortune on spreads - part of the plan? If hyperinflation hits, mortgage rates could resemble the deep double digits of the 1970's, great for banks but horrible for housing - again, I don't see this happening but is certainly possible if hyperinflation occurs. Is this why hyperinflation worriers bought real estate to hedge against? Not until the federal reserve steps in to stabilize the dollar by tightening will the long end come down and that is years away.

I know this is a touchy subject, and the following are my thoughts only. Everyone has their opinions, and I would love to hear yours even if it is outright the opposite of mine. We are all in this together!

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Fed Buys Less in 4-7YR Auction - Treasuries Plunge

A: Don't say I didn't warn you about the HUGE issuance upcoming to fund our gov't operations, deficits, stimulus packages, and bailouts! If/when rates surge, all those that screamed YAYYYY for the Keynesian stimulus to get stocks back up will be walking around dazed and confused wondering 'where's the growth'? There are no free lunches and its quite possible we are now seeing the lowest rates we will ever see for the next decade. This is what is called an unintended consequence to policy actions taken to stem this crisis.

You want to know strange? Equities selling off, oil selling off, and treasuries selling off all at the same time. Where's the money going? Gold perhaps? Recall my feelings that being short long end of treasury curve and long gold as a texas hedge against unintended consequences of policy actions and money printing:

"One big fear I have right now, which happens to fit as a texas hedge with my gold trade, is a sharp selloff in some bond market, in some country, somewhere, at some point down the road. Its a very possible event that could spark a global equity selloff that ultimately earns a color to depict the day it happens on! This is part of the gold trade."

The news from Across The Curve:

The bond market failed to attract even a modicum of a bid and that motivated the sale.

Keep in mind the treasury market is set for $101,000,000,000.00 of issuance in the next holiday shortened week! It seems the fed only purchased $7.398Bln of 4-7 yr notes today out of more than $45Bln submitted! Hence the market reaction. Keep your eyes on this as endgame ensues.

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Contracts Continuing To Be Signed

A: Many of you may have noticed your SAVED searches on Streeteasy.com are starting to dwindle? Are you? Speak up in the comments about what you are seeing so we can all get a clearer picture. For the past few months this market has been steadily picking up steam and it seems the past 3-4 weeks have been particularly active in seeing deals happen - and the normal euphoria that the worst is over with it. I don't need to remind everybody here of the seasonal nature of this local market, which is why you must use either a seasonally adjusted measure of activity or compare data y-o-y to see the bigger picture. How did this wall street bonus season compare to previous ones? It's active because it's supposed to be active now. But the busy season is coming to an end, and once you get past Memorial Day Weekend we get into the transition period to the slower summer months. But this year is different because of what we experienced, and that is what I think is causing many to wonder if this pickup is a sure sign of a bottom.

Going back 2 years ago, I wrote about the seasonal nature of Manhattan's marketplace:

If I were to visually design for you how the NYC real estate market is seasonal, it would look something like this, for months JAN - SEPT. I left out OCT-DEC because those months seem to me to be very erratic; sometimes hot and sometimes cold. The months of JAN - SEPT have market characteristics to them that are easy to notice and eventually take advantage of:

But when the busy season starts right after a frozen 4th quarter that saw hardly any deals done, even the slightest pickup will seem to be more than it is. People are really starting to wonder, is this it? Is this market at its bottom and on the road to recovery? Of course you know my feeling on this, no, I don't think it is because of fundamental reasons and where this market came from. Prices are still too high compared to rent ratios, unemployment is still rising, there is still a strong negative wealth effect even with the markets 38% rally in 10 weeks, buyer confidence is still depressed, and the system of credit that allowed the boom to occur is changed forever. Folks, forget about seeing peak prices here for a long long time! Right now it is a question of when do we stabilize.

Lets start at the contracts signed trend for the past 6 months:

*IMO, contracts signed data is the lowest quality of all the data I collect. It is lagging in nature and only as good as the agent that updates the listing and the system that picks up on this update. It is good to watch for trends, but that is as far as I will look into it. I will try to solve this problem for UD 2.0.

When you go from a weekly average of under 10 contracts signed to a weekly average of between 20-30 contracts signed, you are bound to both hear and see this activity on the blogs and in the field. Many of you may have noticed those saved listings are now IN CONTRACT, and you are wondering if you missed the boat? I continue to call this a countertrend pickup in activity embedded in a larger adjustment process - nothing goes in a straight line and there will be deals at every price.

This is the psychological aspect of home ownership; yes there is a huge one. Put timing the market away for now and lets just talk this out. Missing out on a few of the homes you have been keeping your eye on, may make you a bit edgy and more eager to pull the trigger if another home you like happens to hit the market. Emotion plays a role here, and I always try to remove the emotional element in my consults with my clients so we can focus on what the market is doing and where the product is likely to trade given current trends. Not to say emotion is a bad thing, its not, but sometimes it may cloud the bigger picture. If my clients like something enough, they bid appropriately regardless of what I say - that's how it works. To each his own and you can't day trade or perfectly time real estate - so at some point emotion will likely lead a bunch of sideliners to ultimately pull the trigger earlier than they may have originally thought. Will it move the entire market? No, of course not! Buyers are just comfortable making the decision regardless of where the market may be headed in the medium term.

On to the data. Over the past 30 days, my widget states:

1,755 NEW LISTINGS
867 CONTRACTS SIGNED

Using one of my internal sharing systems that is a direct source for brokers, I see the following data for the past 4 weeks:

1,072 NEW LISTINGS
742 CONTRACTS SIGNED

A bit of a discrepancy here. I would tend to monitor the internal system more, to be honest with you. But my widget has some rules to it that fine tunes the data so who the heck knows what is really going on out there. One thing is for sure, the period of MARCH - PRESENT saw a nice uptick in activity when comparing it to the frozen market in the 4-6 months prior. This will come out in the data later on, but when it does we should focus on the year over year changes instead of the month to month advance.

For me, instead of looking at month-to-month or quarter-to-quarter pickups, I like to focus on the bigger picture and the macro fundamentals for where we might be in the cycle:

Fundamentals ---> still deteriorating, although pace of decline has slowed and confidence has risen with latest equity rally (so called green shoots)
Wealth Effect ---> still big time negative, even with the latest 38% rally
Buyer Confidence ---> still depressed, although a bit less so with the rollover from peak to the first comfort zone + recent equity rally and green shoots media blitz
Affordability ---> price/rent ratios are still out of whack and with rents declining, the fall in property prices on this ratio is muted
Availability of Credit / Lending Standards ---> tight, tight, tight...the days of e/z money are gone and you actually have to prove you can afford a property to get a loan commitment. Credit has tightened and there is more liquidity in the mortgage markets from last year, but still not anywhere near what we saw during the boom years. Another wave of the credit tsunami can change this, so my eyes are watching out for that
Inventory ---> up abut 40% from last year, and up about 100% since I started collecting inventory data in late 2007 (total inventory was about 5,400 at that time)
Rates ---> something to watch out for as part of endgame to this credit crisis, will rates surge and how will this effect both the economic recovery and housing.

Yet with all this, contracts continue to be signed as buyers are comfortable putting money to work with this market trading down to its first comfort zone; a move down that most brokers/executives denied as even possible this time last year. If this market was so strong, you wouldn't see Coldwell Banker Hunt Kennedy closing its doors! Fact is, even with this pickup being reported the first two quarters of 2009 are probably going to prove to be the most sluggish in terms of number of sales in the past 10 years.

I will leave you with HSBC's MAY 2009 Mortgage Bulletin with the following Housing Update for Manhattan, which included the following charts. I'll let you interpret them on your own and I apologize that I don't have the full report available. Notice the first chart showing the widened gap between condo & coop prices and market rents - now that rents are falling too, it makes the down move in prices more muted for this ratio of valuation premiums and affordability:

*Sources: Prudential Douglas Elliman, Citi-Habitats, Miller Samuel

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Reflation Trade?

A: Seems to be on, but for how much longer remains the question! Equities up nearly 40% in 10 weeks, gold creeking higher ever so slowly to its highs, treasuries selling off.....hmmmmmmm, sounds like a reflation move to me! The 'reflation trade' was inevitable as a result of the fed's zero interest rate policy, trillions in money printing via QE, and fiscal actions taken to stem this crisis and prevent another depression. Ben wants to inflate. Banks are rushing to take advantage of this opportunity to fortify balance sheets by raising capital through stock offerings that are dilutive for shareholders. Keep in mind that those betting on the reflation trade via equities, should think about current deflationary pressures and how cheap the company's stock is after the huge move. Also, what commodity inflation can do to profit margins down the road. An era of shrinking profit margins could be ahead of us as endgame ensues - remember, there are no free lunches.

Make no mistake about it: THE FED IS TRYING TO INFLATE US OUT OF THIS MESS!

Here is what a reflation trade looks like:

Equities UP 40% in 10 weeks

Gold UP 8% in 7 weeks

10YR Treasury Yield UP 70 basis points in 9 weeks

I gave my thoughts about using Manhattan real estate as a hedge against inflation in March:

"The combination of where we came from and what has changed that allowed the boom to take place, must be taken into account when looking into the future. In short, prices are still high and the system of credit that was in place during the boom, has deconstructed itself.

Given the artificial lowering of rates by our fed through rate cuts, lending facilities, and quantitative easing, the snap-up of rates may be quite fierce - unless of course you think that the fed can keep low rates forever and ever, without any consequences at all. I wonder about things like, how will housing perform if mortgage rates are 200-300 basis points higher? I think early signs of inflation will move the markets that make money more expensive, and that means inflation as an unintended consequence of policy, will act to depress real estate a bit further as the latter stage of the housing cycle plays out. I want to buy towards the end of that phase, not in anticipation of it for a hedge."

The re-flation trade will move markets, and as that occurs borrowing costs are likely to rise. The fed will try to contain it when they announce an increase in planned purchases of treasury securities - who knows when they announce this. We may very well be at the beginning of an era marked by declining profit margins if this inflation trade continues; especially in the treasury and commodity markets. I'll discuss thoughts on that in detail in another post.

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Bank Credit Update: C&I Starts to Unravel

It's time to revisit bank credit quality again, utilizing the information collected by the Federal Financial institutions Examination Council of the Federal Reserve. I've been doing this rather depressing task for a year or more now. The idea has been to chronicle the unwinding of the debt bubble using data that are not influenced by mark-to-market accounting. Additionally, because this data set was originated after the last major real estate downturn, it includes a couple of economic cycles including a the early 90s "credit crunch." As longtime Urban Digs readers know, the numbers have been shockingly bad and have given lie to the notion that the credit mess is being way over-exaggerated by mark-to-market accounting and a broken securitization system.

The delinquencies you see in these charts are real individual loans going bad as real borrowers stop paying their debts. The charge-offs are real writedowns by banks of the value of the loans they can no longer collect.

Here are the particulars regarding these statistics from the Fed's web page:

The 100 largest banks are measured by consolidated foreign and domestic assets.

Charge-offs are the value of loans and leases removed from the books and charged against loss reserves. Charge-off rates are annualized, net of recoveries.

Delinquent loans and leases are those past due thirty days or more and still accruing interest as well as those in nonaccrual status.

Now, one can argue all day that the broken financial markets have caused the broken economy and vice versa....some will even argue that the economy is now fixed. However, the data you are about to see suggests something else, and that is that we are just entering the teeth of this credit crunch, with likely negative effects on the general economy, if not the credit card market, commercial real estate market and now corporate debt market. Until now, I was not tracking the corporate loan market, believing that it was far enough away from the eye of the storm to be a side show. This may still prove to be the case, but recent trends are ominous. So here goes.

Residential Real Estate Loans:

Residential real estate lending continues to be an utter, unmitigated, butt ugly disaster....can I be any more emphatic? Here is the chart of delinquencies (View image)and the chart of charge-offs (View image).

Here are the latest clicks: 7.83% of all residential loans are now delinquent; this is the highest number on record and we blew by the peak numbers of the early 1990s a couple of quarters ago. Residential loan delinquencies are up a staggering 361 basis points year-to-year and 176 basis points quarter-to-quarter. That's an acceleration in the year-to-year pace from 243 bps last quarter and in the quarter-to-quarter pace from 101 basis points between Q3 and Q4 of last year. This disaster shows no sign of slowing down. I personally can't see how the banking system can begin functioning normally again until this stops accelerating.

Commercial Real Estate:

I like to think we were early at Urban Digs in both warning about the potential for trouble in commercial real estate and later declaring the likelihood of a debacle that would significantly impact bank balance sheets and and potentially feed back into the economy. I think we are about to start seeing the effects of that if the stress tests are any indication of the severity with which the government is regarding this problem. Of note, Sandler O'Neill, a brokerage firm that focuses on analyzing the financial services industry, recently estimated that small banks need $24 billion in additional capital to meet the same stress test standards as the big banks, due largely to commercial real estate exposure. I have been writitng for quite some time that I anticipated that there would be a second shoe to drop after the first credit contraction, from the shutdown of the CMBS market, in the form of bank lending being severely curtailed as a result of the need to absorb losses. I can tell you that I had a conversation with a relatively healthy regional bank in Pennsylvania the other day (non-performing assets are 1.58% of their loans) and the lender said to me "None of us are doing much, we are all just absorbing losses right now." I don't know how much more clearly the message need be expressed.

Here are the charts of commercial real estate delinquencies (View image) and charge-offs(View image).

Latest clicks: Commercial real estate delinquencies are now 6.94% of all commercial real estate loans; this is up 322 basis points year-to-year and 148 basis points quarter-to-quarter. That is an acceleration from the 270 basis point year-to-year rise last quarter and the 94 basis point increase from Q3 to Q4. We have clearly gone ballistic on commercial real estate losses, but we are nowhere near the depraved peaks of the early 90s at 12.57%, we are however on quite a trajectory towards that neighborhood.

Credit Cards:

Here are the charts for credit card delinquencies (View image) and charge-offs (View image). I have to admit to being wrong on credit card delinquencies. I really thought that with all the advanced warnings that credit card companies had of an impending consumer debacle and with the short length of their liabilities and ability to discourage consumers from taking on new debt, they would have been able to manage through this downturn better. However, my guess is that the severity of the residential real estate debacle is just dragging so many people under that the credit card companies are just being overwhelmed. The numbers are turning truly ugly.

Here are the latest clicks; Credit card delinquencies are now 6.61% of credit receivables (loans), this is a notch up from the all time hit, hit last quarter. Delinquencies rose 181 basis points year-to-year and 89 basis points quarter to quarter, these are accelerations from the 104 basis point year-to-year rise last quarter and 82 basis point climb quarter-to-quarter in Q408.

C&I (Commercial & Industrial) Loans:

This is the first time I am showing the chart of delinquent C&I loans, which I now believe are becoming relevant to the second phase of this credit crunch. We all breathed a huge sigh of relief back in the fall, when the run on money market funds and seizure of commercial paper market was halted, and the fear that corporate giants who borrow for their everyday cash needs in the commercial paper market would not be laid low. However, I am now worried that a version of this potential debacle in miniature could happen to the many small and mid size businesses who fund working capital needs through bank loans and lines of credit as this final loan class starts to head south in a big way. Maybe I am wrong and this is a lagging indicator, showing the final stages of a recession where businesses that held out through the downturn finally succumb, but I have a gnawing feeling that we are on the front end of this trend, rather than the back end.

As you can see from the chart above, which I borrowed from yesterday's Wall Street Journal article, which was highlighting the risk from commercial real estate loan losses under "stress" scenarios, that C&I loans are a smaller but still substantial source of risks to banks balance sheets. I believe that we are seeing the beginnings of a stress scenario for C&I loans. C&I delinquencies are currently at 3.15% of C&I loans; the prior peaks were 6.58% in Q1 1987 (not a recessionary perido, but bad corporate debt was probably a legacy of the high interest rate era of the early 1980s and severe pressure of international competition on U.S. manufacturers) 6.25% in Q1 of 1991 and 3.93% in Q2 of 2002. The latest reading was up 170 basis points year-to-year, up from a 128 basis point increase year-to-year last quarter. I will note that prior big year-to-year increases came near the peak of the delinquency cycle in 2002. The quarter-to-quarter increase of 56 basis points was actually a little smaller than the 79 basis point surge from Q3 to Q4. I would note that several retail REITs have expressed some surprise that retailer bankruptcies weren't worse in Q1 and one noted that the June/July time frame is particularly tough for retailers in trouble as their sales are down (cash flow in), while they need to start buying for the fall (cash flows out). How distressed retailers fare this summer, will say a lot about the economy and credit markets.

Lastly, here are the charts for total bank loan and lease delinquencies (View image) and charge-offs (View image) .

Latest Clicks: Total loan and lease delinquencies clocked in at 5.7% of all loans and leases in Q1, versus an all time high of 6.33% reached in Q1 1991. For all intents and purposes we are in the same kind of banking crunch as the early 90s - when a lack of funds caused widespread maturity defaults (a refi crisis). Delinquencies were up 280 basis points year-to-year in Q1, an acceleration from the 229 basis points last quarter. The quarter-over-quarter increase did moderate from 116 basis points in Q3 vs. Q4 of 2008 to 85 basis points in Q1. Interestingly, banks appear to be dealing with the bad loans more aggressively than in prior periods, with charge-offs at 2% of all loans and leases, down slightly from 2.03% last quarter and above the prior peak of 1.9% in Q4 1989.

There is no way to sugar coat these numbers, they are horrible and the fact that new loan types continue to see accelerating losses, while the initial problems still have not slowed down is discouraging to say the least. I hope those green sprouts turn to big oak trees....and quickly.

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Manhattan Sales Trends: The Bigger Picture

A: I really don't get the fascination with month to month increases in activity as a foundation for making an argument that a bottom is in or that we are on the road to recovery. For housing sales numbers, especially Manhattan, there is a STRONG SEASONAL PATTERN! So, either you seasonally adjust the numbers OR you compare year-over-year to get the bigger picture! If you choose to ignore this, and instead focus on month to month trends or quarter to quarter trends, you are getting a very misleading picture! This is the exact type of spin that the NAR, and specifically David Lereah, used to argue against a falling housing market in 2006, 2007, and for most of 2008. And now, they lost all credibility. You want to see Manhattan sales trends, look at the bigger picture and understand that this is a seasonal market that must be analyzed year over year!

I can see the Bracha Blog did a whole piece how, 'Contract Out: There Is Something In The Air', focusing only on Manhattan sales trends from February, March and April 2009. This information should be interpreted as anecdotal and not used to establish any meaningful trend or to build an argument that we have turned the corner.

Nobody denies the pickup, but to cherry pick data and focus only on the near term bottom and where we came from since in order to build a bullish argument, is an exercise in futility. Let me show you why.

Here is the past 10 years of Manhattan sales activity for co-ops and condos, courtesy of MillerSamuel:

Looking at month to month pickups, without rationalizing why this pickup may be happening, gives you a very narrow window into what is happening. Doing so means you ignore the seasonality of this market and usually leads to a false interpretation of a trend. Ask yourself:

1. Why ignore the seasonal nature of this market, and where we just came from after the Lehman collapse?
2. Why ignore a 38% stock market rally and that short term effect on buyer confidence after a sharp move down in prices?
3. Why ignore macro economics and simply interpret the pickup as evidence things are on the road to recovery from now on?
4. Why ignore year over year trends which clearly show Q1 as being the most sluggish in the past 10 years!

Why ignore all of these things? It was like ignoring alt-a when subprime collapsed and everyone stated that it was 'contained'. Remember that? They chose to ignore the bigger picture of this crisis. That didn't work out too well. Well, looking at a quarter to quarter pickup in activity and ignoring all of the above is outright silly! Either you do so and drink the kool-aid, or you analyze the right way and understand where this market is in the grand scheme of things.

Why not tell it like it is? What's the problem here? Why can't I say, yes, there is a pickup in activity but I strongly believe it is simply a counter trend pickup in activity embedded in a longer term correction - comparing y-o-y will show a slowing market. When you look at the graph above, its clear that is what this is!

When Q2 sales data comes in, it will show a tick up from the Q1 data and be interpreted by media, brokers, and brokerage executives as a sure sign this market has finally turned the corner! YAYYYYYY - champagne for everyone!

As I noted above and stated many times here, YES, there is a pickup in activity and YES, it will show up in the Q2 data when comparing it to Q1 - the trend that hope is being built on. I learned long ago to ignore such trends and focus instead on the seasonal nature of markets, trending macro fundamentals, the state of the consumer, the state of the credit/banking system, and the state of buy side confidence for the asset class.

I am estimating that Q2 sales, released July 1st or so and reflecting April-June, comes in around 1,700-1,800 or so - a significant pickup from Q1 but well below Q2 from 2007 and 2008 and either at or below trend for the past 10 years. Putting both together, it will seem that the first two quarters of 2009 will prove to be the most sluggish in the past 10 years. That's the bigger picture. Comparing month to month or quarter to quarter non seasonally adjusted data is quite misleading; so interpret at your own risk.

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Bond & MarkDavid Enter CRE

A: More a sign of the changing times. Make no mistake about it, if the future was bright for residential sales volume in Manhattan there would be no need to expand your business model into a sector (commercial) that is hurting big time right now! Either you innovate, or you cut costs, or you get more production via more agents, or you expand into new markets to get that extra production! I would not look at these moves as a sign the commercial sector is getting hot - its not! In fact, its very very depressed. Rather, these moves are a sign that new revenue must be squeezed from somewhere, and commercial is the closest and most likely match. Whats amazing to me is the lack of innovation or even the lack of interest to innovate in this marketplace! If there is one thing consumers should expect from a good old fashioned slowdown, its innovation that benefits them! If the big boys don't, somebody will; trust me! Streeteasy.com already innovated their way to basically solve the public MLS problem for Manhattan real estate - so what's in store for the brokerage model?

Via The Real Deal:

Bond Launches Commercial Division

The expansion wasn't the original plan. In the midst of this fall's economic fallout, Ricciotti said, Bond was considering closing the 19th Street office, which is the oldest and smallest of the company's five offices.

"We thought, 'if we're going to cut any expenses, why not that one?'" he said.

Instead, Gerage approached them about joining the company and almost immediately became "a raging success," Ricciotti said, by specializing in sales of mixed-use buildings priced between $5 million and $20 million. Gerage brought two agents from Coldwell Banker and hired several more, and the office is now overcrowded, necessitating an expansion of the 53-desk office, Ricciotti said

"We were very excited, and rather than take a step back to cut expenses, we increased revenues instead," Ricciotti said.

MarkDavid Enters Commercial Market

"We decided to expand because a lot of people we helped find apartments were looking to start businesses and asked us to help them," Fromm said. "We used to refer them out. Since we have relationships with landlords who have retail and office space, we were able to put deals together."

These are not stupid moves and they are not unexpected moves. It's very clear that the times, they are a-changin'. And change is happening. It will continue.

The change thus far has been on the brokerage side of the model - that is, reduce ad budgets to brokers, shutting offices, canceling perks and holiday parties, eliminating food deliveries for sales meetings, tightening split levels, weak performing marketing cutbacks, etc..

We are yet to see any change in the actual business model that benefits the consumer! I see the Rutenberg Realty 100% Agent Commission Model as attracting more and more brokers because less deals doesn't necessarily have to mean less income - giving a boost to the virtual realty's 'rent-a-desk' transaction model that benefits agents. I also see the Thomas Demsker flat fee sell side consulting model over at NoBrokersPlease.com. A step in the right direction. It wont be long for more innovation to come out focusing on the consumers and making transactions more efficient and making market trends and valuations more transparent for all - after all, what the heck is really going on out there? Time will tell, but I have a feeling this industry will be vastly different in 2 years time.

I wonder how prepared the big boys are, especially after seeing Realogy post a $260M net loss for the 1Q. I would expect Q2 to be significantly improved though, as the 1Q represented the after-effects of a frozen 4th quarter, but the long term prospects continue to be very pressured. I just don't see sales volume getting anywhere close to what we got used to in 2007 (I see sales volume below trend for a number of years) and if borrowing costs rise further, it will continue to be a drag on the company's ability to squeeze out maximum profits.

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Keep Your Eye on the Credit Markets

A: Its what got us here in the first place! Credit is looking MUCH better - so keep your eyes on it and don't be fooled for a moment that the world is saved and nothing can bring us back to the hell we just came from! Credit has been leading the equity markets for the past 20 months or so; or I can say equities have been lagging the credit markets for the past 20 months or so, whichever you prefer. Looking at credit now, and where it has come from (always know where you came from!), its significantly improved! This is one reason why the stock market was ready for a sustainable fierce bear rally - as credit improves, investor confidence rises especially in financials that were severely beaten down. Ahh, but there is a danger with such renewed confidence! If you look today, credit is much tighter and many believe the fed/gov't has achieved their goals and fixed the financial problem for good! That is exactly when I want to get more worried - when hope creeps back in. All I am saying is, just keep your eye on credit, because if another wave is coming, it should show up in credit first just as it did in late 2007 and late 2008 before a sharp wave down came! Ignoring distress in credit markets at this stage of the game is highly dangerous - and I wonder now since credit has come in so much, are eyes starting to turn away?

Take a look at the significant improvement of some of the more widely used credit indicators to check in on the distress level in the financial markets:

TED Spread - measures the spread between 3-MTH Libor and 3-MTH Treasuries - normal being around 50bps. The wider the gap, the higher the level of distress because money flocks to safety in short term treasury market sending rates lower, at the same time lending between banks experiences a rise in credit risk, sending rates higher. The result is a widening gap. The TED spread is that gap and current is at 72.41:

3-MTH LIBOR - the rate at which banks lend to each other in London wholesale money markets; stands for London Interbank Offered Rate. Bringing LIBOR down was crucial in getting banks to lend to each other w/out fear and avoiding another wave of distress with adjustable rate mortgages due to reset higher - the last thing we needed for all those with ARMs. With LIBOR down so much many with adjustable mortgages actually reset to a lower rate! But before we start celebrating, know that its the recast that is more troubling. Here is 3-Mth LIBOR:

CORPORATE BOND SPREAD TO TREASURIES - spread between corporate bond yields and 10-YR treasury yields can tell us the level of distress in the corporate bond market. Like the TED Spread, a widening gap is a signal of distress in the corporate bond market as rising credit risk sends rates higher.

It's all in the natural order of markets. What amazes me the most is the dramatic shift in psychology from a 'financial Armageddon' scenario to a 'worst is over, V-shaped recovery' scenario over the course of the last 9 weeks! People really believe, and hope seems to be creeping in as the rally in equities, and specifically the financials, create the illusion that a new foundation for growth is set. Outside of fiscal stimulus and government jobs, what will drive growth for the years to come? And who says we won't get another wave of distress in the credit markets leading to higher interbank lending rates? Again, the natural order of markets at work.

This could last a bit longer as it seems blistering clear to me the stock market has been chosen to be the recaptilization vehicle for this latest round of money raising by the banks. Just look at bank stocks leading to the latest rounds of offerings (Goldman, Wells, BoA, Morgan Stanley, Northern Trust, Microsoft, Capital One, Ford, US Bancorp, KeyCorp, BB&T, Bank of NY Mellon, etc.) to raise capital via share dilution. Lets not kid ourselves here, the TARP kitty was running low and bank stocks were prime for a bear rally - the perfect setup for a short squeeze pumping the banks to levels that restore enough confidence as to allow for an offering. Some might say the game is rigged, but because it played out from the lows in the marketplace after a 60% drop in stocks, how can anybody argue that the banks were not ready for a rally?

While euphoria sets in now that the credit markets are on a path to more normal levels, focus starts to shift away from credit and onto growth expectations. I say, resist that urge because you might miss a reversal in the credit markets if one comes. It's an issue of belief here, and I am just not ready to believe that all is well. Its hard to declare us out of the woods with rising commercial delinquencies and the fact that defaults are spreading to higher quality debt classes.

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The JUMBO Problem - Manhattan Wont Help Banks

A: Wave 1 of the credit crisis brought a lot of pain but seems to be behind us now leaving the residual damage to the real economy. Of course I am referring to the carnage brought on by subprime, near prime, and option ARMs to the banking system. The first wave took some of our biggest banks, insurers and IBs, and took the markets for a roller coaster ride. This wave is behind us because most of the damage done to the banks is in the past - writedowns were taken, capital was raised/injected, and fed facilities help to keep the financial system functioning. The efforts by the fed to bring down the indexes tied to ARM resets will help us avoid another wave of defaults that would have come this year and next - potential wave averted. But for the ARMs, don't forget that its the recast that will negate any savings from a rate reset downwards. A recast is when the loan is re-amortized to the higher principal amount for the remaining loan term, raising the minimum monthly payments as the payment cap no longer applies - lots of recasts lie ahead. Lets keep it real here folks. But the real problem that seems to be largely ignored is what is going on in the jumbo market and prime market! Delinquencies are rising, fast. We must ask ourselves, is it right to ignore this or is it right to be cognizant of what could be the next wave of this crisis; especially when the high end in Manhattan is struggling like it is.

Bear rallies have a tendency of re-installing hope and euphoria that all the bad news is behind us and so called green shoots will blossom into a full gear bull market. In my trading days, we called this the 'sucking in' phase - pace of decline slowed, bad news sent shares surging, shorts got murdered, and retail investors get sucked into the rally as the move nears maturity. I don't care what the VIX says, expect plenty of volatility moving forward if this crisis does indeed prove to be of the tsunami kind. The stock market is a pricing mechanism and is currently discounting ('re-pricing') the removal of the 'world is over' scenario and pricing in rosier times ahead. That is why even bad news sends shares soaring leaving many baffled. But what if rosier times are farther out than what stocks are currently pricing in - making stocks more and more expensive? That's the million dollar question and the argument I bring forth. After what we have been through, it pays to at least be aware of what is going on out there for what could be what Bernanke calls another, 'credit market relapse'.

I want to re-introduce this chart (a bit outdated right now in regards to JUMBO & PRIME delinquencies) by T2 Partners on Page 16 showing us the rise in delinquencies by loan type/class - notice the 3 problem areas (subprime, alt-a, option ARM) and the 2 higher quality areas hiding at the bottom (jumbo & prime):

Looking at this chart, you can see the types of loans that sparked this credit crisis in 2007 and caused such problems for those holding securitized mortgage bonds; they included subprime, alt-a, and option ARMs. Then you see prime & jumbo way underneath, holding firm but showing the initial trend of distress. Its as if we could view this in waves:

WAVE 1 - sparked by subprime, alt-a, option ARMs. Fed facilities, rate cuts, and Treasury capital injections handled this wave. Option ARMs will reset lower, bringing payment relief to many of these homeowners. Loan recasts will ultimately come and negate some of this relief. Those with 3YR ARMs will have 2 years of rate relief before seeing their first loan recast if they have not refinanced into a new loan product. Subprime/Alt-a/Option ARM etc., recognized losses so far have been about $684Bln with this first wave, and banks both privately and publicly raised about $690Bln as of the 4th quarter of 2008 (view image)! I'm generalizing here as there were other factors contributing to losses during the crisis, but the point is that the bulk of losses were from these three areas of credit.

WAVE 2 (yet to come) - perhaps sparked by commercial, prime, jumbo, HELOCs, lbos, credit card writedowns. How quickly we forget that the IMF recently upped their total global credit writedowns estimate to $4.1Trln - this assumes total US writedowns of $2.7Trln, up $500Bln from previous estimate (view image).

Some math: $684Bln in global losses taken so far as of Q4 2008 compared to $4.1Trln in total IMF expected losses for global institutions. That leaves some room for more stuff I think.

Now some of the writedowns have been taken towards the 2.7Trln estimate already, so its a matter of where we are now and what may be left ahead of us - I don't know who has access to that kind of transparency right now; not even the federal regulators. Clearly the issue is not the stuff that already was dealt with, but the stuff that is marked as performing yet the actual pace of deterioration is accelerating - in other words, a performing loan book / bond is starting to non-perform. What are the marks on these guys and how does the recent accounting change cushion the possible blow that lies ahead?

I can't find any up to date data on delinquency rates for jumbo and prime, but I did see this latest article noting a report out of Barclays Capital about a "disturbing trend" among so called jumbo loans:

Loans to borrowers who bought pricey homes are going bad at a faster clip. Barclays Capital notes the “disturbing trend”–worsening delinquencies among so-called jumbo loans that are too large for government backing. The investment bank tracks the share of loans that roll into delinquency every month, and nearly 0.88% of jumbo loans made in the first half of 2007, for example, went delinquent in March from February, up from 0.77% in the previous month.

Some of those delinquencies will become foreclosures. Foreclosure starts have jumped by 221% among jumbo loans made to prime borrowers, or those with good credit, according to March mortgage report from LPS Applied Analytics. That’s more than among any other loan type.

If the trend continues these higher quality and larger debt classes could produce losses that will have to be absorbed by the banking system - which is why banks seem to be hoarding cash in reserves to the tune of 1.1Trln to deal with the upcoming losses expected from business and household loans. Banks are preparing, are we? It's safe to say that Manhattan's high end / commercial sector blues won't help matters in the near term - unless people think the high end and commercial sector in this great city is unaffected by this slowdown and will continue to perform. Tomorrow we get the stress test results, and I just don't see how the gov't will collapse the markets at this stage of the game. But who knows. After the stress test Broadway show passes, its back to reality and that is why caution is still warranted as to the wavey nature of this crisis.

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Keeping Broker 'Uptick' Reports In Perspective

A: Everybody is hearing about the 'uptick' in foot traffic and deals since prices in Manhattan completed their first wave down from peak. The 4th quarter was dead, the 1st quarter started out dead and then got a bit busier, and the 2nd quarter saw continued increase in traffic/action. The drop off of sales volume in the 4th quarter really marked the beginning of the rollover in this market; even though we were trending down every so slightly for most of 2008. For brokers, who happen to be the source of these uptick reports, the months of MARCH & APRIL & now MAY brought with it a gradual increase in confidence and traffic. Funny, because the equity markets hit their lows in March and are now running on a 30%+ gain in less than two months. I wonder if there is a correlation there? Anyway, brokers are reporting on a month-to-month observation of increased action while I think it would be more prudent to put this market into perspective by observing year-over-year trends. So, how do we stand compared to this time last year, the year before, and the year before that? Warning, it may not be as rosy as the reports!

The NAR is famous for spinning data to the positive by noting month-to-month pickups in activity, even though the y-o-y comparison would show a continued deterioration in the marketplace. Data can be presented in so many ways!

The number of sales in Manhattan's 1st and 2nd quarters should reflect the action reported by brokers during the period of NOV through APRIL or so - removing the variable of lagging new dev closings. The reason for this is that it generally takes a deal 60-90 days to go from contract signing to closing (reasons include securing the loan, preparing the board package, mgmt review, board review, etc.); so if the broker reports on action and deals signed today, it will only be reported in 2-3 months when the deal closes. Front line reporting is very useful, but it could also cloud the bigger picture.

Here is a chart showing you the NUMBER OF SALES in Manhattan's 1st & 2nd quarters, dating back the last 10 years (the 2nd quarter of 2009 is not in the books yet):

*data courtesy of MillerSamuel

THE GOOD: When 2Q data comes in, I am confident it will show an uptick from the 1Q
THE BAD: Taking a step back, year-over-year, sales will likely come in at the lowest pace in 10 years

Both statements are accurate, yet one is misleading and the other is being ignored? As you can see, the 2nd quarter usually tracks well with the first quarter action. Each quarter likely reflects the previous 2-3 months activity, so its lagging in that sense. If only I had more contracts signed data directly from the internal system, we could learn a lot more. Moving on.

You can see the outlier in 2007 as the Manhattan market saw a surge in activity. That spike was the period leading up to the credit boom's peak and the subsequent fall reflecting the illiquid nature of Manhattan sales volume after the Lehman bankruptcy - classic overshoot and now undershoot of activity. Will prices follow the same pattern? This market is likely experiencing the most sluggish action in over the past 10 years! Yet we hear reports that sales are picking up. Picking up from what, dead silence? Nobody is denying that on a month to month basis activity is rising, but if you put it into context of where we just came from and how it compares to this time last year, and the year before, and the year before that, etc..clearly this is a market experiencing its slowest action for this time of year in the past 10 years. Puts it into perspective doesn't it.

There are over 9,000 agents doing business in NYC. Even in a market that sees sales volume year over year down some 47%, you will have agents reporting on a pickup in activity - and as I reported, I am hearing and seeing this pickup in foot traffic myself. But for every top producer benefiting from a pickup in action, trust me, there are many more brokers out there struggling to survive. Plus, what is this pickup being compared to - a period that saw barely any deals done? Even I reported on the pickup in activity, but I called it something different - 'a countertrend pickup in activity embedded in a longer term correction'. I still believe this as buyers seem to continue to price in downturn risk and every deal seems impossible to get executed.

But some will have you believe that this pickup in action, both in foot traffic and in deals signed, is a sure sign of the bottom. That is where you must be cautious as higher foot traffic does not necessarily mean that fundamentals have reversed course - that is where I differ from my peers. Putting things into perspective (even with the pickup in activity), this market is not nearly as active as it was this time last year so we must take the pickup in activity bit with a grain of salt! People want to know when the market will recover, and I worry that these headlines paint a misleading picture of this market and recovery argument on faulty logic. The drop off in 1Q action is sure to lead to a similar type drop off when 2Q numbers are released in July; on a year to year basis. Yet, there was improvement month to month as accurately reported by agents.

As long as this equity rally lasts, there will be a reflation argument out there that is enough to make even cautious buyers pull the trigger with prices down from their peak; that is, if the time and the property is right! And I think this is what we are seeing now. Remember there are deals at every price!

I don't buy into the sustainability of this countertrend pickup in activity because fundamentals continue to deteriorate, and to expect wage inflation in the near future is certainly way too optimistic for me. Let proctologists pick bottoms because as far as I am concerned, we wont know the bottom is in until we have already passed it. Arguing for a recovery based on a 2 month pickup in activity is quite silly, especially when sales volume is so much lower than it normally is for this time of year - again, the bigger picture.

Lets keep it real, because if sales volume all of a sudden gets sluggish again it will lead to another bout of illiquidity leaving brokers wondering why properties are not moving again even with prices down X%. What would be more interesting is if brokers can reveal WHERE the bids are coming in at for these signed deals being reported! That would be useful. Are we seeing an improvement in the strength of bids bringing deals back closer to 2006 levels? Or are properties still receiving bids closer to 2004-2005 levels, yet now we are seeing sellers willing to trade there? Don't forget the nature of this slowdown and that it is affecting the higher price points much more severely than the lower ones. One thing is for sure, WE NEED MORE DATA TO REALLY KNOW WHATS GOING ON OUT THERE!!

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Gross: Fed Saving Ammunition to Buy Treasuries?

A: Now why would the fed want to do that?

Via Bloomberg, "Gross Says Fed ‘Saving Ammunition’ in Debt Repurchase Programs":

Bill Gross, who helps run the world’s biggest bond fund at Pacific Investment Management Co., said the Federal Reserve is “saving ammunition” by refraining from increasing purchases of Treasuries and mortgage securities at today’s policy meeting.

At the previous Federal Open Market Committee meeting in March, policy makers agreed to buy $300 billion of long-term Treasury debt within six months while increasing purchases of mortgage-backed securities to $1.25 trillion this year from $500 billion and doubling purchases of housing-agency debt to $200 billion.

The fed is saving its QE firepower because they know they will be forced to buy longer term treasuries to satisfy the huge demand from increasing issuance to fund our deficit, bailouts, and hometown stimulus packages. When demand from our friendly foreign funders start to wane we will have to make up for that demand internally, THE FED!

To keep rates low, the fed will be forced to buy treasuries to stabilize that market by purchasing the assets from primary dealers at NY Fed. The effort is the modern day equivalent of printing money electronically. The fed is saving this firepower because they know they will need it in the future. Will the fed be big enough to hold down the treasury market? Doubtful.

A rollover of the treasury market and a surge in rates is seen as one of the more likely unintended consequences that come with where we are right now, and the path we chose to take. I had it listed as one of the Stages Yet To Come, in my discussion on EndGame:

STAGE 10 (Yet To Come, End Game) - Treasury Market?: massive treasury issuance to fund bailouts, nearing the end of rate cut cycle which is yet to come (I'll bet on 75-100 more bps of easing), stabilizing economic data which is far off, unwinding or slowing of treasury purchases by foreigners, rolling over of treasuries, selling of widely owned treasuries for this slowdown, and most of the damage done to equities already may all contribute to the selling of treasuries. The treasury market is arguably at the tail end of a 27 year secular bull market. What will treasury buyers demand in yields 12-24 months from now? Will treasuries still be in huge demand, as they are today, right in the center of the crisis? The end game may bring with it the end to the secular bull market in treasuries and higher yields; especially in the longer end of the curve! How will lenders and businesses adapt to higher borrowing costs should this occur and drag credit rates with it?

Should that occur, the environment will have to adjust to higher borrowing costs across the board and the residual damage that comes from large holders of treasury bonds for either rate hedging purposes or safety purposes. The question is how much of an impact internal buying from our fed will cushion any bond market roll over. Are higher yields a sign of future growth prospects OR an unwinding of a crowded trade when issuance is set to soar?

We very well could be witnessing a period of the lowest lending rates that we will ever see for the next 5-7 years. Here is the trend worth watching in the 10-YR treasury via Yahoo Finance:

The US economy is not a very strong patient right now. I'm not sure we can handle an unexpected 'event' sending borrowing rates much higher right now; especially after the equity move we just made pricing in better times
.

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Sell in May and Go Away?

A: Everybody wants more Manhattan real estate updates! I kind of feel like providing weekly updates on Manhattan is counterproductive, beating on a dead horse so to speak. Everybody knows what is going on in this market, whether a broker or executive babbles or not. Things are tough. Period. If JAN - APRIL is our busy season, then I can imagine many agents wanting to find a new line of work. Traffic is still fine, buyers are out looking and appointments are plentiful, and I'm even submitting bids for my buyer clients, but getting buyer & seller to agree on price and get into contract with little resistance is proving very difficult. I truly believe that most sellers feel the worst is over and couple that with reports of higher foot traffic, and all of a sudden the motivation to hit a bid that otherwise perfectly fits into where this market is trading, is dampened. That sell side psychology may come back to haunt you!

There is a common saying that the first bid is usually the best bid; sometimes that is true and sometimes it isn't. When I was trying to sell my own apartment at 245 East 93rd Street, 2M, in early 2006 I decided to test the market and price high at $1.075M. I figured, if I got close to a mil, or above it, YAY!!! I was not desperate, inventory was tight, and good products with huge terraces were hard to find, so why not!

But there is a catch:

THE MOST ACTION YOU WILL GET ON YOUR PROPERTY IS IN THE FIRST 3-4 WEEKS OR AFTER A NOTABLE REDUCTION IN PRICE (WHICH IS WHAT THE SELLER TRIES TO AVOID) - THEREFORE, IGNORING A BID IN THE FIRST 4 WEEKS MAY COME BACK TO HAUNT YOU LATER ON

Do you guys remember me spilling my guts to you in October 2006, on my efforts to sell my property? I called the piece, 'Don't Mess Up In Here', referring to the scene in Casino where Joe Pesci warned DeNiro not to make a big deal over the fact that he was secretly seeing his wife:

THE FIRST 2 WEEKS (The 'Should Have' Period)

I like to call the first two weeks of every exclusive the 'should have' period. The first 2 weeks is the period of time where you get a bunch of appointments scheduled from 'B' buyers who are trying to learn the inventory of their price point and their agents who just want to do a deal already. Maybe you'll get a few 'A' buyers too. Most likely, you'll get a low ball bid. Many times this very early bid is the nightmare for sellers 5 months later. So, I refer to it from the seller's point of view as the, "I should have accepted that bid and saved 5 months of agony" period. In hindsight, every financial decision is 20/20; including whether or not YOU, THE SELLER should accept that offer.

I SAY TO YOU, THE SELLER, DON'T MESS UP IN HERE! And if you do mess up and ignore the offer because there is so much activity and you won't sell below a certain price in the first 4 weeks, to NOT blame it on your broker for failing to move your property at the highest & best price possible down the road.

That was one of my favorite personal stories + discussions on listing history that relates to the market in general in any time period. My story was that I received a bid of $950,000, some $125K below my ask, in the first few weeks that I didnt respond to. Tough guy aren't I. Well that bid walked away, and four months later (and about $6,000 extra spent on advertising costs) I reduced my asking price to $975,000 (man, that $950K bid looked really good at that time) and ultimately hit an all cash bid of $935,000. Why did I do that? Well because my traffic really started to dry up and I found that minor price drops were NOT having the desired effect. The most traffic was in the first 3-4 weeks, and turns out, the highest bid came in that time period as well!

So, my advice to sellers out there now is to be very cognizant of where we are in the seasonal component of Manhattan real estate. This IS the active season and we ARE heading into the slower summer months. If you didn't sell, or you ignored a bid because you deemed it too low, seriously reconsider what your agenda is. The market is what the market is and it has become increasingly more difficult for brokers to influence buyers to raise their bid and pay a premium for any property. Does it happen, sure, but there are 11,000+ units actively for sale in Manhattan right now and it is safe to say that most are having problems getting that strong bid in. If I was wrong, we would see a big tick up in sales volume and a decrease in active inventory.

As I said in my recent State-of-the-Market piece:

"It's hard to sell a property when traffic is light. So, my view is that this countertrend pickup in activity (which is mostly foot traffic and not a surge in contracts signed) will not last for much longer. Once we enter the slower summer months, history will probably repeat itself and this market could get significantly more illiquid; similar to what the 4th quarter of 2008 saw and bad news for anyone that must sell. If this seasonal component proves correct, serious sellers will find it even more difficult than it is now and that may ultimately mean a bid will have to be hit. Therefore, I think the latter half of the 2nd quarter all the way up to the 4th quarter will show continuing sluggish sales volume and perhaps the second wave of adjustments in pricing that is only proven after the fact. Time will tell."

Terry Naini describes this market perfectly with the exception of one phrase in The Real Deal's, "Agents team up to augment their business":

"A year ago, it would take one week to a month to get a listing into contract," she said. "Now it can take six months to sell a property."

While the listings take longer to sell, they also require a lot more work than in the past, with more marketing and negotiating necessary for each deal. "It's very busy, but there aren't necessarily as many deals," she said. "People are coming out and making appointments, just not pulling the trigger. Or when they do, it's an unrealistic offer."

Yes, it is active out there, I am busy, I am submitting bids, I am showing properties, but deals are very hard to secure and there is still a disconnect between buyer & seller; as buyers have become patient & picky. Who are we to say that a buyer's offer is unrealistic if it is in the range of where this market is trading now! The term 'unrealistic' is too broad to just blame on the buy side. What if the buyer submits a bid 25% below peak levels for a property whose price point is actively trading down 20-25% below peak; like the $1M - $2M price point? To me, the bid would seem perfectly realistic and chances are the seller is being 'unrealistic' because they are not ready to take that kind of hit on the deal after calculating buy & sell side transaction fees. Cases like this are happening everyday out here and brokers, buyers and sellers are frustrated. Buyers want to price in downturn risk into bids, sellers want to get a bid at a premium to where their price point is trading, and brokers just want to move the property while satisfying their responsibilities to their client.

It's easy to lay blame that the buyer's offer is unrealistic, but then again, its the buyers that MAKE this market! Never forget that a property is only worth what someone is willing & able to pay for it at any given point in time - I thought my place was worth more than $950K in JAN 2006, but in May 2006, I realized it was only worth $935,000. Turns out it was ME THAT WAS UNREALISTIC in JAN 2006!

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BAC: 'Extremely Difficult Challenges'

A: About to head out for a few days, but hopefully Jeff will publish some articles he has been working on the past week or so. Before I go I just want to re-iterate the nature of this recession, debt deflation, and that with unemployment levels rising the way it is we must expect consumer credit quality to deteriorate as well. This is not an environment we should want banks to aggressively lend into and certainly we don't want lending standards to be loosened just to 'get things going' again. It seems we have become a society that fears recessions, instead of embracing them for what they are: healthy and normal disruptions of economic growth (normally brought on by tighter monetary policy to cool overheating economies) necessary to ensure longer term sustainable growth. We must purge the excesses, reform the system that allowed the excess to occur, write down the bad debts that came out of the old system/boom, restructure the bad companies that no longer are viable without the old system, allow poorly managed firms to fail, and see risk capital take haircuts - not pass on all the crap to the taxpayer. Because of the nature of the parabolic credit boom that we experienced and the excess that came out of it, this purging/deleveraging process will take longer than most think. Lets just be prepared for that.

This is an overall debt problem in a society that has become very comfortable with buying now & worrying later. Lets face it, Americans tend to live above their means and use credit like it was an endless luxury. Not so. As we all have learned, when the party stops it is not so much fun anymore to realize how much debt we actually built for ourselves.

A week ago I discusses whether or not we were "Out of the Woods - Loan Loss Provisions Being Taken":

A few questions we must ask ourselves: are defaults starting to decelerate - are defaults spreading to higher quality debt classes - are banks taking the proper loan loss provisions to cushion against future losses?

This is why I think the markets got the severity of this crisis right, but not the duration of it right.

Lets take Bank of America's latest earnings report, which comfortably beat estimates. Did you know that they set aside an additional $5Bln in loan loss reserves from the 4th quarter of 2008 to cushion against what they see coming? The Wall Street Journal reports, "BAC Posts Profit, Says Credit Quality Still Weakening":

Chairman and Chief Executive Ken Lewis said that the company welcomed the profit amid the harsh economic environment, adding that "we continue to face extremely difficult challenges primarily from deteriorating credit quality driven by weakness in the economy and growing unemployment."

Credit-loss provisions more than doubled to $13.38 billion and climbed from the prior quarter's $8.54 billion, while the net charge-off rate rose to 2.85% from 1.25% a year earlier and 2.36% in the fourth quarter. Credit-card losses increased to 8.62% from 5.19% and total nonperforming assets jumped to 2.65% from 0.9% in the prior year and 1.96% in the fourth quarter.

Right there, "...deteriorating credit quality and weakness in the economy & growing unemployment" + "...Credit-card losses increased to 8.62% from 5.19% and total nonperforming assets jumped to 2.65% from 0.9% in the prior year and 1.96% in the fourth quarter". Non performing assets jumped big time, and is something to watch as time goes on.

Banks are hesitant to lend to a consumer that is experiencing deterioration in credit quality and already laden with debt. As unemployment rises, savings will increase and consumers will work to pay down debts and repair their balance sheets. Not the American way, is it? After all, we are a spend spend spend economy, not a saving one. This is debt deflation, a contraction of credit, all occurring at the same time that banks balance sheets are in complete disarray after suffering ginormous losses in the shadow banking system. This is why the fed is gaming the system to help the banks recapitalize - and leading many to worry about the future unintended consequences of such policies on the broader economy. It's an adverse feedback loop in which one stage feeds on the another.

But what about the PPIP plan which uses FDIC powered leverage to get private investors to participate in the market for toxic assets? Well, I am hearing rumors of VERY LITTLE INTEREST in this program. Add that to little interest in the TALF program and we have two huge programs that may not work at all! Besides, even if the PPIP turns out to be a big winner, it does NOT change the fact that there are still good assets on the books of financials that are quickly turning bad; that is, starting to non perform! As the economy continues to struggle, it is clear that what started out as subprime is now spreading to higher quality debt classes; proving the broad nature of this crisis.

Only the bottom of the 4th Inning? So says ZeroHedge based on a Ken Rogoff / Carmen Reinart report:

This epic report examined 15 other credit contractions and asset deflations in the past, and found that the bear markets in equities last an average of 3-1/2 years, with the bear market in house prices lasting an average of roughly six years. So, when asked “what inning are we in?”, the answer we’ve been giving, on this basis, is “the bottom of the fourth”.

Time, good policy that removes future unintended consequences from occurring, corporate restructuring, letting bad firms fail, letting risk capital take haircuts, writing down of bad debts, is what we need to get through this. Band-aiding over every new laceration that is revealed will only defer the recovery and prolong the recession because it prevents the natural forces from doing what needs to be done. I don't think the administration understands this, or it is just not politically correct to see America go through pain; even if that means we end up in better shape in the long run.

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UrbanDigs Press: NY Times / NY Mag / IBD

A: Jeff Bernstein doing his 'reality check' in today's front page story on NY Times. Jeff joined UrbanDigs about 2 years ago and his presence here has proven to be incredibly beneficial for all readers. We will continue to monitor this market and offer commentary on the fast changing macro environment, and how that may impact our local real estate marketplace. While its not the best sales tactic to tell it like it is in a commission driven industry, we are on a mission to make Manhattan real estate more transparent and to offer a venue where reality trumps babble. Lets continue to keep it real!

Front Page NY Times Real Estate, "Don't Even Say The Words":

New Yorkers have moved from a love affair with real estate to a “short-term hate” phase, said Jeffrey Bernstein, a former Wall Street analyst and a partner in a real estate investment banking firm, Guild Partners in Armonk, N.Y.

“You’re in a short-term hate market when you have prices coming down 30 to 40 percent, but there’s still some feeling you can make some money out of this,” said Mr. Bernstein, who has blogged about the psychology of asset cycles for UrbanDigs.com, which examines the New York City residential market through a macroeconomics lens. Whether the asset in question is oil, tech stocks or condos, he said, “this is all part of the cycle.”

A hate market, he said, is not a market bottom. That, he explained, will be marked by a sustained period of apathy — and quiet.

“Apathy is when people are so turned off they’re just not interested anymore,” he said. “That means all the speculative juices are wrung out and the only buyers are true buyers who need shelter and might even be grudgingly buying.

“Apathy means there are no expectations and maybe the market gets a little bit better, but really over two to three years there is not much progress. And finally no one is talking about real estate as the great wealth-building vehicle anymore. That is what makes a really good bottom.”

I totally agree with Jeff. What marks bottoms, is when nobody wants to even discuss the asset anymore, the market is sluggish, and frustration is high - sellers just want to get rid of the asset to eliminate the stress of trying to sell it. We are not there yet. Markets usually do not go from peak to trough in a straight line (except it seemed that the cliff dive crude oil did from mid 2008 - early 2009 was a straight shot from 145 to 30 or so). Rather, there are a number of waves or adjustments and then the market takes a breather as the new comfort zone is reached. For Manhattan, I'm positive there are deals happening right now that will define the next wave down when closings are recorded, ushering in a new round of price discovery. The most surprising deals will be found in the high end & mid/high end market. This includes the Classic 6s, 7s, & 8s, and larger trophy properties that must be sold for whatever reason. I think the next round of price discovery will occur in JUN/JULY, right at the time this market normally slows significantly - the seasonal component of Manhattan real estate I discussed in Friday's State-of-the-Market piece: "

...my view is that this countertrend pickup in activity (which is mostly foot traffic and not a surge in contracts signed) will not last for much longer. Once we enter the slower summer months, history will probably repeat itself and this market could get significantly more illiquid; similar to what the 4th quarter of 2008 saw and bad news for anyone that must sell. If this seasonal component proves correct, serious sellers will find it even more difficult than it is now and that may ultimately mean a bid will have to be hit. Therefore, I think the latter half of the 2nd quarter all the way up to the 4th quarter will show continuing sluggish sales volume and perhaps the second wave of adjustments in pricing that is only proven after the fact."

If you have not read Jeff's previous discussions on the Psychology of Asset Cycles & Waiting for the Hatin', the links are provided.

UrbanDigs also got some press recently in the following publications, but I was too busy to add to our PRESS page. Enjoy!

NY Mag: Flipped or Flopped -

Normally, apartments are priced based on “comps”—similar sales nearby, adjusted for layout and condition. But now that we’re a year into the market slowdown, the data pool is big enough that the gurus at Streeteasy.com can go beyond that inexact science. They’ve isolated a list of individual apartments that sold at the peak (mostly in 2006 and 2007) and then again in the past few months. “It’s a true apples-to-apples comparison, assuming a property hasn’t changed considerably,” says appraiser Jonathan Miller. “The only variable is time.” Adds Noah Rosenblatt of Urbandigs.com: “It clears out the noise and gives you a pure look.”

Investors Business Daily: Manhattan Housing Hurts Amid Job Losses -

But buyers are "pricing in further downturn risk," said Noah Rosenblatt, publisher of Manhattan housing blog UrbanDigs.com.

"Generally, nobody likes to buy a depreciating asset," he said. "There are value-hunters out there. But the bids they are putting in are not where the seller at this point is willing to go ."

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Broker State-of-Market Comments - Manhattan Real Estate

A: Want to have a quick discussion on what brokers see out there and provide some of my feelings on this market today and looking foward. It's best to do this every once in a while, because what I see and discuss here is only a very tiny crack of the overall picture. The market is way too big for me to accurately interpret on my own. Mainly, I am looking at how this market reacted to the first stage down and what buyers are thinking as we head closer to summer. If there is one takeaway I can come up with, it is that buyers are still lacking motivation to submit aggressive bids. Forgetting for a moment why they are lacking this motivation, what does this mean for sales volume as we enter the normally slower summer months. Will we see a spike month to month that is interpreted too optimistically? Or will we see continuing negative data/headlines that enhance these distractions to buy side mindsets? Will the comfort zone hold? Lets do a quick check around the brokerage community (sorry, only got 4 colleagues to participate here), and see what brokers are saying about today's Manhattan real estate marketplace.

Todd Stevens, Senior VP, Douglas Elliman

QUOTE: "The market would quickly get better if all realtors demanded checking account statements of 20% price of each home's price from any buyer that’s wants to view a property. For Harlem, Mayor Bloomberg just needs to demand 125th Street vacant building and land owners to build or be triple-taxed. With these demands, the buyer demand will indirectly have a quick rise."

Rosemarie Deane, Senior VP, Halstead Property

QUOTE: "I see the market coming back to life. Phones are ringing, agents are running out to show properties. Sellers are becoming more grounded, accepting the new reality of lower prices. Deals are being made at 5%-27% off summer 2008 prices. The savvy buyers are buying now."



Christine Toes, VP/Associate Broker, Corcoran

QUOTE: "Buyers and sellers are still 10% apart on price. There are a lot of buyers are getting into the market but they're all hoping to buy at the "bottom" and no one knows where that is. Some people think there will be a gradual leveling out / increase in prices after the "bottom." But with all of this buyer activity (I speak mostly of the under $1.5M market), it's possible that there could be more of a U shaped curve where a lot of buyers who are trying to get in while rates are low may jump in at once. Only time will tell."

Broker I Know & Trust Who Chose To Remain Anonymous

QUOTE: "Deals - Deals are being done but they are moving very slowly. That's not such a bad thing - buying your home is a major investment and it was crazy trying to do a deal from the middle of a stampede like the 2007- 2008 market. The starter end of the market is the most active and the top end is the softest. Buyers - The downside for my buyers is that it is more difficult to get a mortgage and the financing process takes longer. In this market, it's crucial for buyers to get a handle on the financing side even before they start their search. On the upside, I can now show buyers a better selection of apartments than I could have done at any other time over the past four years. I'm definitely seeing a trend of renters, who felt locked out of the Manhattan property market over the last years, finally seeing this as their opportunity to own their home. Sellers - My sellers are being realistic about pricing - since early 2008 I have been refusing to work with sellers who aren't. There are opportunities but it requires realistic buyers and realistic sellers - both of whom are negotiating from solidly researched data points."

UrbanDigs Two Cents: I think the Manhattan real estate market hit a comfort zone in its first initial snap down move from peak trades, during the first four months of 2009. Moving ahead, lets get a bit detailed and see how things may play out in medium term as the process continues.

As I noted before, this is a high end recession for our local marketplace due to the nature of the crisis that we are dealing with. The high end market is significantly more illiquid than the sub $1M market, and therefore you will see the sharpest price declines from peak occurring in that segment of the market. This leads me to believe that at some point in the next few quarters you will see a bunch of quality Classic 6s, 7s, and 8s, looking mighty attractive!

Right now, do not be surprised to see some high end or even mid/high end properties trade for up to 35-40% below peak - as a seller feels no choice but to hit a bid. The problem is that almost all buyers expect to get a deal in that range regardless of price point and property features; and that is just not the conditions that this market is operating under right now. Not all, but many buyers want protection against future downside risk and are pricing that into bids. This explains the disconnect between buyers & sellers that I mentioned before - buyers are picky and patient if they don't get their price & terms. Even though a price point seems to be trading down X% from peak, that is not to say a seller is eager to hit the bid that comes in around that level!

The fact that this market is quite active right now could lead to a sell side unintended consequence because it is happening at the same time that buyer confidence is still depressed. Crazy right, but hear me out. What I mean is, there is a lot of foot traffic for my listings and I am setting up a lot of private appointments for my buyer clients - but buyers are still patient. Brokers I talk to are reporting a similar trend across the board; with some agents doing many deals, but more agents doing fewer.

Now, take this environment a step further to see the issue that it may cause. Sell side brokers are seeing this activity and passing along the feedback to their seller clients. This affects sell side psychology - how could it not! So, if a 3M property is trading in this market down 25-30% or so and that is where the most willing & able bids are coming in at, the seller's motivation to hit that bid may get muted by feedback of increased activity that is accurately being reported by the listing agent. Hope sets in that perhaps tomorrow will bring a stronger bid, making the seller less motivated to 'hit a bid' that otherwise represents exactly where the market seems to be trading right now! The point is a psychological one: reports of higher traffic give the seller one reason to expect more because of where this market has come from in the past 8 months.

Focusing on the sell side, the problem I see is one of timing and where we are in the seasonal aspect of this market. If a seller is serious and needs to sell or really wants to sell, they should be very cognizant of the fact that we are rapidly approaching summer when traffic usually slows dramatically! Do not ignore a bid just because you think higher traffic will produce a higher offer in the near future. For stocks, the saying goes, "Sell in May & Go Away" - well, one could argue that saying should also apply for sales in Manhattan. Whereas an open house today might procure 10+ prospective buyers, once we get into JUNE/JULY/AUG that usually falls closer to 2-3 prospective buyers; unless of course the price is uber-aggressive compared to competition in the price point - something most sellers hope to avoid. It's hard to sell a property when traffic is light. So, my view is that this countertrend pickup in activity (which is mostly foot traffic and not a surge in contracts signed) will not last for much longer. Once we enter the slower summer months, history will probably repeat itself and this market could get significantly more illiquid; similar to what the 4th quarter of 2008 saw and bad news for anyone that must sell. If this seasonal component proves correct, serious sellers will find it even more difficult than it is now and that may ultimately mean a bid will have to be hit. Therefore, I think the latter half of the 2nd quarter all the way up to the 4th quarter will show continuing sluggish sales volume and perhaps the second wave of adjustments in pricing that is only proven after the fact. Time will tell. Nothing moves in a straight line and there will be deals at every price along the way. By the end of the 4th quarter of 2009 and more likely the 1st quarter of 2010, I think the bulk of the adjustment will be complete - unless the world changes again by some unforeseen event.

For now, just like stocks had countertrend bear rallies embedded in a larger move downward, I think Manhattan real estate will follow a similar pattern until pricing is more in line with trending macro fundamentals, incomes/affordability, and price/rent ratios sparking buy-side demand - basically, the new world. To visualize this, I plotted a chart of the DOW since the beginning of this crisis to show you the bigger trend, and embedded inside that a number of countertrend rallies that brought with it both hope and bottom calls:

Some macro/psychological factors that I think will power the continuation of this adjustment process for our local market include:

1) rising unemployment
2) rising taxes & maintenance / city budget issues
3) rising inventory / sluggish sales volume
4) local auctions
5) deteriorating commercial sector / empty retail spaces
6) zombie condos / lawsuits against developers
7) household deleveraging / selling because you are forced to - many will do anything to avoid the decision to sell their home, and sometimes that emotion works to build an uglier situation down the road

Its hard to argue these forces although I am way less bearish today than I was only a year ago on Manhattan real estate because the process is happening. It must happen. It will happen. And we will get through it! I look forward to the day that I can say with clarity the worst is already behind us. For now, lets keep it real.

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Retail Check: Manhattan Besting Boroughs For Now

We recently had a reader inquiry about the New York City retail market and its impact on building revenue in co-ops. Back in February, Crain's ran an article about how rising maintenance charges were impacting Coop and Condo owners. According to the Crain's article "Income derived from renting retail space and levying charges on unit sales is plummeting, and the number of owners defaulting is starting to rise". Faith Hope Consolo of Prudential Elliman, a dean of New York City retail leasing was quoted in the article commenting on the big spike in retail vacancy rates in Manhattan residential buildings, so I decided to catch up with her as well as Cushman Wakefield's Gene Spiegelman to get an update.

First let's go through some macro statistics:

According to Marcus Millichap's recent 2009 National Retail Report, New York City ranked 6th among major MSAs down from 4th in 2008, in their National Retail Index, which ranks cities by 12-month forward looking supply and demand indicators. These factors include forecast employment growth, vacancy, construction, household formation, retail sales, rent growth and an analysis of local housing market conditions. San Diego (1), San Francisco (2) and Portland (5) are reported to be long-time supply constrained markets. New York has likewise been considered a supply constrained market for time immemorial. It is for this reason that Marcus Millichap believes that New York City will experience less draconian rent declines than most other markets nationally. Specifically, Marcus & Millichap writes "Job cuts in banking and finance will weigh on property performance in New York City (#6), but supply constraints continue to restrict construction keeping vacancy in check and supporting one of the more modest rent declines in the country this year".

CoStar Group just put out their national Q1 retail real estate trends report. Trends across the country are somewhat bleak, with negative absorption (net move outs) of 23.8 million square feet, versus positive absorption (net move ins) of 22.9 million square feet in Q1 of last year. According to CoStar, 60.3 million square feet of new retail space is under construction nationwide. The average total vacancy rate is 7.2% at the end of the first quarter, the highest since CoStar started tracking data in 2000. The vacancy rate rose 50 basis points quarter-to-quarter and 100 basis points year-to-year. As far as New York City goes, it was cited as the city with the lowest average retail vacancy rate nationally at 2.4%. Further, New York City was one of only 5 markets that notched a decline in vacancy rate in Q1, down 22 basis points. However, New York City did make last place in the top ten rankings for markets with new retail space coming to market with 1.49 million new square feet. Unfortunately for New York City, Northern New Jersey and Westchester/Southern Connecticut, with which the city vies for retail dollars, ranked numbers two and three for new retail space additions at 5.4 million square feet ad 3.6 million square feet respectively. Interestingly, a recent Real Deal article cites a Prudential Douglas Elliman estimate of retail vacancies citywide hitting 12.4 percent this year, versus 8.7 percent in 2008. I confirmed with Faith Hope Consolo that those numbers are for the five boroughs, with Manhattan being below 10% (still reflecting a healthy market, though weaker than what CoStar is implying). With regard to the weaker retail trends in the boroughs, a recent survey by Congressman Anthony Weiner's office found a 14.1% vacancy rate in Brooklyn, a 12.2% vacancy rate in Queens, a 9.7% vacancy rate in Staten island and a 9.1% vacancy rate in the Bronx.

Considering, Manhattan's relatively better retail performance than much of the nation thus far in the economic downturn, it is not surprising that I found both Consolo and Spiegelman in the glass half full camp on Manhattan retail. Much more importantly to Urban Digs readers, neither believed that retail rent declines, however severe, would be a significant burden to significant numbers of coop and condo owners in Manhattan, for several reasons.

According to Consolo, the old 20% rule, which limited the income of cooperatively owned real estate corporations to 20% from non-residential real estate activities - if they wanted to be able to deduct property taxes and mortgage interest from their taxes like other residential real estate owners - had a couple of impacts on retail real estate in coop buildings. The first is that some buildings made the choice to turn their retail units into condops and sell the units to outsiders, thus relieving themselves of the issue and bringing in a one-time cash injection. The number of buildings that did this was said to have been small, but they had good market timing - better lucky than smart. Future maneuvers of this nature were rendered unnecessary recently due to the Mortgage Forgiveness Debt Relief Act of 2007, which created several ways for coop buildings to get around the 20% rule (read here). The second and more important impact was that for many years coops signed long-term leases of 20 - 30 years in duration at below market rents and often without significant annual inflation adjustments. Many of these leases are now coming up for renewal. It is true that the timing of the expiration of many of these leases could be worse for the retail tenants (like 18 months ago). Consolo recently saw one expiration where the coop was charging $50 per square foot in a $300 per square foot market. In this situation, current softness in the market seems beside the point.

Away from the market distorting impact of the 20% rule, retail around Manhattan though soft, is by no means dead. Gene Spiegelman, of Cushman Wakefield, believes that we are too early in the cycle for retail to really make a firm judgment on how low rents will go. According to Spiegelman, "retail rents actually held up well through 2008, but since New Years, you have seen a big decline in leasing velocity". He thinks it's still hard to say exactly where rents settle out, with most transactions he is seeing still in the proposal phase. Spiegleman makes an important point regarding the difference between the office and retail asset classes. Office space is much more of a commodity so when space comes back on the market through sublets deals pricing gets hammered across the board. In retail, location is critical and product is by no means a commodity, additionally since landlords often participate in the success of tenants businesses through percentage rents (a piece of the revenue driven by the retailer), the leases have very specific limitations on use, requirements for signage etc. As a result, although about 25% of the space currently available is for assignment or sublease, it does not have anywhere near the corrosive effect on rents that subleased space has on the office market.

Spiegelman notes that retail south of 96th Street remains supply constrained and that there is significant contrast between various Manhattan neighborhoods and even more so the boroughs. Spiegelman offers that 3rd Ave between 57 - 79th street has seen availability tick up, but it's still at a somewhat reasonable 7 to 9%. Fifth Avenue is still very supply constrained and one of a couple of locations worldwide where retailers feel they have to be to be an international brand. However, where this drove rents to $2,300 per square foot at the peak, they may settle back to $1,500 to $1,700....still incredible numbers, but I would note a near 35% decline on the lower end of the range. Broadway between 59th and 86th Streets, is still holding at a 5 - 6% availability rate, and SoHo still holding at 7 - 8% despite a speedy turnover rate in that boutique driven market. Surprisingly, the posh Madison Ave shopping district, famous for shishi designer brands saw availability hit 13% in mid 2007 and stay there, versus a normal 6% to 7%. Apparently, as with apartment prices, luxury retail seems to be taking on the chin harder as people trade down. Some have attributed this in part to a Madoff effect.

Consolo also commented on the "trading down" phenomenon, but noted that lower rental rates are enabling lower price point retailers to get into New York City for the first time. As a result she sees a dozen new openings for every chain store closure. Sure Circuit City and Virgin MegaStores are closing, but the likes of youth retailer Forever 21, who is replacing Virgin in Times Square, are coming into these sought after slots. She sites the opening of the city's first JC Penney in the moderate price category as another example. Teen retailing, which remains a relative bright spot has kept Hollister (recently took down 20,000 square feet at Houston and Canal), Zara and Mangos (new Lower east side unit) rolling out new stores in the city. Newcomers like Topshop of the UK are absorbing large blocks of space including 40,000 square feet of space in SoHo for 1 of 3 new stores planned this year.

The Wall Street Journal had a piece yesterday on the Chicago's Magnificent Mile, discussing the increasing vacancy rate on Chicago's major retailing thoroughfare. One longtime retailer was quoted as saying "The stores that had declining sales but wanted to keep a presence for marketing purposes are rethinking their strategy". Fortunately for New York City, the conflict between the need to have a marketing presence in the "world's capital" is not in conflict with the need to generate profits. According to Consolo, New York stands apart from Rodeo Drive, Worth Ave and the Magnificent Mile, in that the sheer density of the New York City population drives sales per square foot much higher than in any other area of the country and allows profits to be generated even in a poor economy. For this reason she believes it is even more recession resistant than any other prime retail location in the country.

Even the retail banking industry appears to be pulling back somewhat less than expected in New York City. Spiegelman offered a couple of comments on bank branch consolidation fears which he sees as having been a bit overblown. According to Spiegelman, banks had been consolidating space for the past 2 years and the combinations that have happened are less negative than some that were contemplated. My piece on potential bank branch blight which considered the impact of a Citi/Wachovia deal and Chase/Wamu marriage was a bit premature. With Wachovia going to Wells Fargo instead of Citibank, there will likely continue to be branch growth in that system, versus overlaps and closures. While JP Morgan is closing some Wamu branches, many of those will actually be mid-block locations and not the coveted corner spots. Meanwhile, Citi, TD and Doral Bank continue to expand, he even goes so far as to say that the banks are being careful not to give the public the perception that they are widely shuttering branches.

So at the current time, while a lot has been made of the "missing teeth" that darkening retail windows resemble in some buildings, the market does not seem to be in a complete meltdown, like office, hotel and new build residential. I admit to leaning towards the pessimistic in most cases of late (which I think has served my prognosticating well thus far) due to my overall concerns with the economy.

That said, although retail is normally supply constrained in New York City making it a "demand driven" market as it is in the hotel, office and residential market. We know that weak demand can still cause significant downturns even in the "greatest city on earth". To wit, here is a little reference to history in the form of some text from a New York Times article circa mid-1988, after the last Wall Street debacle gave unemployment a big boost.

AFTER almost a decade of heady growth, store rents in many Manhattan neighborhoods are beginning to decline as landlords sitting with large blocks of space grow nervous.

The leading broker of retail space in Manhattan, Garrick-Aug Associates Store Leasing, reported a 24 percent drop in average negotiated rents between the second half of 1986 and the same period in 1987. Since then, average rents have continued to slide - especially along such trendy stretches as West Broadway and Columbus Avenue - despite stability within a few retail districts.

''Landlords today are concession minded,'' said Charles Aug, president of Garrick-Aug, ''whereas a couple years ago their attitude was: You better rent the space now, without any concessions, because it'll be more expensive tomorrow.''

The jury is still out on just how bad retail in Manhattan will get. At this point the impact on coop and condo cash flows seems to be minimal. Retail is certainly worse in the boroughs and will undoubtedly have some impact on mixed use properties there.

From the Blogosphere:

Manhattan Rents Slide Down

Help for Atlantic Avenue Retailers To Keep Storefronts Open

Brooklyn Stores Hit Hardest By Retail Slump

Buyers Are Precious on Retail Strips

Banks' Rental Sanity

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S&P Warns of Coming CRE Bust

A: And the dance continues. Remember, its not just a subprime problem but an overall debt problem covering commercial MBS, HELOCS, credit cards, auto loans, option arms, cosi/cofi neg am loans, alt-a, prime, jumbo prime, lbo's, etc..As Mike Mayo mentioned yesterday, as one area of the banks balance sheet is cleansed, another seems to deteriorate faster reflecting a 'rolling recession by asset class'.

Via Housingwire.com, "S&P Warns on CMBS; CRE Bust Here?":

Standard & Poor’s Ratings Services warned Tuesday morning of a coming slide in commercial mortgage-backed securities, as the economic recession appears set to take a bite out of one of the few remaining real estate asset classes to survive much of the turmoil in financial markets worldwide.

“Since September/October 2008, Standard & Poor’s has witnessed significant deterioration in the credit performance of the CMBS transactions it rates,” said credit analyst James Manzi. “The economic recession combined with the absence of readily accessible financing in the capital markets has, in our opinion, skewed the credit risks related to the performance of CMBS sharply to the downside, and in excess of what we expected at origination or in our prior scenario analysis.”

“Recent-vintage CMBS fared the worst in the analysis, with the 2005-2007 vintages posting PLLS in the double digits,” said Harris Trifon, a credit analyst with S&P.

Reality sets in. Only last week did we witness the John Hancock Tower in Boston foreclose and sell at auction for a 65% haircut -

MISH - "...This property sold for $1.3 billion in 2006 and $935 million in 2003. Today's price is $660 million, a 50% haircut. But that's only part of the story. A friend writes "Don't forget the value of the financing that Normandy now gets to assume: $640 million mortgage at a rate of 5.6%. Thus the real price the Hancock sold at foreclosure is more like $470 million not $660 million. That is a 65% haircut in three years."

Calculated Risk discussed the plunging MIT CRE Price Index early in February:

Transaction sale prices of commercial property sold by major institutional investors fell by more than 10 percent -- a record -- in the fourth quarter of 2008, according to an index developed and published at the MIT Center for Real Estate that also posted a record 15 percent drop for the year.

The 10.6 percent drop in the transactions-based index (TBI) for the fourth quarter is the largest quarterly decline in the gauge's history, which dates to 1984. The previous record was a 9 percent drop in the fourth quarter of 1987. The 15 percent fall in 2008 is also a record, topping the 10 percent and 9 percent declines in 1992 and 1991, respectively.

CR follows, "The price declines will impact property owners who are now underwater and can't refinance, and also impact banks and other investors in CMBS who will experience see higher default rates. The coming decline in non-residential investment will impact GDP and construction employment, but that decline will probably not be as severe as after the S&L related boom."

Richard Parkus, head of CMBS research for Deutsch Bank, released his 2009 Commercial RE Outlook and offers us this doozy of a chart showing aggregate CMBS delinquency rates visualizing the performace of this sector:

Tidbits:

Deterioration accelerating sharply since September 2008

30-day and 60-day delinquency rates up 300-400% in six months

Expect aggregate delinquency rate will be in excess of 3.5% by end of 2009, and 5-6% by late 2010

So lets see here: prime is starting to deteriorate faster than subprime, Jumbo prime faces $241 Billion of downgrades, lawyers are reporting of CRE deals falling apart mid-stride, office rents are falling and vacancies are rising, delinquency rates on more than $700Bln of securitized loans backed by office buildings/hotels/stores/other more than doubled since Sept 2008, and now S&P warns of the worse-than-expected credit deterioration of CMBS. Well, at least Jim Cramer said the depression is over, so, look away, nothing to see here!!

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The Real Deal Tossed For 'Not Sugar-Coating' Market

A: Interesting reading that this blogger can certainly relate to. Telling it like it is in Manhattan is a tough thing. You see the brokerage industry is a sales industry that plays the role of a service industry on TV. Our job is mostly service based, but the fact remains that we only get paid if/when we close the deal! We do not get paid up front to provide a service independent of the overall decision. Rather, we work for free in the hopes of earning our commission at the close of the deal (the sale). So, we have a vested interest in getting that deal done no matter how the near term outlook on the market you are buying/selling in appears. That is the root cause of the lack of trust and the deteriorating reputation of the brokerage industry. When times are good, sales volume is high and fees are made. When times are tough, sales volume is slow and fees collected drops. No sales industries like bear markets. So, to hear that a brokerage firm advised their agents not to talk about what is going on in this market & pull a publication that is trying to report on real time trends, proves to you what the agenda is - paint a good picture & get that sale! Thats fine by me but if you want to keep it real without bias, you keep it right here at UrbanDigs! The fight for transparency is ON!

Publisher's note from The Real Deal (via Curbed):

From the April issue: It has come to my attention that the principals of two firms have advised their brokers not to cooperate with The Real Deal's reporters and have pulled the magazine from some of their offices. We always knew we had a tremendous impact on the city's real estate industry, but this came as a surprise even to us. When we talked to the principals, they essentially said they didn't like that we weren't sugarcoating what's going on in the market. So let me set the record straight: The Real Deal covers the New York City real estate market more thoroughly and accurately than any other media outlet in the five boroughs. Maybe these principals would prefer if we wrote about how many Girl Scout cookies brokers are buying and how great the market has been this month. But that wouldn't be fair to our readers, because we have a responsibility to report what's actually happening in the market — even when it gets ugly.

I don't know the conversation or the firms that caused such a response over at TRD, but I do know that brokers have earned a reputation of babbling, sugar-coating, bait & switch, and pretty much any tactic that is associated with a sales based industry. But should all brokers be subject to such a generalization?

Here in Manhattan there are many agents that are honest, ethical, tell it like it is, and out there to fully service their buyer/seller clients - understanding that good service is good business which produces sales. But we also know there are many more mired with their own agenda to see with any clarity, what is actually happening in the market they sell in.

In my opinion, there is nothing wrong with telling it like it is because in the end the market is bigger than all of us media folk! The market will do what the market wants to do, and even the fed and the treasury are powerless to change it. Haven't we all learned this by now?

Therefore, knowing this, it's just a matter of what level of service any buyer or seller is looking for. Maybe a seller is looking for an agent that has no problem 'testing the market' even in this environment. Maybe a buyer already decided to make the purchase, but they want to get their friend who is a broker involved to get some action! Maybe a seller really needs to sell and is looking for cut-throat advice/consulting in terms of pricing and marketing. Or maybe the first time buyer just wants an agent for emotional support, and guidance through the stressful process of buying and closing on your first home. The needs vary so greatly. Not everyone wants to buy the bottom or trade this market like its a game. There are buyers at every price!

I just view the market as a trade, and I write about what I think here. I talk about trends, macro, future possibilities, unintended consequences, etc., all in an effort to try to put the pieces of the puzzle together as fast as possible to see what the picture may be. Where will the trend go? Thats what interests me. So I talk about it.

If the market is slow, if the news ain't good, if the jobs market is weak, if the taxes are being raised, if the auctions are coming, if the sales volume nosedived, if the bids are low, we should be able to talk about it. Clearly, TRD feels the same way. They write the good quotes and the bad ones. When I talked about how I felt this recent pickup is only a countertrend surge embedded in a larger correction, they broadcast it. Transparency is good, and honest consulting has a place in this brokerage industry. If the big boys fail to see that, and continue to steer towards sugar-coating, they will insult the intelligence of the very customers they are trying to service! It's time we all suck it up and have the courage to address the issues we face, because trust me, one sugar coated line from a broker is NOT GOING TO CHANGE THE COURSE THAT THE MARKET IS DESTINED TO FOLLOW!

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Markets Getting Severity Right, But Not Duration

A: This latest equity rally is bringing with it the normal amounts of hope and euphoria that the 'bottom is in' and 'the depression is over'. First off, we had a depression only once in the last 100 years and that equity bear lasted 3 years (14 months for us so far) and the economic side effects another 5-6 years after that. If this is a depression, no way its over now. Second, lets stop trying to declare that whatever we are in is over when we do not know how unhealthy the banks are, how gov't programs will work, how many good assets will eventually start going bad, and how corporate America/consumer will handle the very weak jobs market, higher savings and personal deleveraging to shore up balance sheets. Let us at least admit that there are simply too many uncertainties to declare anything with certainty right now. Mayo's note out of Calyon Securities, reminds us that while the bad assets are taking all the headlines recently, their is a growing trend of deterioration in the good assets - and the jumbo good stuff too! This has never been a subprime-only crisis, rather a broad overall debt crisis that encompasses higher quality debt classes too.

I think the stock market got the severity of this crisis priced in correctly, but I'm not sure they have the length of the problem right. Why? Well, while the PPIP program works to cleanse the troubled banks balance sheets of legacy whole loans & securities, what happens about the good stuff ("...spreading of toxicity to higher quality debt classes as more performing loans deteriorate") held? What if that starts to go bad? I mean, after all we have been through, are people still out there keeping their head in the sand that higher quality debt classes are unaffected by this slowdown?

Bloomberg states, "Mayo Says Loan Losses Will Exceed Depression Levels":

“While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class,” Mayo wrote. “New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average.”

Not sure how he confirmed that the whole loans were only marked down to an average of 98 cents on the dollar, but from what I am hearing many of these loans are marked down more and sitting on 'accrual (hold) books', which are marked on the spot based on loan defaults and overall book performance - you are not selling, so mark-to-market is meaningless. By the nature of being a hold book this is nothing new, illegal or other - just how it is. Loan loss provisions are done on a quarterly basis, not as assets stop performing.

If the total loans in the book deteriorated 5%, well then the entire book is remarked down 5% from the previous mark or par. It's backward looking. In this regard, Mike Mayo is correct to assume future adjustments because only the eternal optimist would think that higher quality debt classes are completely unaffected by this slowdown; heck the low bids for these loans are telling you that there is downside risk not priced in properly. So it is fairly safe to say that whole loan books considered good with no plans to be resold in PPIP, are behind the curve in terms of their current market value and present a valid concern for the future. In addition, if banks are allowed to suspend mark to market accounting on these loans and carry them at par or close to it then PPIP will have no influence since there will be no upside for the banks to take something off the books.

Moving on to the point, while one toxic area of the banks books gets cleansed by PPIP we should expect another area to start increasing in toxicity due to the nature of this crisis. Bankruptcies are rising, unemployment is rising, consumers are cutting back, banks are rolling back credit, everything is tighter, and for many, borrowing costs are rising (or at the very least, not falling as much as you would think given all fed's actions) due to the deterioration of credit quality as a result of the current environment. The core of the crisis is causing a loop whereby one stage feeds from another.

To get through this crisis we need good old fashioned withdrawal from the drugs that caused this whole mess (using debt to solve a debt problem seems very stupid to me) - unfortunately, its not politically correct to 'bring on' the symptoms of withdrawal to the very people that elected you into office. Last I checked, for most people their job security has deteriorated, incomes were pressured or lost, and yet the debt obligations remain. So we need to let the bankruptcies and restructurings occur so that the banks have sounder entities (consumers & corporations alike) to lend to - and occur it will! As it does, the banks need to take the writedowns, stop hiding the bad stuff, stop refusing to mark down the good stuff, then recapitalize and restructure to the new world. By hindering one of the steps in this 'cleansing' process, you increase the likelihood of having zombie banks infected for years - prolonging the duration of the economic slowdown because of the adverse feedback loop created when banks cut back on credit, instead of expanding it. Its a lose-lose sure, but one scenario gets it over & done with at a sharper pace, and the other strings the process out for many years.

Its not that equities mis-priced the severity of this cycle, rather, I think they have not correctly accounted for the length of the crisis for the above noted reasons.

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Unemployment Hits 8.5% / The New Normal

A: I usually don't report on these numbers anymore because the financial blogosphere is filled with discussions on it, and I try to keep the focus here on Manhattan (by the way I'm checking on the total inventory widget # that seemed to drop by 600 today). But it was something that Bill Gross of PIMCO was just discussing on CNBC when talking about the jobs report and the recent rally that motivated me to write this. He said, '...we are in for a NEW NORMAL'. I don't normally plug the guy at the firm who is going to be a major beneficiary of treasury/fed actions, but in this case he is exactly right. The new world is going to be much less sexy than the world we got used to over the past five years or so, just be prepared.

First off, the unemployment rate has spiked to a 25-year high if we use the U3 measure of employment; here is the visual on that:

But the U3 doesn't paint the entire picture because it excludes those who are working a part-time job but wish to work full-time and can't find one, and those disgruntled workers who simply gave up looking for a job altogether. That measure is the U6 measure, and that rate hit 15.6%. Bloomberg reports, "Unemployment in U.S. Increases to 8.5%, 25-Year High":

The U.S. unemployment rate climbed in March to the highest level since 1983 and the economy lost more than 650,000 jobs for a fourth consecutive month, a sign renewed reductions in spending might slow a recovery.

The jobless rate increased to 8.5 percent, as forecast, from 8.1 percent in February, the Labor Department said today in Washington. Employers cut 663,000 workers from staff, bringing total losses since the recession began to about 5.1 million, the biggest slump in the postwar era.

Should GM be placed into a pre-packaged bankruptcy, the unemployment rate could tick up even more with the amount of jobs lost as part of a restructuring effort tied to the automaker and the residual side effects at the suppliers, dealers, etc.. I think I am on record for expecting the U3 rate to hit mid 9% or so by years end, and peaking around 10% or so. It's highly possible I have to revise that higher.

Back to Gross's comment on the new normal. Stages 7 & 8 seem to be IN PROGRESS now of the 11 stages of the slowdown discussed last October:

STAGE 7 (Early In Process) - Economic Data: This is where we start to see confidence reports really dive, GDP really contract, Unemployment really rise, manufacturing contract, etc..Time goes slow and it feels like these lagging reports don't ever get better.

STAGE 8 (Early In Process) - Mainstreet Blues / Saving / Capacity Reductions / Budget Crises: the real pain of job losses, and the slowdown hit the people. Time slows down and it feels longer than it is. However, this time it is likely to be longer than past recessions. Saving increases, and spending decreases. This makes the economic data noted above continue for longer than expected. The cycle feeds on itself for an economy that is driven 70% by the consumer. Capacity is reduced to adjust to the slowing demand. With the slowdown comes less revenue for cities and states. Traffic volume is down a record 5.6% in August as consumers cut out unnecessary spending/driving; driving costs money. The Terminator already called for a special session as California's budget shortfall surpasses $3Bln. It would be narrow sighted to think they are the only one in trouble.

When STAGE 9 is upon us, regulation, we will see that, "The new world will be a lot less sexy than when credit was on its way to its peak." Just like Gross said this morning! Nobody likes a crisis like the one we are facing, and unfortunately the actions that are taken by treasury/fed/congress to stem this crisis could have unintended consequences that kick in right when things seem to be turning around. That is the reasoning behind STAGES 10 & 11 of the cycle. Let us be prepared.

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M2M / PPIP - Please Pay Insane Prices

A: Why not let it stand for that? Stocks are rallying ahead of the FASB 'mark-to-market' decision that will be made tomorrow. Equity investors are thinking that with relaxed rules and the PPIP plan, even if trades occur below current marks, it may not affect banks' balance sheets too greatly. The latest treasury PPIP, public-private investment program, is flawed because it allows a homerun for banks that are holding toxic assets to participate and buy their own toxic assets + bondholders of these troubled banks to participate to protect their larger investments from going sour. As Mish accurately points out, this plan does not increase lending, offer a fair market for valuing these assets, help the troubled homeowner meet debt obligations, or protect taxpayer interests. Lets discuss.

According to WebCPA, "FASB Caves on Mark-to-Market":

The Financial Accounting Standards Board has bowed to pressure from lawmakers and banking interests and put forward a proposal to relax fair value standards.

The board has formally scheduled a vote for Thursday on the proposed revisions to the standards, but the outcome seems to be a foregone conclusion at this point. Financial institutions want the ability to avoid further steep write-downs on impaired assets such as mortgage-backed securities and the exotic but hard-to-sell financial instruments clogging their balance sheets.

Investors have good reason to be worried about the financial statements the banks will be issuing as a result of the changes. Banks will be able to start keeping the “other than temporary impairments” on their troubled assets out of net income and reclaim billions of dollars they had previously written down.

It seems the market & banks will get what they want to help cushion the blow to balance sheets as price discovery continues and equities react positively. Perhaps we may even get markups. My thoughts? Just another temporary fix for the markets that further clouds transparency and makes it harder for investors to know exactly what the assets on the books of a company are worth. If a company is to be liquidated, how will anybody know the real value of the assets held?

By changing mark-to-market, you can allow banks to value illiquid securities using models that may paint a very misleading picture. Kevin Drum notes:

"...allowing banks to value assets using models that can be tweaked so egregiously that they bear only the vaguest relation to reality. That's how IndyMac could claim it was "well capitalized" right up until the day it was taken over and shown to be a shell of its claimed self."

But stocks are down, banks are hurting, and people want CHANGE! Unreal how easily the powers that be can be pushed. On to the PPIP.

The latest Geithner plan is the PPIP, so called public-private investment program that is a HUGE incentive for banks holding toxic assets. First let's break down the gist of the plan. The plan involves a 1-1 government match of private capital that is then levered up by the FDIC 6:1, to buy toxic assets at marks way higher than current bids. The FDIC loan is a non-recourse loan, meaning if the toxic asset purchased at inflated levels turns out to really be worth much less, well, the taxpayer is out of luck.

Those with a vested interest in cleansing their own toxic assets or protecting their bonds in a mismanaged company, will have GREAT interest in this regardless if the new investment pans out - the goal is to save bigger losses elsewhere. The taxpayer does not fit into either of these categories.

I referenced a Steve Waldman quote a week ago, on how the plan to rescue these banks from nationalization is a big saving grace for those holding billions of corporate bonds in these troubled institutions:

Steve Waldman - "Under Geithner's plan, PIMROCK's $10B permits a $10B equity investment from the Treasury. Then the FDIC levers the whole thing up, providing $6 of debt for every one dollar of equity. So, $140B of bad loans are lifted from J.P. Citi of America, nearly $90B of which is sheer overpayment to the bank.

Why would PIMROCK go along with this? Because they feel it is their patriotic duty to work with the government for the good of the financial system, even if that involves accepting some sacrifices. And because they hold $100B in J.P. Citi of America bonds, and they've received assurances that if we can get the nation out of the financial pickle it's in, there will be no haircuts on those bonds. "Shaking hands with the government" means that nothing ever has to be put in writing.

This PPIP concept helps get rid of the toxic stuff at more reasonable prices than the current bid, at the taxpayer expense and using FDIC leverage, while minimizing the risk to the private investor. The banks come out healthier and the bondholders are one step closer to be saved. Therefore, its a no brainer for those holding the toxic assets to participate as a private investor, get the government match, and then get the FDIC leverage to pay a higher than market price for these assets to get them off the books of the same players that are participating! Amazing what a little creativity can do right?

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Hotel Hell - The Zombies Cometh

After reading some downbeat assessments of the U.S. hotel business in the media recently, I decided to circle back and get an update on the New York City hotel market. I caught up with John Fox, SVP at PKF Consulting and their New York City hotel guru.

John confirmed what I intuitively anticipated, that considering the travel slowdown I had reported on back in the fall in my piece New York City Hotels Going from Foist to Woist and Mike Stoler's Real Deal article on insane hotel prices I cited in a piece earlier this month.. According to Fox, PKF is expecting a 26% REVPAR (revenue per available room) drop in calendar 2009. Interestingly, about 16 percentage points of this is coming from rate declines and 12 points from the occupancy drop caused by the travel slowdown (#s don't add due to rounding).

As an aside, many in the industry have been talking about hoteliers getting smart regarding price cutting, having learned their lesson after 9/11. During that time period, internet hotel reservations were still ramping up significantly. I remember because I owned Hotels.com in my fund big time.....BOOOYA! The hotels put all their excess room availability online and saw a race to the bottom on price, as internet sites discounted the rooms like crazy to move them. The lesson was, you can boost occupancy by X%, but you put huge pressure on the rates you can charge for your entire hotel, 50 or 60% of which would have sold at higher prices. Long time readers of Urban Digs who understand how markets work, also know by now, never to believe that an industry has "learned its lesson." If there is excess supply, all it takes is a few guys holding weak hands to start cutting price and eventually the whole market will follow (we are seeing this in residential real estate in New York City now). Trust me, it's an immutable law of the universe (price fixing only works for periods of time when there is lots of industry concentration and no truly weak hands.....even OPEC can barely manage it).

It's not surprising then, that despite New York City enjoying occupancy way above the rest of the country - PKF expects NYC to bottom out at a 72 - 75% utilization rate, vs. the high 50s for the U.S. as a whole - rate compression is having a greater negative impact to REVPAR than occupancy declines. Perhaps even more interesting, Fox avers that half the decline in occupancy is actually denominator driven, i.e. it's not from slower travel trends it's from a greater number of available hotel rooms due to supply additions. I believe that this is a major reason why the Manhattan market is getting hit harder than the nation as a whole.

I did some hotel feasibility analysis work a couple of year's ago when the hotel boom was still inflating - fortunately we didn't build one. At the time, according to my calculations, there was a pipeline of new development that would have increased the number of rooms in Manhattan by 25 - 30% over the next 3 to 4 years. With the onset of the credit crunch, a fair amount of attrition of this pipeline took place as many projects failed to get financing. According to Fox, however, 10,000 to 12,000 new hotel rooms will open in New York City this year and next. That's on top of an existing 68,000 to 69,000 base, according to PKF's calculations. This equates to growth of about 14% to 18% (on top of significant 2008 deliveries), fueled by projects PKF sees as fully financed and likely to open.

New York is coming off an extraordinary period of 3 to 4 years where utilization was 85% or so and for the majority of the year Manhattan was "sold out". According to Fox, "No one had ever seen this before in any market." It is no surprise then that developers were happy to accommodate the market (pun intended). Please note however, that as in many corners of real estate, even novice hotel developers were given previously unheard of levels of leverage to work with. So despite the fact that New York City will trough at an occupancy rate that will be the envy of other markets in the U.S., I have to differ with PKF's outlook for 2010 and 2011. They are looking for Manhattan REVPAR to decline an additional 4% in 2010 (all in Q1), and an increase of 12% in 2011, driven by a resumption of rate increases. My guess is that 2010 will see double digit declines again, as more product comes to market and desperate new hotel owners slash prices to try to make their debt service payments. As for 2011, it's too far out for my radar, but my guess is if the economy cooperates there could be some recovery from a lower than expected trough. It is worthwhile to note that Fox reports year-to-date through March REVPAR is already down 28 - 29%, so the 2009 numbers are already looking hard to hit. As more companies do like Goldman Sachs, who now mandates that employees traveling to New York bunk at the Embassy suites, and more new hotels are delivered, I'm expecting second half room rate declines to accelerate.

As far as projects around town go: The Shangri La that was to be built at the old YMCA building on 53rd and Lex has reportedly been "tabled", while the Orient Express, that was to have been built at the New York Public Library (5th Ave and 42nd) has reportedly been "sidetracked". The Nobu downtown has reportedly been derailed completely by the Lehman bankruptcy. My conversations with a couple of brokers who have "off market" hotel listings indicates that deals that were supposed to have gone through a few months ago have fallen through and sellers are becoming more "flexible", but still looking for per key valuations that are outlandish in my book. I see these folks flexing much more in the coming months. If you built a zombie condo and have a big balance sheet, you can go rental, but what do you do with a zombie hotel? Especially with New York City hotel rooms that run on, shall we say, the anorexic side of petite. According to a Real Deal article, just out, Wells Fargo has reportedly filed to foreclose on 250 Bowery, a 63 unit hotel with $40 million plus in loans outstanding, putting the cost of the property at north of $630,000 per key, which ain't peanuts. In some cases, like that of the Jasper on Park Ave in the 30s, a zombie condo has morphed into a potential zombie hotel. Back in November, the developer told the Real Deal that a European investment group had signed a deal to convert the erstwhile condo development into a boutique hotel....yes they were going to gut 80 brand new condos to turn them into 200 hotel rooms. You see, the highest and best use of midtown real estate, was still naively believed to be hotel rather than condo, despite the developing travel weakness and abundant supply of hotel rooms coming on (these guys gotta start reading Urban Digs). Predictably, the European money never showed up. For anyone who cares, when I first looked at this deal I found that the lender of record was a big European bank, I couldn't tell from the filings if they were owed $51MM or $94MM. Either way I bet this one leaves a mark. If any more evidence of the coming hotel price debacle were needed, Sam Chang, the top developer of New York City hotels in terms of volume, recently seemed to display a change of strategy. Chang is a consummate land developer and hotel manufacturer. He generally puts together sites, permits them and builds them to order for clients. But in a break from past practice, Chang is reportedly going to hold onto a Holiday Inn he has in progress at Delancey and Suffolk street on the lower east side. My guess is his buyer walked and Chang has gone from trader to investor....don't ya hate when that happens. But hey, the hotel won't be done until late 2010, by the earliest. If PKF's current forecast is correct, Chang will undoubtedly have a buyer lined up by then.

One of New York's smartest hotel developers in my book is Richard Born, who has had his share of very successful developments in the city. One of the pearls of wisdom I heard drop from his lips last year regarding the cyclicality of the hotel business was "I don't particularly like to build hotels, I like to buy them from the guys who build them". I'm with you Rich.

As for how this impacts the New York City residential market, expect the collection of stalled semi finished construction eyesores to continue to pile up, particularly in otherwise "happening" neighborhoods. Fox at PKF avers that downtown will likely be hit hardest in terms of straight to bankruptcy new hotels, due to the significant amount of room capacity being added and the huge decline in Wall Street business levels. Of course, the fully constructed hotels that become bank REO zombies could become great homeless shelters, or maybe the city will come up with some other novel use for them.

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Agents/Wall Streeters Reveal Their REAL Estate

A: Ahhh, nothing like a story like this to start your morning. What do you do when wall street is dismantled and real estate volume in Manhattan drops like a stone? You start pole dancing of course!

According to the NY Posts, "AXED GALS TAKE POLE POSITIONS":

Scores of professional New York women stripped of their six-figure jobs are now working as "gentlemen's club entertainers" at upscale Manhattan jiggle joints. Former Wall Streeters, fashion executives and real-estate agents are pole dancing and strip ping for as much as $1,500 a night -- but also because they like the flexible hours.

Randi Newton, 28, who lives in Midtown, was a financial analyst at Morgan Stanley before the crash but was fired.

"A few nights after I got laid off, I went with friends to a strip club to get drunk and forget my unemployment troubles," Newton said. "The manager offered me a job as a dancer. I thought it was different. And fun."

Katie Haverton, 27, is one of them (real estate agents). She worked as a broker for a large real-estate company for three years until January, when she says she hadn't made a sale in six months and had $2 left in her bank account. She now performs at Flash Dancers in Midtown.

"With real estate, you can work 10 hours a day showing people apartments and you never know when the next sale will be," said Haverton, who lives on the Upper East Side. "But with dancing, the money is instant. Now that I make better money as a stripper than as a real-estate agent, I'm going to buy my own apartment."

I absolutely love the line, "...Now that I make better money as a stripper than as a real-estate agent, I'm going to buy my own apartment". Classic. If only there was a market for Jewish, balding, male bloggers with a gut to do this line of work, I would be the first to sign up!! What, no love?

It seems Randi Newton was an actress, professionally trained poker player, and former Morgan Stanley financial analyst before dancing (does this not sound perfect to anybody else?); what, she didn't know what a collateralized debt obligation was? All I know is, I plan to go see her special purpose vehicle over at Ricks Cabaret one of these nights real soon.

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Picky & Patient: The Buyer-Seller Disconnect Continues

A: Four months ago I did my best to explain the Buyer - Seller Disconnect taking place in the Manhattan residential real estate marketplace. As we entered the normally busy wall street bonus season (JAN - APRIL or so), we had to deal with the fact that wall street was quite different than it was in years past. Brokers expected to get many deals done, sellers expected high traffic and strong bids, brokerage executives maintain that it is always a great time to buy, but buyers sang to a different tune. Hopefully by now everybody understands that real estate is an illiquid asset class that really is all about the buyers. When the bids disappear, the rest of the players (brokers, sellers, brokerage executives) in the game must adjust to the changing world. When they don't, you get very low sales volume and surprising deals taking place. As other brokers call this a temporary lull, I would argue that the marketplace is in medium term correction process, with the asset re-adjusting its value on the open market to a world significantly different than the one that powered the boom. It seems to be happening at lightning speed, and come 4Q 2009 or 1Q 2010, I would not be surprised to see the bulk of the correction complete. A muddled L-shaped picture then appears in my head. In the end, the new buyer in this new world is more picky and patient.

That is how I view the current marketplace; I'm a trader so if you have issues with looking at the world as a trade, you may not understand why some properties are not selling even though the asking price has been reduced to pre-peak levels. I discussed the recent pickup in foot traffic as a counter-trend surge in activity embedded in a longer term correction; via a Real Deal audiocast in early February. The world has changed, and so should your view of it - higher foot traffic does not necessarily mean the market is reversing course.

In December, I described the Manhattan real estate market (story):

Why is the market illiquid? Two main reasons:

a) sellers are anchored to peak pricing; yet to realize the significant decline in buyer confidence OR that their property is likely worth 15-20% below peak levels

b) buyer confidence has not only declined, but has been shattered; as prices fall and fundamentals deteriorate, more buyers have rushed to the sidelines rather than jump into the market to take advantage of deals. The sideline money theory (the argument, mostly by brokers, that there will be a floor on prices because buyers will flock to pick up deals from the sidelines on even the most minuscule of price adjustments) was proven wrong once again

...the disconnect is making the market illiquid. Lets discuss each.

Today we get word from The Real Deal that, "Sales off 60% in 1st Quarter":

According to preliminary first quarter residential data, apartment sales are off more than 60 percent compared to last year. Condo sales in the first quarter totaled $1.8 billion, down from about $5.1 billion during the same period last year, the data showed. "The buyers and sellers have gotten different memos of what the price should be and no one is budging," said Dolly Lenz, vice chairman of Prudential Douglas Elliman.

Sellers got different memos because their broker probably promised a sky-high transaction price to secure the exclusive listing. Buyers don't need memos from anybody; all they need to do is look at what is happening to their portfolios and their job security.

I discussed the high end nature of this slowdown, and the NY Times recently stated that "Only 10 co-ops costing more than $4 million sold in the first quarter"; that is quite a statistic reflecting the nature of this crisis.

If we look at residential real estate (in declining markets) as a curve, the buyers would be the leaders and the sellers would be the followers. So we must ask ourselves, are sellers ahead of the curve or behind it? To hear Dolly say it, sellers are still way behind the curve. But should we listen to a person who claimed last year that Manhattan real estate "hasn't worsened and most of the bad news is already factored in...prices have not slowed down; two red flags are inventory levels & buy versus rent analysis, right now it absolutely pays to buy..."; ummm yea, sound advice that wouldn't have turned out too well for those listening. Yes it was a year ago, but even at that time UrbanDigs warned readers to keep their head out of the sand, in regards to the severity of this credit crisis and the ultimate hit on the macro economy.

Buyers today are both picky & patient, and who could blame them considering the macro economic forces and negative wealth effect taking place. This is NOT a market where brokers can convince buyers to aggressively bid, because "the property is worth full ask and if they don't act now they will be priced out forever". Rather, this is a market where buyers bid what they want and set the terms that they are comfortable with. Brokers and sellers alike have to deal with this trend.

In my opinion, most sellers are just not ready to accept that current bids submitted are the best they will receive. Now you can't just expect to submit a bid 70% below peak for a property and then complain that the seller is unrealistic. To me, the market seems to be in a trading range of down 25% - 40% or so depending on the price point, property features, location, light & views - the high end is significantly more illiquid than the sub $1M market. Manhattan property features vary so greatly that it is impossible to generalize that the entire market is down x%; sorry, it doesn't work that way. Given the range that I suggested, if your bid is in that ballpark and the seller is not biting, it is highly likely that the seller is just not ready to accept the reality of where the market is today. That is the core of the problem here, and a big reason why sales volume is off so much. The disconnect continues and the inventory trends reflect this:

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Transfer of Wealth - Taxpayer TO Banks via AIG

A: Tyler Durden is not just the founder of Fight Club, he is also the founder of ZeroHedge.com and quickly becoming the must read blog out there in the financial world. Bookmark it. The latest post gets into a correlation desk trader email, and if proven accurate, spills the details of the largest transfer of wealth this country has seen to date from you, the taxpayer, to the banking system. And it was only 5 days ago that I remarked, "...for what its worth, I am hearing that the banks are having a great quarter", when trying to put the recent rally into perspective. Could AIG be the vehicle to transfer taxpayer funds to the banks as part of a larger re-capitalization plan?

I am begging for some reader participation here to help verify if this claim is fully accurate, partially accurate, or just a rumor? It is NOT news that the AIG counterparties got bailed out in this mess, but this takes it one step further.

From ZeroHedge.com's, "AIG Was Responsible For The Banks' Januray & February Profitability":

"During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent - these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever".

As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks - effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities - run a chart from say last September to current of say S&P 500 and Itraxx - credit has underperformed massively. This is largely due to AIG-FP unwinds.

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period."

Tyler offers his layman translation of this:

"In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were:

a) one-time in nature due to wholesale unwinds of AIG portfolios,
b) entirely at the expense of AIG, and thus taxpayers,
c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent,
d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this "one time profit", which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity, also funded by taxpayers' money flows into the market."

All I know is, the banks were big time under capitalized, marks were way off, AIG was on the wrong side of huge CDS trades and had to be bailed out by the government, AIG counterparties were made whole, and during this period of chaos it's hard to imagine no scams taking place as firms fight for survival. When the government takes taxpayer money to bail out the banks, this kind of behavior happens. The average Joe usually doesn't learn about the scam until much later, but in this new virtual world with so many attentive and capable bloggers feeding off of inside tips, scams are harder to get away with in regards to the unknowing public. I am still digesting this and must admit that this is something I know very little about (I assume AIG is unwinding whole portfolios of issued CDS positions at vast discounts funded by taxpayer rescue funds, but the article gets into corporate synthetic and asset backed CDO positions too), but I am not shocked at all to learn that there in fact was a transfer of wealth from the taxpayer to the banks. Does anyone really believe they will make out well with these investments; if you can call them that anymore?

I would have liked to believe that the banks claim on recent profitability was a result of a pickup in traditional banking operations; mainly due to the fed's actions and ZIRP policy in place during this period of bank repair. I did NOT want to hear that the bulk of banks' profits to start the year came from taxpayer rescue funds that allowed AIG to unwind trades to the benefit of the counterparty; AIG received $182.5Bln in rescue funds to date.

Oh what a tangled web we weave! I knew the plan was to recapitalize the banks, but if this is the preferred path to achieve that, well, we may see chaos yet again. If we see a new round of share dilution to raise capital from the major banks left standing, well then we know there is some truth to this.

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2 out of 16: Hamptons Auction Deemed 'Success'

A: In a bizarre interpretation of a traditional baseball statistic, the latest Hamptons auction batted .125; selling only 2 out of 16 properties listed for sale yet considered a 'success'. Imagine that. For those of you not familiar with this analogy, batting .125 in baseball means your job as a bench warmer just got much brighter. Yet, in this case, batting .125 was deemed a 'success'. Anyway, the local Hamptons housing market will have to re-evaluate just how real they deem the latest round of price discovery to be. Apparently, that is where the market is right now. But who knows, the treasury may be minutes away from announcing a plan to stimulate Hamptons home prices, to make buyer & seller meet at the tax payers expense through an FDIC levered up program! Because if the bids are too low, someone has to prop them back up to make those deals happen - otherwise, the bank will get hurt!

Okay, I was joking at the end there. But the latest round of price discovery from the Hamptons is no joke. This is what happens when bids disappear - do you still think housing markets are not all about the buyers?

According to the NY Post, "Hamptons Homes Go For Nearly Half-Off" (Via Curbed):

Lucky buyers were able to purchase two luxury Hamptons homes for almost 50 percent off at an Internet auction of 16 properties in the tony East End.

One of the homes was a three-bedroom Victorian in Westhampton that has 2,277 square feet, a fireplace and a Jacuzzi. It was listed for $800,000, but the buyer reached a deal for about $488,000 or about 39 percent off the listing price.

The other home is a 1,800-square-foot, three-bedroom condo in Southampton Village.It was listed for $1,275,000 and went for $701,000, a 45 percent reduction.

Morabito, who organized the auction with fellow Prudential broker Vincent Horcasitas, said it was a success although agreements had been reached on only two of the properties.

Thank god it was a success! I would hate to see what a failure might look like!!

Come on now people. Seriously. Spinning an inactive auction because the bids were not even high enough to meet the reserve price set by the bank, is to insult the intelligence of anybody listening. They are now asking the bidders to submit new, higher bids. Well how nice of them. Sooner or later these assets will have to be sold. Now that we have a new level of price discovery, existing homes trying to be sold by owners will have to convince some buyer that their house should not trade at such a discount. That is the feedback loop and residual damage that occurs when home auctions start occurring in your backyard.

Manhattan & Brooklyn will see their first 5 mid range to high projects auctioned off in April. How will this affect buy side confidence when results are published. The process continues.

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Rally It Up - But What About Good Assets & The Household?

A: Another crazy day in the world of equities. This time the spark was Geithner's toxic asset plan. You've probably read about it everywhere so I won't dissect it, but basically the goal is to revitalize private capital via incentives to take on risk provided by the public; a so called public-private investment program (PPIP). The plan eliminates a major chunk of uncertainty for tradable markets and when applied to a market that plunged 60% or so, you end up with a monster rally. I learned long ago that bull markets don't rally 23% in a month off bottoms, bear markets do. So please do not confuse this bear market rally, which are always fierce, with the start of a new bull market because everything is OK again. As equities reprice the clarity that was just provided (whether you like the plan or not doesn't matter here), you must prepare yourself for a few future realities: more sour upcoming macro economic data reflecting the past three months of economic activity + spreading of toxicity to higher quality debt classes as more performing loans deteriorate + fed printing money to buy the government issued bonds to fund the incentives for the PPIF. So while this trillion dollar asset purchase plan works to rid one area of the banks balance sheet, trust me, other areas are still worsening! The fed & treasury's job now is to maintain order, limit chaos, and prevent global collapse. Well, we just saw their latest move. Don't think for a second that all these free lunches come with no strings attached.

It seems to me the goal of this plan is to just get private money into the market for residential mortgage backed securities that weren't trading. Why weren't they trading? Because the current bid in the marketplace was too low for banks (for what its worth, I am hearing that the banks are having a great quarter) to consider selling at; we know what happens when banks sell securities below their current marks, and the need to raise capital due to the writedowns. Enter the treasury to make the trade work.

Calculated Risk puts it best:

The key problem with the Geithner plan is that it incentivizes investors to pay more than market value for toxic assets by providing a non-recourse loan and with below market interest rates. The investors do not receive this incentive, the banks do. And the taxpayers pay it, so this is a transfer of wealth from taxpayers to the shareholders of the banks. The taxpayers will pay the price of the option in the future, the investors receive any future benefit, and the banks receive the current value of the option in cash. Geithner apparently believes the future value will be zero, and that is a possibility. If so, this is a great plan - if not, the taxpayers will pay that future value (and it could be significant).

Lower than market rates, financing provided by FDIC, use of leverage, and investors can buy assets with very little equity at risk; what a world! So, the public-private investment fund will buy the stuff that nobody wanted to raise their bid for in the free, open market last week? Okay. So lets use leverage, subsidies, and put most of the downside potential onto the taxpayer so that private money is incentivized to buy these bad assets that nobody seemed to want yesterday. Great, confidence seems to be restored and there is a market again for these securities. Nothing like artificially propping up a market when the bid is too low!

But what about the stuff that is considered GOOD on the books, and is not being traded in this program? Let us not forget that this plan is for the more toxic assets, the assets with no bid that were being held on the books of banks at much higher mark-to-model prices. Does this mean that ALL toxic assets are now transferred off the books, and all is well again? Candy canes and sugar cones? Doubtful.

Second, think about who this plan helps and who it doesn't. Are consumers really getting jobs, salary, and repaired balance sheets from this? I mean, did the economy just turn around on a dime because of this bad bank asset plan and the huge stock rally that came with it? Did households balance sheets just fully delever and get repaired? Did distressed sellers just get a solid bid at full ask and go into contract on their homes they have been trying to desperately sell? Did the mall landlord just fill all their empty spaces? Did the office complex owner just rent out their vacancies? Did those with massive credit card debt just wake up debt free? No, no, and no! So I ask you, what happens to the assets on the books that are considered good right now, but then start non-performing if the economy continues to struggle? Let's at least keep it real here and avoid the smoke & mirrors that this is a magic bullet to fix our ailing economy. The banks may be in better shape, but the household is not!

Via Steve Waldman:

Of course the whole notion of repairing bank balance sheet is a lie and misdirection. The balance sheets we should want to see repaired are household balance sheets. Banks have failed us profoundly. We want them reorganized, not repaired. A world in which the banks are all fixed but households are still broken is worse than what we have right now. Too-big-to-fail banks restored to health are too-big-to-fail banks restored to power. The idea that fixing legacy banks is prerequisite to fixing the broad economy is a lie perpetrated by legacy bankers.

Waldman also discusses the saving grace for bondholders of troubled banks' and why it is worth it to participate in this plan, and take a loss on one investment to secure that no haircuts are taken on bigger holdings. An excellent point and a great read.

Back to the point. Have we forgotten that this is a complete debt crisis that is quickly spreading to higher quality debt classes. It was only four days ago that Moodys came out and announced that they may downgrade $241 billion of securities backed by prime quality 'Jumbo' mortgages:

In a move reflecting widening stress in the U.S. housing market, Moody's Investors Service on Thursday said it may downgrade $240.7 billion of securities backed by prime-quality "jumbo" U.S. residential mortgages because defaults will be higher than they expected.

Moody's put on review for downgrade 4,988 tranches of jumbo residential mortgage-backed securities with a current outstanding balance of $173.3 billion, and an original balance of $240.7 billion. The securities are backed by mortgages issued between 2005 and 2008.

It said 70 percent of the 2005 senior securities will likely remain investment-grade, with the rest falling to "junk." Securities issued later may suffer deeper downgrades. Moody's also said subordinated securities from 2006, 2007 and 2008 transactions "will likely be completely written down."

I think we will end up seeing PPIP round two and maybe round three before all is set & done, especially if the first round only works to remove toxic subprime/alt-a assets held on books that were causing the arteries to clog up. What about jumbo-prime, lbo's, cmbs, credit card, helocs, option arms, cosi/cofi, auto loans, student loans, etc.. Do not forget the nature of this crisis (debt) and how many types of debt were securitized back when there was a market for these assets. And do not forget about the consumer balance sheets that are still distressed and comprise 70% of the US economy.

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Manhattan Inventory Trends NOV 2007 - Present

A: Many asked me where Manhattan total inventory came from, y-o-y changes, longer term trends, etc.. We launched the chart system in November using Streeteasy data, however UrbanDigs Charts only goes back 6 months. You guys will have to deal with this for a while longer, but I promise you that I have grander plans to improve transparency for Manhattan buyers & sellers. Hopefully by fall of 2009 we will be ready to launch a suite of new data tools for you guys. For now, here is all the data I have for total inventory showing a whopping 79% increase in total inventory year over year. However, that stat could be a bit misleading as Streeteasy may have had less reach for all active listings here in May 2008, compared to today. Nevertheless, the trend is clear.

According to my widget, which:

a) deletes all duplicate listings
b) only for island of Manhattan
c) excludes listings with no exact address
d) includes coops, condos, condops, townhouses
e) streeteasy took years to expand their listings' reach, so earlier data may not have had the reach that today's data has; please keep in mind when analyzing year-over-year percentage changes
f) streeteasy data is ONLY as accurate as the real estate agent that updates/edit's the listing; in the end, maintaining quality of data is an ongoing project

According to the data from today, it seems year over year inventory rose by about 79%:

MARCH 23, 2008 - 6,121 listings
MARCH 23, 2009 - 10,965 listings

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Wall Street & Blogger Quotes on 90% 'Bonus Tax'

A: Wall street is reeling with talk about this new tax on bonuses over $250K for TARP recipients of $5Bln+; pay back the government to get below that, and the new tax wont apply. Thousands of employees could be affected. The Senate votes on the measure next week. I can think of both very real reasons and very psychological reasons why this law is causing such nervousness for many; yes, even those that are not on wall street but are trying to sell high end Manhattan properties. I discussed last month the high end nature of this Manhattan housing adjustment. It appears we have entered the 'regulatory' phase of this crisis - expect more. The new tax law, if passed, will be retroactive for 2008 tax year bonuses since it would apply to bonuses paid out by TARP recipients after Dec 31st, 2008. Bonuses are generally paid out during the first four months of the new calendar year, based on 2008's production. What happens to those that got their bonus, cashed that check, and spent the money already? Doh!

The fact that this law is going to Senate, is causing an immediate psychological reaction for both buyers and sellers of Manhattan real estate. As one would expect, sellers are more nervous than they already have been and buyers have one more reason to be cautious. I did not do this people, so don't blame me for any effect out there; as the media, I'm sure many will blame me for this. I'm just telling you what I sense.

The real impact comes later when we see how deeply this affects those who still have their job, but have big mortgages, expensive lifestyles and much lower net income. Think further along the economic chain how this may affect the local economy. Also consider how 'retention of talent' plays out with this new law. Seems like there will be a lot of good people (yes, there are some out there) heading to firms with no connection to TARP funds. Expect wall street to innovate ways around any tax code change to reward employees and retain talent.

Here are random thoughts from wall streeters (posted anonymously of course) versus bloggers on the expected new bonus tax.

RANDOM WALL STREET THOUGHTS ON BONUS TAX

“Feels like we are on the titanic. Some are oblivious, still dancing to the band that's still playing. Others fighting to get in boats. Many stunned, wandering the deck, not realizing what's going on. The bridge arguing over who's is at fault (that's congress right now). I am outraged at the street's performance, but we should be worried that the situation is spiraling out of control. Our leaders have no idea what they are doing, and the market and the country doesn’t fully know that yet.”

"Although the public is cheering at effective potential bonus caps of $250,000 that this tax imposes, the ramifications for the global economy are huge. There is a trickle down effect, it does start at the top, the tap will be shut and every sector of the economy will suffer."

"I'm shocked that a New York representative (Charles Rangel - D New York) doesn't understand the ramifications for his own city. I would have expected this from an out of stater."

"I don't know who gets credit for this, but it goes like this: "When a poor American walks by a rich American's house he says "Someday I'm gonna be that guy". When a poor Irishman walks by a rich Irishman's house he says "Someday I'm gonna get that guy". In the past, that was very true, and it's the reason I left Ireland. It's an incredibly counterproductive attitude. Now I think the US has switched to this way of thinking."

"Instead of trying to prevent the spoiled cookie from crumbling and piecing back together all the tiny crumbs back in an effort to preserve the rotten cookie, we need to just let the cookie crumble, gather all the crumbs and bake another new, much better and improved cookie.

If we had let market and Darwinian forces work to begin with, these entities would have failed and we wouldn't be in this situation. As always, unintended consequences from market intervention always comes back to bite, and the bite is more damaging than the original problem.

Class warfare is a dangerous seed."

"The markets are damn near impossible to trade right now - not only because of deflationary and recessionary fears, but because no one knows what the government will come out and say next, and deciding to tax 90% of TARP bonus money only adds to the overall uncertainty. It's well known that our elected representatives are more concerned with the appearance of reform than with actual recovery, but this legislation is so flippant and irrelevant that it's downright embarrassing. If they want to focus on fairness, focus on the AIG counter parties."

SOME BLOGGER THOUGHTS ON BONUS TAX

TYLER DURDEN (Zero hedge) - "getting some more color for public disclosure but everyone i speak to who is solidly in the money this year (trader wise) is saying "screw this" i will get nothing at all and thus nobody has any incentive to take on any more risk and people are just unwinding profitable positions and planning on a beer break until the end of the year as they realize they will all get screwed one way or another."

ROLFE WINKLER (OptionARMageddon) - "Imagine building a sand castle to hold back a tsunami. Policy-makers are right to be very fearful of the tsunami's destructive power, but it's just too large to be held at bay. Either we recognize there's no stopping it, and retreat to higher ground with whatever meager resources we can salvage, or we take our stand on the beach and drown."

Your thoughts? Bloggers can reach me here to participate and publicize their thoughts.

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Waitin' for the Hatin': RE Frauds Still Going Strong

I was recently shown a couple of "real estate investment opportunities" by a professional acquaintance of mine. I believe that she may have made investments in both of these partnerships and she was encouraging me to take a look. The first was a partnership that was going to invest in sub-leasing retail space from retailers who were closing down stores.....ostensibly on the cheap. Then they were going to subdivide the space into kiosks, I guess flea market style, and sub lease these to small shop keepers. They had a whizzy web site, which you can find here. Now maybe this idea will have merit in certain very high traffic markets, when the real estate cycle is in its final leg down and the economy is set to recover....who knows? But the up-front advertisement of 30% to 37.5% proven annual returns was a dead giveaway to me that this was likely to be a fraud. (Although I love the touch of using a non-whole number like 37.5%) Interestingly, the entity uses the catchy phrase "private equity" in their name and you were supposed to be able to have 24/7 visibility of your investment using web cams and direct visibility of your investment account, with the ability to withdraw your funds at any time. All very reassuring.

The second "opportunity" was a firm that would help you buy foreclosed properties or real estate REO in hard-hit markets for cents on the dollar. I mean, imagine the opportunity to get rich buying foreclosed single-family homes in other markets, while you sit on your couch at home. All the management, financing etc, would be taken care of for you. You could buy properties for as little as $10,000. You can check out the site here. To me, this idea was just preposterous on the face of it (maybe its not a fraud but I am fairly certain its a really bad investment vehicle). Are you going to trust some company you know nothing about to buy foreclosed real estate for you in garden spots like Michigan (yeah, they advertise California, too but much of California is a desert) and believe that they will manage it so no squatters come in and rip out the copper piping, and that you are going to make big bucks when the market rebounds?
I had my partner take a look at the web site to get his reaction. He replied: is she working for Madoff now?

NEWS FLASH - There was a bubble in real estate, especially residential. It popped. Some day...not today....prices will stop falling. There is very little reason to believe that they will then have a big move upwards (in some circumstances there may be a bounce from well below long-term trend levels, but you can't play bounces in real estate). In fact, history indicates that it is more likely that prices will malinger near the lows for years. Eventually, there will be a period of strong returns, particularly in certain growth markets, but if you get in too early, the holding period to get to those returns will make your annual results very pedestrian. There may be better opportunities in income-producing commercial properties, where you can get paid to wait, but that bear market has just gotten going.

Yesterday, I received a frantic note from this colleague, who I am not trying to embarrass or ridicule and whose name I will not reveal, saying that she had cut off all relations with the first investment group mentioned above, when she had seen the following news concerning the Chairman of the operation article.

My point for doing this piece is three-fold. The first: If anyone promises you or suggests strongly to you that they can earn returns above the risk free rate, which is CURRENTLY ZERO, run the other way. If they say "we aim to make", or "our hurdle rate of return is," etc. etc, be appropriately circumspect and do your due diligence carefully (It's a post- Madoff/Stanford world). Stanford and Madoff were particularly brilliant in that they didn't offer world beating results, but rather appealed to conservative folks with pitches about security and consistency.

We are in a deflationary environment, so while many legitimate investors are still looking to earn 15% IRRs in real estate and higher, my guess is sights are going to have to be lowered.

Secondly and perhaps more importantly, in my personal experience, great value plays take place when people hate an asset....and I don't mean that they actively watch it and hate it obsessively. I mean they could care less about it and don't even want to hear about it....like gold at $260 and $300 and $400, oil in the teens and stocks in the late 1970s and early 1980s. Way back in September of 2007 I wrote my original Psychology of Asset Cycles piece, which has proven to be a great road map for the general course of things that followed, and I talked about how fraud gravitates to where frenetic investor activity is taking place....I neglected to mention that the frauds often come to light as a direct result of the tide going out on these investment themes.

The country is still overly interested in real estate (yes, I know it's the biggest purchase people ever make blah blah blah), but to my recollection most people just didn't think and talk about it much in 1993 and 1994, unless they were having a change of life of some kind, when it was a great time to buy from an investment perspective.

Lastly please be aware, that with times being tough folks are looking for hail marry passes to save the day. Lotto sales are up! and it is an environment where people are easily tempted by "long odds" bets. Beyond that, folks are simply in vulnerable positions and states of mind. be careful out there!

From the Blogosphere:

Experts Warn Recession May Fuel Financial Scams

Officials Say Scammers Taking Advantage of People Seeking Jobs in Hard Times

Beware Government Stimulus Program Related Frauds & Scams

As Stock Losses Loom, Don't Throw a "Hail Mary"

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"Every Action Has An Equal & Opposite Reaction"

A: An interesting piece out today by Andrew Mickey over at Q1 Publishing, discussing the "Bernanke Buying Spree: The Good, the Bad, & the Reality". Many similarities to how Jeff & I view this current crisis via writings here on UrbanDigs - except that I don't think the fed's push to lower lending rates through QE will stop the more powerful housing market forces at work. A refi boom sure, but a surge in new applications? If you can't afford to buy a home with a 5.5% rate, I'm not so sure you should be buying a home, or worse, more home with a 4.875% rate. You can't force banks to lend and you can't force people to buy homes or take on huge amounts of new debt - housing will NEVER be anywhere as sexy of an asset class as it was from 2002-2006. Right now, it ain't cool being a debt turkey so close to Thanksgiving! And turkey-day is a ways off!

As long as unemployment continues to rise, debts remain on household balance sheets, and a huge negative wealth effect from plunging equities takes hold, housing prices will continue to be pressured. Last I checked it was the consumer who buys homes, not corporations with access to TARP funds. Yes we will see signs of life in distressed markets where sales volume surges due to record amounts of foreclosure activity; but that is hardly a sign of a strong market now is it! I mean, could you see how silly a statement like the following would be, "Sullivan County local real estate strengthens as foreclosure buying surges!"

In the end, the unintended consequences of policy actions (monetary inflation) will kick in to further stall economic growth; and the fed will do the unthinkable to try to stop it - raise rates and reign back credit facilities that were put in place as an attempt to reflate our way out of this mess. How will that affect lending and borrowing costs?

Andrew Mickey writes, "Bernanke Buying Spree: The Good, the Bad, & the Reality":

The big move though, and what got the markets rolling again, was when the Fed said it will be buying “longer-term” treasuries. This basically means the U.S. government can now borrow money directly from the Fed. It doesn’t have to worry about China or Japan financing a massive debt load and can disregard any sort of fiscal discipline. The Fed is now the official sugar daddy.

How will the Fed get all that money, you ask? Well, it can’t tax people. And it can’t take it from the banks. So it creates all that money out of thin air.

John Embry, of Sprott Asset Management, said, “Eventually, you reach a certain point where you can’t really add any more debt because the capacity for the system to handle it has been exhausted. Once it reverses, it’s very hard to change. They are going to try to change it by simply debasing the money.”

Well if China not only stops buying treasuries but decides to sell current holdings, I'm not sure the internal demand from the fed will be able to control the market from rolling over. Yet people STILL feel this time the fed has it right! I own gold because I thought the fed buying treasuries was a very likely final course of action, not because I thought it would be the magic bullet to save the economy. People should actually sit back and think about WHY the fed is taking such measures. Could it possibly be to combat the worst economic period since the great depression? Does anyone remember a time in the past 20-30 years where housing prices collapsed like they did, stock prices collapsed like they did, debts remained/rose on household/corporate balance sheets, huge demand destruction for goods/services, overcapacity/over-investment, credit contracting the way it is now, and the level of wealth destruction on banks balance sheets as it is today - all at the same time? The answer is No! You have to go back 75+ years to see that amalgam at work at the same time.

If anything, understand that there is a reason they are using every option at their disposal to attempt to stop a deflationary spiral, and it is likely policy will have not one but many unintended consequences down the road as an opposite reaction to the initial actions taken. Just don't act surprised when they appear.

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Don't Count on Manhattan RE as an Inflation Hedge

A: A new argument floating around out there is that future inflation threats are good news for Manhattan residential real estate - so buy now and protect yourself against the dreaded 'inflation monster'! Umm, no. Not this time around anyway and right now deflation is the battle. These are anything but normal circumstances and unless you were asleep at the wheel, we just witnessed a housing boom of unprecedented proportions fueled by parabolic credit that the system allowed for at the time. Now fed/treasury policy has been to print/borrow their way out of this mess. If your looking for a real estate related inflation hedge, income producing property is a better way to play it because you will generally benefit from rising rents; but you still have market risk there that is linked to the strength of the local economy. I would argue that the type of inflation we see will be the result of fiscal & monetary policies, showing up as an unintended consequence that further stalls future economic growth. I don't see wage inflation threats. Outside of that I would want to know, 'where did we come from' and 'what allowed housing to boom so fast', to figure out if future inflation is good news for property prices.

Q: Where did we come from? Well, from a level a lot lower than where we are today. In 2001-2002, you could buy a doorman condo unit for about $500-$650 per square foot or so; I'm ballparking here so lets keep range wide to account for variable sell side features. Then something happened. BOOM. Money was cheap, lending standards were very loose, banks wanted to pump & dump loans, loan products were designed to allow people to buy more house than they would otherwise afford, more loan products were designed for the buyer whose credit was too weak to get an affordable loan, and appraisals were easy to come by to make the deal work for all parties involved in the transaction. The secondary mortgage market was alive & well and RMBS were traded actively. Banks created loans, packaged them up, sliced and diced them, rated them and resold them to investors as structured credit products. Bank earnings soared and housing began to become a very hot asset class that everybody wanted a piece of. In the beginning housing was still fairly affordable given salaries and price/rent ratios - the asset boom had not yet occurred! But that would change quickly.

That is where we came from. When I look at the market now, I see that housing prices appreciated about 100% or so, more in high end I'm sure, from 2001-2002 levels. Take a look at DEC 2008 S&P / Case-Shiller New York Condominium Values Index, and you can see the runup since 2001:

Ask yourself, did incomes follow suit with a related rise to justify the higher prices? Rents certainly rose, but not to levels that would justify where prices went. The price rise was more a function of a parabolic credit boom and cheap/e-z money.

Paul Fried, chimes in on this past Real deal article titled, "This time, inflation may have different impact":

Paul Fried, a principal at AFC Realty Capital, a national boutique investment bank, said real estate might be a hedge in inflationary environments — as long as it's not the sector that went through the inflationary period.

"Normally, you would think it would be good to hold real estate in an inflationary period, but you're assuming real estate is not the asset that's in the inflationary cycle," he said. "Right now, real estate values are at historical highs as a result of going through an inflationary cycle caused by cheap monetary policy."

Exactly. Moving on to the system in place that allowed the boom to occur.

Q: What allowed housing prices to boom? When I look at the credit/mortgage markets now, I see something very different than what was in place during the boom times. Today, I see:

1) a frozen securitization market - very low bids for toxic MBS, flawed ratings models
2) more expensive money; especially for jumbo loans, weaker credit quality borrowers
3) elimination of exotic loan products that allowed buyers to buy more house than they can afford - now you can only buy what you can afford to buy
4) a significant tightening of lending standards - banks now actually check to see if you can afford the property before committing to the loan
5) appraisals using negative time value - for markets deemed to be declining, appraisals are negatively adjusted for time. No more e-z appraisals to make the deal work.
6) banks cutback on lending / hoarding cash for own balance sheet repair and corporate survival

The combination of where we came from and what has changed that allowed the boom to take place, must be taken into account when looking into the future. In short, prices are still high and the system of credit that was in place during the boom, has deconstructed itself.

For now deflation is the enemy the treasury/fed are fighting. But many look at recent policy, bailouts, and fiscal stimulus as ultra-inflationary and something to be on guard against if it comes early. Me? I think it's a ways out and any inflation we see in the early phases will be confined to food, energy, health care, metals, etc..That first inflation wave will be painful, an unintended consequence, because it will hurt consumers at a time when they are already hurting from years of deflationary beat downs.

But lets assume inflation comes, what will happen? Well, for one, rates will rise! Given the artificial lowering of rates by our fed through rate cuts, lending facilities, and quantitative easing, the snap-up of rates may be quite fierce - unless of course you think that the fed can keep low rates forever and ever, without any consequences at all. I wonder about things like, how will housing perform if mortgage rates are 200-300 basis points higher? I think early signs of inflation will move the markets that make money more expensive, and that means inflation as an unintended consequence of policy, will act to depress real estate a bit further as the latter stage of the housing cycle plays out. I want to buy towards the end of that phase, not in anticipation of it for a hedge.

For most people, buying a house means taking on a mortgage; DEBT! If debt is more expensive, well then, the borrower can afford less house. How will confidence in housing as an asset class be viewed if/when inflation does appear? Will people be so sick of housing that the asset class is simply, unsexy? Will people be afraid of taking on debt? These are the questions that remain unanswered right now.

Inflation as an argument to buy real estate, to protect your precious dollars? I don't buy it at all right now or in the near future, given what type of inflation I see down the road, where we came from and the changes that have occurred that allowed the housing boom to occur in the first place. Buy a home because you can afford to do so, need a place to live, and you are happy with the products and the value out there right now; not because someone tells you it is a hedge against inflation!

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Late Night Happenings

A: Two pieces of news out later today that I think are more important than it appears at the moment. In my opinion anyway. Once we find out more and something official is released, I'll provide thoughts on it. For now, I'll leave emotion out of it and just report on the news and my gut reaction from a day trading point of view; considering where we are right now and where we came from.

Via Yves over at Naked Capitalism: Now It's Official: Public Private Partnership to Overpay for Toxic Bank Assets

Our suspicions have finally been confirmed. From Andy Lees at UBS:

"The U.S. will give further details of the Geither public/private partnership plan to take bad assets off banks books, later this week a senior department official has said. The official said that the Treasury wants to put out enough information in the coming week so that the potential participants can better judge the proposal. It will also detail the timeframe in which it will become operational. So far the plan is expected to leverage both public and private capital to buy assets using government financing. The initial funding would be from what remains of the USD700bn financial rescue fund, but a “placeholder” provision in President Obama’s fiscal 2010 budget plan signals a possible request of around USD750bn in new funds. Neel Kashkari, the Treasury’s interim administrator for the USD700bn rescue fund told law makers last week that private investors are ready to invest in distressed mortgage assets if they can get financing. With no private financing available, they could only pay prices that are too low for banks to be willing to pay. The bad asset plan is expected to be structured along similar lines to the TALF, which is scheduled to launch this week, although the TALF will be restricted to funds investing in highly rated asset-backed securities."

NOAH here. So, basically the price that will be paid for toxic assets will be somewhere in between current market bids and the much higher mark-to-model prices assigned by the institutions holding them. Shocker. Banks didnt want to hit the bid, so they stopped adjusting current market bids to assets held, or hid them in Level 3, and kept those higher valuations based on the previously proven flawed mark-to-model valuations. Debates raged on both sides - assign current bids to all the toxic assets and you have a big problem, assign model price and nothing will sell. Looks like a new market will be made in between - ain't life grand! Moving on to the next piece of news.

Via Calculated Risk: FASB to Propose Changes to Mark-to-Market

The Financial Accounting Standards Board, pressured by lawmakers to change the fair-value rule blamed for worsening the financial crisis, proposed permitting companies to use “significant judgment” in valuing assets.

Companies would be able to apply the revised rule to their first-quarter financial statements, FASB Chairman Robert Herz said today during a meeting at the U.S. accounting rulemaker’s Norwalk, Connecticut, headquarters. The board is set to vote on the proposal April 2, after a 15-day public comment period.

NOAH here. Ok, you guys seeing what is going on here? Is everybody getting it? These two forces are linked. On one hand we have the mark-to-market order by the FASB and on the other we have the mark-to-model method used by comatose banking institutions. Something is about to change and it will come to both forces. Not only will we pay MORE than current bids (current market value) for these toxic assets, yet less than current asks, but the accounting standards board will relax mark-to-market rules via the 'permitting companies to use “significant judgment” in valuing assets' amendment.

That means the remaining assets that were not traded, would NOT have to be marked down much further because of the institutions' judgment call in valuing it. That's quite a 1-2 punch don't you think. Lets keep emotions out of this until we hear the official announcement, but this to me seems like market moving news for equities; maybe not realized right now, but it will.

Will this do what it is designed to do? SPARK PRIVATE INVESTMENT & REVITALIZE THE SECONDARY MORTGAGE MARKET that has been frozen for a heck of a long time; about 15-17 months now I think.

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Price Flooring? Will Boards Try To Stop Price Discovery

A: I have been hearing stories lately about co-op boards rejecting purchase applications because they think the price is too low and may adversely affect future valuations for existing shareholders. I for one do not dismiss such rumors that quickly because of their source, past experience I have had with co-op boards, and colleagues of mine who I know and trust. In times like these co-op boards have a big problem on their hand regarding where to draw the line. Since the co-op board is comprised of, wait for it...., co-op shareholders, there is a vested interest in seeing price appreciation go through and avoiding what may be considered aggressive price deterioration because a shareholder must liquidate their shares. With the mortgage market significantly tighter than it was in the boom years from natural deflationary market forces, how will boards adjust? Will they loosen up guidelines if they were traditionally very tight? Will they tighten up guidelines if they were traditionally very loose? And most important, will they reject a purchase application because the price is deemed too low; a form of price flooring policy?

This is one of those 'look ahead' pieces that describes what ultimately will be an unintended consequence of a declining market. Like I discussed a year and a half ago, when the mortgage markets began to seize up causing the bid for RMBS to disappear, I thought there would be a problem with future new development closings, "New Dev Closings: A Potential Problem?". Well, now I seriously wonder about this co-op laden city and to what extent the boards of private corporations (buildings) will influence their power to 'further protect shareholder interests'.

When a neighborhood is dealing with foreclosures, the nearby homes that are in good standing start to seriously worry about the negative pricing effects that come with mark-to-market price discovery of that bank-owned auction. How will it affect homes next door? Down the block?

While Manhattan is not dealing with a foreclosure problem right now, I am hearing stories of co-op boards tightening up and being on guard against sales that are deemed 'too low' for current market conditions. Granted, these are just stories and I have not had a co-op board rejection to deal with personally, but I could see the potential problem. What rights do the co-op boards have to block a transaction based on price alone? What legal actions may be taken if a transaction is blocked? How will future buyers perceive the building if they will not allow market forces to determine value?

These are the important questions. Certainly boards will not intervene if the price was too high, because hey, that means the board's holdings have risen in value and everybody likes asset appreciation. But asset appreciation is hardly a term to be used today.

The Co-operator lists LOW PURCHASE PRICE as reason #9 for a co-op board to reject a purchase application; here are the rest of the reasons:

1. Financials
2. Job History
3. Bad Credit
4. Pied-a-Terre
5. Guarantor
6. Life Style
7. Home Work
8. Failure to Fulfill Additional Requirements
9. Low Purchase Prices
10. Pets
11. Noise
12. A Poor Interview

The problem is that co-op boards will be filled with people of vested interest in avoiding price depreciation; especially if a board member owns a similar line as the one in question. This is not a new phenomenon and Jonathan Miller would expect it to occur again.

In the NY Mag article, "Co-ops create new conundrums", Miller states:

"I'm finding co-op boards to be even further behind the market than sellers," said Jonathan Miller, president of appraisal firm Miller Samuel. "That's going to be a continuing problem during this period."

The practice of rejecting buyers because of their proposed low purchase prices occurred frequently in the recession of the early 1990s and continued sporadically as home prices in New York skyrocketed. Now, it's becoming more common as prices begin to dip again, Miller said. "Boards are turning down deals that are selling too low," he said.

Now, I have heard of old stories in the early 90's of co-ops amending the by-laws of the corporation to set a minimum floor on the value of its shares, to protect the value of other shareholders' investments. But I have no idea if this is in place today, especially after the boom this market has experienced when credit went parabolic.

Price flooring is not new; the question of legality and if its good policy is an ongoing debate. The one legal case I could find about this was discussed in a 2001 NY Times article:

Bruce A. Cholst, a Manhattan co-op lawyer, said that there has been only one reported court case that addresses the legality of minimum-pricing policies.

In that 1995 case, he said, the court held that a co-op board does not have the authority to reject sales whose contract price is below a predesignated level.

''The court concluded that such a practice constitutes an impermissible restraint upon a shareholder's ability to sell his unit,'' Mr. Cholst said. Mr. Cholst added, however, that since the decision was from a Westchester County trial court and was never appealed, other judges in other courts are not legally bound to reach the same conclusion.

''And I believe, as do many of my colleagues, that the court's reasoning was flawed,'' Mr. Cholst said. ''Since the establishment of a floor price does not actually serve to prohibit the sale of an apartment, the practice should not have been viewed as an illegal restraint against transferability.'' In fact, he said, as long as floor-price policies are enforced in a nondiscriminatory manner, they would appear to constitute a legitimate exercise of the board's business judgment and should not be subject to judicial second-guessing.

My two cents? You can NOT place limitations on the open market - and that includes price flooring policies! If a seller is distressed, and must sell below a price floor, what will happen to shareholders' maintenance when the unit owner goes into default? It will rise, and that will negatively affect all shareholders and market value of all units with the now higher carrying charges. The co-op board has no business trying to control sales prices. The market will do what the market wants to do, and meddling with open market transactions to 'protect shareholder interests' will do more harm than good. Another NY Times article titled, "Should Co-op Boards Set ‘Floor Prices’?" adds these three arguments:

It is an open secret in New York that some co-op boards have adopted what are known as “floor prices” — minimum sales prices for apartments in their buildings.

“It is understandable that shareholders want to keep the value of their shares as high as possible,” Mr. Sonnenschein said. “But the business of a corporation does not include trying to maintain the value of its shares.” He contends that doing so is “basically a form of stock manipulation.”

Aaron Shmulewitz, another Manhattan co-op lawyer, disagreed. “I don’t see why co-op boards should not be doing this,” he said. “Board members have a fiduciary duty to protect the financial interests of the corporation and all its shareholders. And allowing sales for below-market value would damage the financial interest of the co-op and its shareholders.”

Arthur I. Weinstein, a Manhattan lawyer who is a vice president of the co-op and condo council, said that while he believes boards have the power to impose floor prices, this power should generally not be exercised.

“The co-op board should not be trying to second-guess the marketplace,” he said. “And the marketplace determines what the value of an apartment is.”

There will be cases of this no matter what anybody says because greed sometimes overpowers rational thought. Hopefully the members of a co-op board review prospective purchase applications rationally, and it wouldn't hurt for them to get a lesson on what is happening in the broader market so they are prepared for what future purchase applications may bring. Losing today's price means potentially getting a lower price down the road!

It is up to the listing agent to educate the board and consider submitting a written listing history with the board package. Tell the board how long the property has been on the market, where the original price was, number of price reductions, traffic procured as a result, number of open houses held, and even marketing strategies to show the board members that the transaction price was a function of current market conditions. In the end, the market will do what the market wants to do. Outside meddling by anyone, especially co-op boards, will prove counter productive and do more harm than good for the seller and the rest of the shareholders of the corporation. Condos are not affected by this problem because of the nature of real property transactions and the boards right to first refusal. If a condo deal is deemed to low, the board can decide to purchase the unit using reserve funds, matching the deal agreed upon between seller and original buyer.

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Addicted To Debt / Household Formation Slowing

A: It should be no surprise to anyone that Americans were addicted to debt well before the housing bubble even began. Buy now and worry later was a way of life. But when the debt piling started to come from home equity extraction, we went from dangerous to nuclear. I discussed Mortgage Equity Withdrawal (MEW) over twenty times since mid 2006 here, but Calculated Risk should get top honors for showing why we had a debt problem on our hands and the role MEW played. The main point to take from all this is that while asset prices fall due to deflationary pressures, the debt remains! Understanding this reality should put your near term future view on this consumer driven economy into perspective. The drugs (new debt through extension of credit without savings/equity to back it up) are being taken away from us, and the withdrawal (asset price declines) is here. In the end, this is a necessary part of the process of becoming clean. For now, let us understand the addiction to debt first.

Over time the population grows, that we know. As the population grows, there is usually rising household formation that tends to have a positive trickle effect on the overall economy as the house is outfitted with products/services. First time home buyers generally have put 20% down on their homes, but for the period of the boom that reached 0% down in part because of the theory that home prices never go down. Those who have been in their homes for longer periods of time, built up substantial equity, which is why the average % of homeowner equity has tended to be above 50%. Not any longer. Rolfe at OptionARMageddon.com shows us the following chart on "% Homeowner Equity":

Because of the rising home prices, owners extracted equity (MEW) from their asset to be used for consumption - and banks were more than willing to offer their fee based re-financing/HELOC services. Now the asset's value is about to plunge! Consider what happens to percentage of homeowner equity in the home when the VALUE of that home falls, yet the debt remains or worse, rose higher. That is what the above chart tells us and it is not a strong foundation to build a new, sustainable consumer driven economic recovery on. But don't take my word for it, Rolfe adds a 2nd chart on "Outstanding US Debt by Sector":

That's a debt problem! The consumer balance sheet must correct itself through saving, frugality, bankruptcy, rising income, paying down or outright elimination of the debt; just like a corporation would. Think this is a quarter to quarter adjustment?

In the parabolic period, we had an easing of lending standards, cheap & easy money, and an increase in exotic loan products which allowed home transactions to take place with substantially lower up-front down payment requirements. Buyers were starting out with little to no equity in their homes, and that was basically unheard of prior to the early 1990s; before PMI insurance became widely available. It's amazing how government sponsored programs may catalyze the development of new free market products, for better or worse - in this case, the FHA low down payment programs for new homeowners leading to a broader free market solution to buy a home with bad credit and little to no income history. Of course, wall street took it too far proving once again that we are demons of our own design.

As the housing downturn matured (its getting close to being a 3-yr veteran by now), we are finding that household formation is slowing. Why? Let us not forget the level of immigration that had occurred as a direct result of the housing/credit boom, and the surging need for construction workers to build those new homes. The main drivers for household formation is jobs, demographics, and immigration trends; and we got two strikes right there between jobs & immigration trends. According to a recent US News & World Report article, "Household Formation: 2009 Housing Head Wind":

Slowing Household Formation: At the same time, the pace of new household formation is slowing, which further chips away at housing demand. Richard Moody, chief economist at Mission Residential, says the development is linked to three factors: More singles are moving in with each other, young adults are returning to live with their parents, and fewer immigrants are entering the country. "For those three reasons, you are seeing a slowdown in the rate of household formation," Moody says. "And to the extent that the economy and the labor market remain weak this year—which I think they will—then that's going to continue."

Now the process is in reverse. It reminds me of the fiber optics craze of the dot com boom/bust - when bandwidth demand was perceived to be exponentially growing with no end in sight for the exploding internet.

Back to housing, the desire to own a home went up with rising prices/ez-money/no money down, and the desire to own a home is declining with falling prices/tighter lending standards/elimination of exotic loan products. Add in those that forcibly lost their homes due to foreclosure, and we get a dose of what is really going on out there. We were operating under the assumption that household formation was growing at 'X' pace (I believe 1.2-1.5 million homes annually for the US is normal under growth conditions), when that number was a fantasy number boosted by the euphoric boom. This is why when a market tops, it always goes down more than you think! Think back to the rise & fall of JDS Uniphase and Ciena in 2000 - 2002, for the fiber optics analogy - it was a doozy for those playing the game back then.

Slowing household formation is one lagging indicator showing the core of this crisis. The series of purchases that occurs with rising household formation, should ripple through the economic system; yet now we see the reverse effect. Using debt for consumption rather than for productive means has its disadvantages, and unfortunately the corrective phase is not anywhere near as fun as the debt driven party. The pain will run deep for those that mis-used debt and their home as an ever-lasting ATM machine, which is why I think the household deleveraging phase will last far longer than the financial sector one.

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Global Dyspepsia

It's time again to visit some of the garden spots on planet Dearth (yes I have taken the editorial freedom afforded me here at Urban Digs to rename our collective home more appropriately for the times). Let's check out how the world financial crisis is impacting our various friends abroad. This is important because the worse things are and the more terrified people become the more they direct their savings to buying our ridiculously under-priced long-term government debt (which we all know or heavily suspect we will never be able to pay back in dollars worth even remotely what they are today). So for now bad news for our neighbors is good news for our ability to fund bailouts as well as the egregious pork our government throws around in addition to the normal everyday expenses of running the country. When global savings begin to be rededicated by the countries who save to investing in their own lands, we just may end up with an interest rate problem or currency collapse, but those subjects as tantalizing as they may be are the subject for future posts. If your tired of listening to me air out other country's dirty laundry...click on.

We were all briefly reminded by Alan Greenspan's editorial in the Wall Street Journal a couple of days ago, that the housing bubble was global, not just local - and therefore there is no way the Maestro could have caused it. The fomer imperial Count Du Monet points to an IMF study which found that the housing bubble in the U.S. was only at the median of housing bubbles worldwide.

So how are world economies holding up under the strain of popping bubbles in housing, commodities, commercial real estate and U.S. consumption? Let's take a brief tour:

Russia:

According to the New York Tmes "Many of Russia's richest men were highly leveraged going into the financial crisis" Ahhh but how else could they make sure to capture their fair share of baubles, bling bling, Cristal and New York condos (or houses on the French Riviera, London pads et al?. The paper goes on to place the debt coming due this year for these Putin-pals at $128 billion. The sweet irony of it all being, that the Oligarchs, who gained control of their businesses through government privatizations, are now looking to the Kremlin for bailouts. The answer.... Nyet! The Czars ain't biting, as they have reportedly burned through a third of their FX reserves since August and can't be seen by foreign investors to be on the hook for corporate debts lest the ruble take another shellackering. Bloomberg reports that ,"Russia Not 'On Brink' of Moody's Cut on Steadying Ruble, Debt" I guess the cuts to their sovereign debt ratings by Fitch & S&P served to show them the light. With oil acting better the freefall in Russia is said to be over. "U-dA-chi!" (good luck).

Eastern Europe:

The former Soviet Republics of Eastern Europe are no better off, and they likewise owe most of their considerable debt to Western institutions. According to an Op Ed piece in the New York Times by Liaqat Ahamed, author of the highly topical "Lords of Finance - the Bankers Who Broke the World", countries including Bulgaria and Latvia borrowed the equivalent of more than 20% of GDP annually from 2004 to 2008. The 13 countries that were once part of of the Soviet Union collectively owed more than $1 Trillion (with "T") borrowed for investments and real estate (nothing about collectible Teddy bears was mentioned here at least). Apparently, exports have crashed for these countries and now Austrian and Italian banks are on the hook for the debt. No small potatoes for these countries either with the amount owed to Austrian institutions totting up to 70% of GDP (that'll leave a mark - pun intended).

The Financial Times recently published an article highlighting the unrest that has stemmed from the global financial crisis in many corners of Europe saying:

Economics is convulsing European politics. Governments have fallen in Iceland and Latvia; strikes or protests have erupted in Greece, Ireland, France, Germany, Britain, Lithuania, Ukraine and Bulgaria. Financial turmoil has shaken even the continent’s furthest-flung outposts: the French Caribbean island of Guadeloupe has been ravaged by violent strikes, while Russia flew riot police into ice-bound Vladivostok to quell street protests.

No wonder folks want to own a few greenbacks and Yankee bonds. Let's circumnavigate the globe now and check in on the far-east.

China:

According to Reuters the city of Wenzhou in eastern China, which is an export powerhouse is "seeing a recovery thanks to Beijing's stimulus measures and the capacity of privately owned local firms to address challenges". Some how I fail to see how internal stimulus aimed largely at infrastructure projects is helping an export oriented city. Have no fear however, the City's Communist Party Secretary avers "I'm sure that things will turn better in March as compared with the first two months, and in the second quarter as compared to the first quarter". About 24 hours later China reported its export numbers for February.........down 25.7% year-to-year, the biggest drop on record. The comrade Secretary must be getting PR lessons from New York City real estate brokers. According to Paul Cavey, an economist with Macquarie Securities in Hong Kong, "China has finally and spectacularly succumbed to the world financial crisis on the export side, and it's difficult to see why that would improve in the short term,"

The markets were disappointed recently when China did not announce a follow on stimulus to it's original $586 billion stimulus, indeed some are claiming that from the looks of it's budget published last week the stimulus may be much smaller than the headline number. Perhaps China is being smart in saving up ammunition for the long-haul. Without a rebound in American and European consumption the country will be hard pressed to maintain its growth regardless of how many railroads it builds. Others believe that the Chinese government is wary of over-stimulating the economy and producing mal-investment and bad loans as a result. Either way these guys may be smarter than I sometimes give them credit for. I still don't understand how any market, including Chinese fixed investment, can grow 30% per year, year after year, without producing lazy underwriting and bad loans. When this thing blows it's gonna be a doozy. But don't listen to me, Jim Cramer says "China is red hot and staying hot". As I got ready to release this China told a gathering of the G20 nations that it was ready to pump more money into its economy....I guess thats because of all the strength.

India:

Seldom has massive government bureaucracy been seen as a blessing, but in India it apparently has had the salutary effect of ensuring that the brain of the economy has not yet received the message from the body that the world is sinking into near-depression. According to Kranti Kumara writing on the World Socialist Web Site, "Especially troubling for the government was the recent report that India's economic growth slowed in the last three months of 2008 to an annualized rate of 5.3 percent. This was far below government forecasts and belied its claims, confidently repeated in the preceding weeks, that economic growth in India in the 2008-9 fiscal year, which ends March 31, will be in excess of 7 percent. Manufacturing output actually contracted by 0.2 percent in the last quarter of 2008, while agriculture, which continues to provide over half of India's population with its livelihood, suffered a 2.2 percent decline.

Overall growth in the first eight months of fiscal 2008-9 (April through December 2008) is reported to have been at an annualized rate of 6.9 percent. But there is every reason to believe that, following on from the last quarter, the pace of economic growth has continued to slow in the first three months of 2009. Thus the 2008-9 growth rate will fall far short not only of the government's early projections of well over 8 percent, but even the revised 7 percent figure.

Export earnings have fallen for five straight months. In January exports fell 16 percent from a year earlier to $12.3 billion and in February by 13 percent to $13 billion.

India's economic development strategy is predicated on the country registering an annual growth in exports of 20 percent or more. The government had set an export target of $200 billion for this year—less than one-sixth of the value of China's exports in 2007—but it is now expected that the figure will be around $170 billion. "

India's credit rating outlook was lowered last month as S&P said it might lower the nation's credit rating to junk status causing the Rupee to decline to a record low versus the dollar.

Brazil:

The government of Brazil, like so many others in emerging economies, continues to speak optimistically about economic trends. However, a recent jump in the inflation rate and decline of 3.6% in GDP for Q4 2008 belie this false hope. Interestingly, Brazil which is not known for free trade policies, is warning about the potential for an outbreak of protectionism. The slowdown in Brazil is demonstrating that being the world's biggest exporter of sugar, coffee, iron ore, beef and chicken, with a rapidly growing petroleum reserve base, cannot protect you from the global downturn, and of course protectionism would only make matters worse. Brazil just cut interest rates a larger than expected 150 basis points as inflation fighting has taken a back seat to stimulating the economy.

So Urban Digs readers please take solace in the fact that despite the maelstrom going on around you, the rest of the world suffers with you, some even have as far to fall as New York City and are in relatively commensurate denial. In the near-term the "safety" of the dollar and our own increased savings rate is helping keep our federal borrowing binge alive and the dollar buoyant...stay tuned.

From the Blogosphere:

China Businesses Turn to Pawn Shops as Loans Dry Up

Preview from Europe: the Horrow Show's Alive and Well

Testing Times for China's Economy

Financial Crisis Pushes Europe to the Brink of Disaster

India's Malnutrition Crisis

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More Industry Change: William B. May

A: Didn't I tell you the times they are a changin'? The Real Deal reports on the latest brokerage firm, William B. May, to provide all of the commission earned to the agent; a subscription based business model of sorts that lures brokers over by delivering greater earnings power with lower sales volume. Trust me, more change is coming!

Via The Real Deal:

Brokerage William B. May has changed its business model so brokers can receive 100 percent of their commissions. Charles Rutenberg Realty adopted a similar model in 2006, as reported by The Real Deal, in which brokers pay fees to the brokerage, but don't have to give up any of their commission. At William B. May, brokers will be required to pay a one-time $1,500 fee, and $500 per month, according to managing partner Craig Lamb. The brokers don't have to pay a fee per transaction, which sets this system apart from Charles Rutenberg Realty's commission model.

Lamb said he has been working on implementing this model for about two and a half years, and it comes just in time, as brokers are making fewer deals because of the recession.

"I don't really think brokers can afford to have the type of [commission] splits with the major houses anymore," Lamb said, adding that at most brokerages, brokers have to give up 25 to 50 percent of their commissions. "There is pressure on the marketplace in terms of people wanting to pay reduced commissions, and fewer people wanting to use brokers. And in this [economic] environment, it's very hard to justify giving [a chunk of your commission] up," he said.

Below is the list of services being offered to newbies:

It's not a bad idea given the bet that sales volume is unlikely to return to the parabolic 2007 levels. I certainly don't see that happening again for a long time. For those that don't know how crazy 2007 was in terms of volume, refer to the following 10 years of total sales volume provided by MillerSamuel.com:

Talk about 2007 being an outlier for sales volume with 13,430 transactions taking place at the height of the boom! I would not be surprised to see 2009 total volume come in under 7,500 when its ultimately released; being the lowest in 10 years. Switching to a monthly fee based model, at least promises the employing brokerage firm a clear and hopefully sustainable cash flow; something commission-only based firms don't have. Lower the overhead, offer virtual agent services, and collect your monthly fees. There will never be the upside though with this model, only more consistency assuming the firm is successful in procuring more agents willing to pay the fee.

Not the way I would do it, but you never know what changes/trends are seen/discovered to make one adjust a business model. I still think there is an open slot for a different type of brokerage model altogether, one that better suits the consumer (buyer + seller), not the agent. I'm yet to see that. For now, change has been focused on how to better service the agent, and get them over to your firm. In an industry where new agent signups may not fall as one would expect in a downturn, due to the likelihood of those losing jobs getting into real estate thinking they can make ez money for a while, that model may work for a bit. Time will tell. In the end, as time goes by and the correction ingrains deeper into this real estate crazed city, I think a totally new idea will emerge; one that provides more transparency and efficiency to the consumers. The question is, will it work and be used by the marketplace?

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Fair Housing Brings Change To Property Descriptions

It is the policy of the NYC Housing Authority to provide equal housing opportunities for all qualified applicants and residents.

In New York City, there should be no housing discrimination based on race, color, religion, national origin, sex, sexual orientation, age, familial status, marital status, partnership status, military status, disability, lawful occupation, lawful source of income, alienage or citizenship status, or on the grounds that a person is a victim of domestic violence, dating violence or stalking. These laws are extremely important & I have been able to fall back on them many times over the years when working with owners. For example, an owner once told me that she didn't want me to rent her apartment to any Koreans. She said that she, herself, was Korean, so what she was doing wasn't illegal! She "loves the Korean people" but didn't want any of them living in her apartment. I was shocked! I thought that kind of stuff only happened in bad Lifetime movies, not in real life! But I digress...

Despite at least two or three hours of Fair Housing Training that NYC brokers must take each year, evidently some members of the brokerage community have not figured out that saying "Family Friendly" in a property description is ILLEGAL.

We learned in Fair Housing that by saying "Family-Friendly," we are discriminating - for example, we may accidentally be discriminating against a single person who happens to want a huge apartment in a building with a playroom. So any mention of "child," "children," or "family-sized apartments" are violations of Fair Housing Law.

We also can not list school districts in property descriptions. Customers need to check www.nyc.gov for more information.

Likewise, saying "Fabulous Bachelor/Bachelorette Pad" is illegal. What if a family of four wanted to live in an open loft with outdoor space, a wet bar and a hot tub?

Today we received a new list of over 200 banned words, sayings and descriptions that can no longer go into any property ads. Most of them were self explanatory...
But there were some things in the list that caught me off guard. We can't say "No Students," "Board approval required," "Shares," "Walking distance," or "Working."

This creates some frustration. I have had several listings in co-op buildings that don't allow students. You must be a working professional to live in the building. They want the person living in the apartment to be able to afford the apartment on their own. No co-signers or guarantors are allowed. "Board approval is required." Now I will field an extra 50 phone calls from people who don't qualify for the building. Even though my description says "no guarantors or co-signers," students who have their own money call anyway, thinking that they can just hand over a lump sum of money to avoid the guarantor / co-signer rule. Not in this building, sorry to waste your time!

Additionally, there are many buildings and private owners that don't allow "shares" - two unrelated people to live in the same apartment. So no more advertising tiny fifth floor walk up one bedrooms with a wall up in the living room to create a 2nd bedroom as "perfect for shares." Too bad I can't just say "perfect for two people who want to be room-mates" - "people" is on the list also (as are "couples.")

Then there becomes "walking distance," which we can no longer use. By saying "walking distance," I would be discriminating against those who are unable to walk. Hopefully I can still use "close proximity" to public transportation.

The buzzword that really made me crazy, though was "No Smokers". Since when did smokers become a protected class according to fair housing rules?

In case you're wondering some other words we can't use:

"Nanny's Room" (implies children)
"quiet tenants"
"quiet neighborhood"
"secure"

Now more than ever there is more pressure on the apartment seeker to really read between the lines.

You'd be surprised how many buyers and renters ask "what is the ethnic makeup of the building?" My response: "there's a great mix of studios, one bedrooms, two bedrooms and combination of larger units in this building, so you a great cross-section of the population." When pressed by customers who are annoyed that I dodged their question, I encourage them to walk around the block and neighborhood, sit in the lobby or wait by the subway if they want to get a feel for the area.

Thank you for not asking me whether the neighborhood is "safe." My response will be for you to please "visit www.nyc.gov" where you can view the local precinct's crime statistics.

Fair Housing Laws are extremely, extremely necessary, but at times I wonder if maybe the pendulum has swung a bit too far?

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Tentacles of The Credit Beast III

This financial crisis has been like an AIDs virus attacking the machinery that usually protects the system. That machinery is the creation of credit. It is being attacked the way acquired immune deficiency syndrome attacks the body's defenses by using the immune system itself to hide and multiply. When you think further about the analogy, one is an amazing piece of viral evolution and the other is an amazing piece of market evolution. Both lay bare weaknesses in the systems they have infected. The former crisis was only forestalled by instituting safer practices and the same will be the case for this one. Let's hope the patient can survive long enough for the safe practices to be instituted. One wrinkle with the financial crisis is that safe practices when instituted all at the same time can make the crisis worse rather than better.

To wit, in this morning's Wall Street Journal, Meredith Whitney, of Oppenheimer banking analysis fame, and now proprietor of an eponymous consulting firm, writes that credit card debt is the next credit crunch. You can find the gist of her piece here. Whitney's contention is that credit card companies are pulling back from lending all at once and are in fact threatening the availability of consumer credit even to those who deserve it. The credit card companies have found that their tried and true FICO scores failed them, when highly rated borrowers got underwater on their mortgages. They are therefore now limiting credit in hard hit zip codes. Whitney's contention is that revolving credit is used as a cash flow management tool, citing the statistic that 90% of credit-card users revolve a balance at least once a year and over 45% of credit card users revolve every month (I am amazed that the second number is that high). I would argue that for 45% it's not a cash flow management tool, but rather a way of maintaining higher consumption through a larger balance sheet for some period of time. As I have discussed previously on Urban Digs in my piece Regulator Revenge: There's a New Sheriff in Town, after the crimes have all been committed regulators wake up and put strong deterrents in place, that usually cause the collapse of the bubble which incited the fraudulent activity to be even worse. The same apparently goes for unfair lending, where according to Whitney, new provisions of the Unfair and Deceptive Acts or Practices (UDAP) regulations, which would restrict credit card providers ability to raise rates on customers, will likely result in no credit being offered at all.

Whitney makes a good point here about not having the medicine kill the patient. In keeping with this, up and down the economy we have seen officials tread lightly on things like allowing banks to stay open, despite severe losses, as they recognize that causing a panic on top of a crisis is self-defeating. However, moral hazards seem to be running very high and my personal feeling is that tacitly saying to 45% of the population that it's okay to carry revolving debt all year long, is a bad practice. Furthermore we need to all recognize that this unsustainable behavior, won't be sustained long-term no matter how many dollars are printed by Uncle Sam. The Deleveraging Will Be Televised. What do Urban Dig's readers think? It will be a delicate balance to not choke off the economy, by limiting credit, while trying to reform the unsustainable practices that got us here. Going back to 2006 ain't gonna happen, neither should it.

We need a lot more transparency in order to understand how to carry out the delicate work of fixing what is broken, without making matters worse. We still don't seem to be getting it. The Federal Home Loan Bank of Seattle has apparently failed to meet certain regulatory capital ratios at month's end due to writedowns on mortgage backed securities (MBS). I have highlited the risks to the Federal Home Loan Banking system before, but it does not seem like any significant steps are going to be taken by regulators at the present time. Interestingly, the Seattle Home Loan Bank took a $304.2 million write-down on the MBS paper, but said it only expects to have an actual loss of $12 million over the life of the loans. Yet the accounting language trigger for the write-down is if the drop in value is deemed "other than temporary". Come on guys let's get it straight, this paper is either going to go bad or it's not, pick one and conduct yourselves accordingly. This needs to happen up and down the system and hopefully the banking stress tests will give the markets some confidence here. Although I'm not sure I want to wager on that with how it has been handled to date.

Apparently however, another over-leveraged and likely under-regulated part of the system is coming under increased pressure as the tide of leverage goes out. There is no turning this tide, people are not dumb and if they didn't know before, they know now that they shouldn't depend on their bonuses to maintain their basic standard of living, that they shouldn't carry outrageous revolving debt to boost their living standard and speculation on housing prices is an easy way to go bankrupt. The economy must and will shrink to meet this lower level of leverage and activity. Only from that new equilibrium level can we move forward. In the meantime, I agree that the government must keep the patient on life support, but let's not encourage any new risky behavior.

For New York city residential real estate, the question is: Despite working in the notoriously cyclical business that is Wall Street and being ingrained in risk management culture, how many of our brethren engaged in the risky behaviors cited above? If many did, the risk to all will be greater. What are your thoughts?

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Understanding 'Liquidity', or Lack Thereof For Manhattan

A: Everyone wants to know what is going on with Manhattan residential real estate, as if it changes daily. As if it is a liquid market. For the past 7 months it has been anything but liquid, but it does seem like prices have been changing daily. What is liquidity and how should we define it for real estate purposes? Is it simply how easily the asset could be converted to cash, or something deeper? I would argue that in terms of real estate transactions, the most liquidity could possibly mean is for the asset to be easily 'sellable' AND near a value that the seller deems reasonable considering market conditions and transaction fees - a somewhat tight bid-ask spread. That would describe a liquid RE marketplace, and does not interfere with the fact that the property is only worth what a buyer will pay. If one of these things don't fall into place for whatever reason, well then, the market becomes more illiquid. It would be wise to think about the market as such if you are a seller. It may even save you valuable 'denial' time that is usually wasted because the seller is unrealistic about the current market value of the asset. Do sellers truly understand the importance of liquidity or lack thereof, when the asset likely comprising the biggest portion of their net worth is at stake? Do they understand why the 'bids' are where they are? Do they see where their 'ask' is? Do they even know where the market is right now, and whether it is liquid or not? Chances are they don't and that is why this market will remain illiquid for the foreseeable future.

Let the proctologists pick bottoms (not the brokers or brokerage executives w/ vested interest in sales volume), for now, I'll focus on how this credit crisis ultimately affects our local housing market. In my humble opinion, despite the countertrend pickup in activity lately, the market is still for the most part illiquid. But its the definition of illiquid that may be in question here. Sure there may be OH traffic, private showings and low ball bids, but does that make this market more liquid?

I would argue that in regards to real estate here in Manhattan, liquidity is a sell side phenomenon, not a buy side one. The most liquid this market can be is if the property is:

A) easily sellable - meaning bids are being received for the asset, PLUS
B) near a value that the seller deems reasonable considering market conditions and transaction fees - ahhh, the important part and the emotional aspect of the process of selling. Let us not forget that a property is worth only what a buyer is willing & able pay for it, but its the seller that makes the call whether or not to ACCEPT/HIT THAT BID!

Right now the market seems illiquid because the bid-ask spread is too wide creating a disconnect; meaning that either sellers are still in denial about the price drop of their asset (current market value) OR buyers are too cautious to bid more aggressively for the asset. For me, I follow the buyers because in my opinion, they make the market. AngryBear goes into detail about this:

2) Liquidity - A property of an asset which indicates that it can be converted into money quickly and with low transaction costs.

This implies that if an asset is illiquid a rational person would not be willing to buy it intending to sell it again in the near future. People selling things are very unhappy when their market price has suddenly fallen. What if I can sell my asset right now, but I am extremely displeased by the price I am offered ? Is it less liquid ? Certainly not according to definition 2. Certainly according to people who say that the problem with financial markets is a loss of liquidity. This gives third definition:

3) Liquidity - the property of a price being as high as sellers think it should be.

Since Manhattan is illiquid right now, for a number of reasons remove all those speculators and short term buyers that look at purchasing and selling for a quick profit. That train left the station a year ago.

This is really a high end recession in the Manhattan real estate market, that is rippling through to the lower price points. That is the best I can describe it. If I were to divide Manhattan into a few categories and where deals seem to be happening now, it would be something like:

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

Notice the structure of the ranges and all just my gut feeling of course on where I think trades are occurring right now. This is what happens when Manhattan gets illiquid and we start to see where sellers are hitting bids at - the range has to be wider at the top. It doesn't mean every seller will hit a bid down around those levels, because that seller may not be ready to accept the current market valuation of their property.

You should get the idea of how an illiquid market in a city like Manhattan is impacted when the core of the crisis is on wall street and the high end. If you have to sell a high end property, strong bids are not easy to come by. The studio markets seem least affected as of right now, but not immune by any means to a higher percentage discount. In the end, level of desperation of seller and willingness to acknowledge current market valuations of their property plays the most crucial role in the painful process of acceptance.

I am hearing stories of some high end properties hitting the bid at levels 40% or so below peak. But don't take my word for it, the NY Times wrote a story about it:

After he signed the contract for 823 Park, Mr. Singh listed his prior home, a full-floor 4,225-square-foot co-op on the fifth floor of 860 Park Avenue, at 77th, for $13.4 million.

Prices were moving higher in spring 2007, and Mr. Singh, brokers say, rebuffed offers of more than $12 million for his place at 860 Park. But as the market deteriorated he repeatedly cut the price, first to $12.75 million, in February 2008, then to $11.95 million in March, and $10.995 million in April. Finally, in October, after hiring Carrie Chiang of the Corcoran Group, he lowered it to $9.5 million.

Property records show that the 860 Park unit closed on Feb. 23 for $7 million, a bit more than half of the original price, and 42 percent below the $12 million that Mr. Singh reportedly turned down.

Now maybe that original $12M bid wasn't real, maybe it would never have produced a signed contract, and maybe it would never had closed in spring of 2007, but one thing is for sure ---> the Manhattan peak was exactly at that time, ranging from contracts signed between early 2007 up until fall 2007. Mr. Singh eventually 'hit-the-bid' of $7M when his asking price was $9.5M.

You never know how much your property is worth until you list it on the open market and procure a bid that produces a signed contract, and ultimately is able to close. Which means, your property is only worth what someone is both willing & able to buy it for at any given point in time. Your property is NOT worth what your broker insists it is, what past comps claim it should be, or what the owner expects it to trade for. Those dynamics are meaningless to me. The market will do what the market wants to do, and pressuring a buyer to up a bid in this environment is proving to be a very difficult task that has more risks than rewards. In the end, a buyer will bid what they want to bid, and too-pushy brokers will scare away the rabbit. If anything, your seller should know where the market is valuing the property; and if that bid is in the above stated range, I would seriously consider taking it because that is where the market seems to be right now regardless of where you think it is. Adjust your asking price to BELOW that level and you will probably realize that the market is significantly more liquid than it was at the higher price. What does that tell you?

This market is a fast moving animal right now, and you never know how a prospective buyer will value any given property, any given view, any given exposure, any given renovation, any given layout, any given building amenity, or and given amount of raw usable space. The usual valuation formulas (getting $1.50 back for every $1 of renovation you do, getting $15K per floor premium, etc.) simply do not apply in illiquid markets.

With equity prices down about 55% from peak, more and more buyers are becoming alienated from this marketplace (probably because nobody likes to buy a depreciating asset - a great discussion from late 2007 on the warning signs to our local marketplace) because of the correlation between this local housing market and wall street. Is there a correlation? Yes there is a level of relation, but it is more of a wealth effect and psychological one then anything else. I doubt there are studies proving that if stocks rally 30%, real estate will follow soon after and vice-versa. If anything, there is more of a correlation on the downside than upside because its hard to argue the negative wealth effect of a plunging equity market's effect on people's perception of net worth, confidence, and how much property they may or may not be able to afford.

Almost every broker out there discussed the 'sideline buyer' theory up until the tipping point here in Manhattan to support rising prices and floors. Well, its time to put that theory to rest already! It doesn't exist! There are always buyers waiting on the sideline, but to design a theory to support a bottom for a local housing marketplace because buyers will rush in if we fall 10%, is outright stupid and a product of a car salesman desperate to defend a rising market. The opposite is true and even though you can pick up a deal today at 20%-25% discount from peak, and perhaps more, it's clear buyers are NOT rushing back in.

Want some insight into what buyers are actually thinking? Check out this Streeteasy.com discussion thread titled, "Sideline Buyers - How Have Your Circumstances Changed?", where commenter Faustus discusses a personal situation and how he/she feels now about buying in this market:

I'm one of these sideline buyers that real estate brokers, owners and sellers are hoping will save the day. Doesn't it make sense to check in with me and other sideline buyers to see how our circumstances have changed?

I'll start:

i. My net worth. Since the market hit its peak, of course my net worth is down substantially. Down approximately 18% as of today from the peak in 07, which is actually relatively good but nonetheless pours a bucket of icewater on any burning desire to buy a piece of Manhattan.
ii. My job circumstances. Still employed, but highly uncertain as to both longevity and comp levels.
iii. My commitment to NYC. Related to (ii) of course, but I love NYC and would like to stick around (though it's not an absolute).
iv. My general outlook for NYC and the local real estate market. Bloody, grim and worsening. I fail to see what the catalyst will be to bring it back.

There are plenty more on that thread spilling their guts on how they are thinking. Interpret at your own risk, as anything can be made up, but still it is in-line with what one would expect given the unfolding events of this credit crisis.

Lets just keep it real and acknowledge what is going on out there. Lets not make excuses or poor arguments for bottoms & recoveries when the buyers are in total control and the market remains for the most part, illiquid for mostly sell side reasoning and buy side caution. You want a more liquid marketplace? Get those ASKs closer to the BIDS!

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Bring on the Auction Hammer

A: The NY Times discusses a batch of new development units that are going to be auctioned off in April. The meat of the article suggests that bidding will start some 40% - 45% below peak asking prices in the 1Q of 2008. I think its fair to say that PEAK in Manhattan was contracts signed anytime between 1Q of 2007 and 3Q of 2007, closing thereafter. I used contracts signed as an indication of where peak was, even though the transaction didn't close for months or in some cases, years later. The reason is that psychology started to shift around 4Q of 2007, as the credit crisis evolved from early 2007 statements by HSBC and the failure of two Bear Stearns hedge funds in mid 2007. From bidding wars, weak dollars & foreign demand to new development auctions, Manhattan has come a long way in a very short period of time! I discussed the potential problems of 'New Dev Closings', way back in October, 2007, and here we are today.

From the NY Times, "And Do I Hear $2 Million? No? $1 Million? Sold!":

Real estate auctions, rarely used in New York, have the potential to both move property and indicate to reluctant buyers what the true market prices are. Given the current sales drought, even a handful of auctions could reset prices for new condominiums citywide, said Jonathan J. Miller, the president of Miller Samuel, a Manhattan research and appraisal company. He said he expects the auctioned properties to sell for 40 to 45 percent below the asking prices of the first quarter of 2008, when the market peaked.

Accelerated Marketing Partners, a real estate marketing firm, is discussing auctions that will start as early as April on five mid-range to high-end projects in desirable neighborhoods of Manhattan and Brooklyn. “We’re in a deflationary, devaluating market in which no one knows the value of anything anymore,” said Jon Gollinger, the co-founder and chief executive of the firm, based in Boston.

In the auctions run by Accelerated, only a portion of a building’s unsold units are sold in one swoop, to avoid depressing values more than necessary. The remainder are marketed the traditional way, at the new, lower auction prices.

“The general impression I get is that this period of denial — the market-will-get-better mentality — is coming to a close,” said Mr. Miller, the appraiser, who will likely be working with Accelerated to determine the market value of units put up for auction.

Some great statements in this piece that accurately describe the deflationary forces and the effect it has on buy side psychology as this cycle plays out.

"Deflationary, devaluating market" - Yes. No matter what way you slice it, asset prices are coming down as the core engine that drove prices higher (ez credit, healthy securitization market/model, highly leveraged bank balance sheets, cheap money, positive wealth effect, high paying jobs / bonuses, etc.), is drastically changed. Some people still don't 'get it'. You really can't help these people, and they will continue to believe what they want to believe. If you believe the banks are solvent and well capitalized, well, then you probably also believed the chairman of Bear Stearns comments two business days before his firm was forced into a fed sponsored rescue with JP Morgan.

The deflationary process is exactly that, a process. It will continue. The household side has not fully deleveraged, and the hit to the local economy is in its early stages. You may have started to notice a helluva lot more empty retail spaces available in Manhattan; so either you view this as a great time to start a new business or you view it as a symptom of a severe economic slowdown.

"The general impression I get is that this period of denial — the market-will-get-better mentality — is coming to a close," - Yes. It is. Denial marks the early phase of the asset cycle where the seller of the asset is anchored to peak pricing. Afterall, it is their home, and their home cant decline in value! This is enhanced when multiple brokers fight for the listing, and promise to deliver a peak level transaction because of their amazing marketing services that allows their sellers to bypass the deterioration in buy side confidence.

The denial phase is still in play, but not nearly at levels it was 4-6 months ago. Sellers are starting to get it, but not en masse. We declined very sharply, in a short period of time, and we seem to hit a comfort zone; for now. I advise all sellers to get their property sold by May! Once we hit the slow days of summer again, traffic will be significantly lighter than it is now and reducing your asking price to re-stimulate demand will be your best option to get bids. Even still, you don't want to be forced to hit a bid when the market is very slow and illiquid, like it was in the 4th quarter!

"The remainder are marketed the traditional way, at the new, lower auction prices" - Hallelujah! So you are saying, the developer will auction off the first batch to see where the market values the properties and then price the remaining units at or near that level of price discovery?

BRILLIANT! Just like those Guinness commercial guys! The market will determine the value of these products, NOT the broker or the sales office! Re-pricing your inventory to where the market values them, is the first step out of denial and on the road to moving inventory! Sure, it won't be pretty, but nobody said deleveraging and deflation was the American way.

The new level of price discovery will set the benchmark for future valuations placed by buyers. Yes, I recall reading that somewhere on UrbanDigs by that Noah guy! Until then, there will be deals done at every price, and the process will play out in stages - not in one full swoop.

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Bad Loans - Going to Extremes

"Darling I don't know why I go to extremes
Too high or too low, there ain't no in-betweens" Billy Joel 1990

Yes folks, we are back to early 1990s levels on bank loan delinquencies and charge-offs. This according to the latest Federal Reserve Board data just out. I'll be referring to a bunch of charts in this piece, but I am going to make most of them pop-ups, because large charts eat up so much space. For illustrative purposes I am featuring the chart below of delinquencies as a percentage of all loans.

As you can see, with latest surge of delinquent loans from 3.67% of all loans in Q3 2008 to 4.84% of all loans in Q4, delinquencies are now firmly back in late 1980s S&L crisis territory. Surprised? At this point neither am I. But remember when people were saying that mark to market was grossly distorting what eventual losses would be like, etc. Recall that these delinquencies are not market trading related; these are loans where the borrower has gone delinquent and is no longer making payments to the bank. This is a true indication of the trend of loans going sour and it's ugly - real banking crisis ugly. All loan charges also surged in the quarter, rising 55 basis points from Q3 2008 to 2.01%. As you can see (View image), charge-offs have moved up even more rapidly than they did in the early 1990s, at higher rates of delinquency. This signals that banks are actually being more aggressive in reducing the values at which they are carrying these loans and hopefully portends a greater velocity of dealing with these problem assets than in the prior crisis.

The difference between the banking crisis of the early 90s and this one is that commercial real estate delinquencies were much worse and really drove the banking crisis. Don't get me wrong, the residential downturn was bad and killed a bunch of S&Ls, but it happened on a rolling basis, moving from geography to geography over a period of several years. Once the system was weakened in this way, the recession of 1990 sparked a collapse of commercial real estate, which is what really put the large banks and insurance companies on their backs. As you can see from the following graph, residential loan delinquencies are literally off the charts (View image). After surging 100 basis points from Q2 2008 to Q3 2008, residential delinquencies tacked on an additional 181 basis points in Q4 2008. This is a runaway freight train and if it isn't stopped, I really fear for the consequences. Residential charge-offs are just absurd, but at least banks are writing these loans off and presumably liquidating them with abandon (View image).

I don't like to be wrong, but I freely admit when I am. When I first started monitoring these data over a year ago, I couldn't imagine the commercial real estate market getting anywhere near as bad as it was in the early 1990s, because we didn't have the tax-driven over-building that took place in the late 80s. I was wrong. As I work with building owners and developers who are trying to de-lever their portfolios and I see the intimate details of how aggressively commercial real estate was financed and underwritten, I understand why we are experiencing such a painful commercial real estate downturn. I also have a theory about why we are seeing a surge in commercial real estate charge-offs (View image) to early 1990s levels, despite a slower trajectory of delinquencies.

I believe that the initial commercial loan charge-offs are largely tied to new construction projects, particularly residential condominium projects and land loans (I know, tell me something I don't already know Jeff). As I noted in my piece Zombie Condos II - Day of the Charge-Off, when condo construction loans go bad, the severity of the losses can be incredible. So as we begin to see interest reserves on construction loans from the tail end of the bubble roll-off and these loans roll from delinquency to default, we will see a surge in charge-offs. The surge may start to dissipate in the next 6 months. At that point new delinquencies will more likely be from loans on "stabilized" investment properties, where owners paid too much for the property, experienced increased vacancies (particularly in retail, office and industrial) and don't have deep enough pockets to make their loan payments. While values for these loans will be haircut when they are charged off, my guess is the process will be much less severe depending on the market....malls in suburbs full of empty foreclosed homes could still experience pretty ugly writedowns, for example. This is in no way meant to minimize the trend in delinquencies, which is pretty ugly. Commercial real estate delinquencies surged 91 basis points to 5.42%, nearly doubling their rate of ascent from Q2 to Q3, but they are still well below the 10-12% levels seen at the peak of the early 1990s cycle.

Noah and I both get accused of painting dark pictures on Urban Digs for some really weird reasons, like we are talking down the markets so we can profit by it - I wish I had about $100 million to spend buying buildings in NYC over the next 18 months - but unfortunately, I haven't raised it....yet....donors are welcome.... see me after class. Contrary to the doomsayer characterization, I have been an unabashed optimist regarding credit card losses this cycle because of all the warning that card companies had about a coming economic contraction. They saw the residential real estate market topping out in 2005/2006 and consequently tightened up their lending practices. For this reason, I expected the credit card companies to experience less horrific losses this cycle than many have been expecting. I have noted in the past that I also believed that the dysfunction of the securitization market was a much bigger problem for the credit card companies than credit losses. From the data we are seeing now, I have to admit that credit card delinquencies are about as bad as they have ever been (View image), I would note, however, that the credit card business was a much more conservative one in 1990 than it is today. On a relative basis I think these guys are actually hanging in there okay. The charge-off data only go back to 1995. As of today, we have not breached the prior highs seen post 9/11 (View image).

In summary, residential delinquencies are driving the banking system into the grave and we saw an acceleration of this problem in Q4. I prefer to look at non-seasonally adjusted data, and perhaps, there was some acceleration in charge-offs to "clean up" the books, but there is no putting a positive spin on this; it's an unmitigated disaster. Commercial losses are surging, but are still nowhere near the early 90s levels. However, I expect the next 6-9 months to bring the maximum pain levels here, and the severity of losses will be ugly. This may moderate some by year-end. Lastly, I'm not crying for the credit card companies; they are doing relatively okay and continue to agressively pull back on lending, (check this article on American Express customer buyouts,) which will reduce their ultimate losses.

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Bonuses vs. Prices: Correlation or Causation

This graph of Wall Street Bonuses vs. Manhattan Apartment Prices was done by Matthew Kelley, a bank stock analyst at Sterne Agee, which is a brokerage firm that has a strong focus on analyzing banks and financial services firms as well as a couple of other industry groups. The data on bonuses comes from the New York Comptroller's office and Manhattan apartment price data comes from Miller Samuel. I wish I had thought of doing this analysis myself. The chart is a beaut. Matt lags the Wall Street bonus data by a year to reflect when the funds actually get paid out. The implications here are both intuitive and a bit scary, which taken together likely describes the nature of this high end recession. Here is another previous discussion on why 2009 bonuses will hurt more.

Thanks Matt!

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Manhattan's Correction Now Front Page Media

A: Just like they did to support and enhance the upside, with articles focused on the weak dollar, a surge in foreign investment, tight supply, and bidding wars, the media is now putting the Manhattan adjustment on its front page. The latest is Barron's Cover, 'Manhattan On Sale', covering the high end recession discussed right here on UrbanDigs almost a year ago.

Don't say I didn't warn you about the coming impact of the media! The media plays a role both in booming markets and in busting ones. The only problem is that when a market rolls over, the uneducated start blaming the media for causing the downturn!

In booming markets, the media enhances the validity of the up move and argues why it will last for much longer; fooling many into buying at or near the peak. In falling markets, the media enhances the deterioration and tends to depress buy side confidence; causing what sellers/brokers claim to be an adverse feedback loop. Any broker that argues the downturn is the result of negative media, simply doesn't understand the macro forces at work here. Besides, if media enhances the boom side of the asset cycle, of course it should be expected to affect the bust side as well! And it does.

I tried to warn my readers about this in my 'Preparing For Price Reports w/out New Devs' piece way back in July, 2008:

Price data is lagging and misleading, and just as it mislead on the upside and brought unwarranted happiness to many homeowners out there, it will also bring unwarranted depression and media headlines!

According to Barron's Cover Story titled, "Manhattan On Sale":

First came Miami, Las Vegas and Phoenix. Now Manhattan's high-end housing market is cratering. With Wall Street firms stepping up layoffs, and money for big-ticket mortgages drying up quickly, prices for new york apartments and townhouses of $5 million or more have been falling and may well drop by another 30% before finally bottoming out. That could help turn the Big Apple into the ugliest housing market in America.

Streeteasy.com, a Website that pulls together listings and insights from a variety of brokers and buyers, now shows 795 New York apartments offered for $5 million or more, up from 518 a year ago.

Realty brokers, the industry's natural cheerleaders, are now unabashedly glum about the high-end market. "The $5 million-and-above market is inventory-rich and buyer-poor," says Dolly Lenz, a broker to the stars and vice chairman at Prudential Douglas Elliman.

One of the thorniest issues for the New York market is mortgage availability. Though high-end buyers historically have paid mostly or entirely in cash, more now need to borrow -- just when large mortgages have all but vanished.

I would have been more impressed with Dolly Lenz if she was on record for predicting this downturn a year ago. But I guess that is not good business for one of the best producers, in a sales based industry. And here is stupid me, spilling my guts on UrbanDigs trying to tell it like it is! I digress.

I'm sure we will hear calls for bottoms & recoveries from all the top brokers and firm executives, who never saw this downturn coming to begin with; or at least, who publicly wouldn't acknowledge it to begin with. This industry is a changing, you can count on that. Today we get news that BrownHarrisStevens is acquiring Edward Lee Cave boutique realty, via The NY Times:

"I would assume that almost every firm has a negative cash flow," said Hall F. Willkie, the president of Brown Harris Stevens. While the number of closings filed each week is still plummeting, he said that the pace of new deal making had picked up a bit in January and February.

For consumers, this changing landscape could create some nervousness, but the best brokers, those with the strongest deal-making skills and deepest knowledge of the market, will no doubt continue to thrive and offer useful advice throughout the downturn.

That's quite a statement from Mr. Willkie, president of BrownHarrisStevens. I tend to agree that most brick & mortar based realty firms are being squeezed, from the drop of sales volume and prices that started with the collapse of Lehman Brothers last September. And I would also agree that the most established and seasoned agents will gobble up what's left of sales volume amongst themselves, making it especially hard on new agents that are yet to learn the ropes of this industry and build a solid referral base.

Expect more innovation as time goes on, more transparency, virtual realty firms, new models, new buy side / sell side services, etc.. as this market continues its adjustment. It is virtually impossible to get away with broker spin and dirty real estate sales tricks to convince buyers to pay peak prices; without making the broker look like an idiot. Those with the deepest connections, networks, referral base, consulting expertise, sales savvy, and vision will succeed. The rest of the brokers will have to adjust to a new, slower world where more work is needed to make less money. Nobody likes slow markets, especially in a commission based sales industry like this one; but the future can be exciting if you envision it that way!

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Citi ATM Fees Can Buy You 1.6 Common Shares

A: Hat Tip to Johnny for pointing out. Quite a statistic huh? With Citibank charging $3 for ATM fees at their E 86th / Lexington branch, I could have purchase 1.6 shares of the glamorous Citigroup common stock instead - although I think the end result would be the same. Quite telling isn't it. Citigroup common stock is trading as if the company will be nationalized, and is basically a call option right now. At $1.90/share, the fee they charged me to take my money out of their amazing, technically superior ATM machine, could have been spent purchasing 1.6 shares of the common stock!

Just do it already! The market knows it already. Do it while its almost fully priced in, lets open up limit down on Monday, take the global selloff medicine, get it past us, and move on! Don't do it half-way! Destroy the common and preferred, and give a haircut to bondholders. Get rid of management, selloff/writedown bad assets, restructure, and lets move on! Hurt those who took risks on their investments.

Barry Ritholtz has a LIST showing those in favor of nationalization.

The problem is I'm not sure you can just do one, without dragging down the remaining 3 big boys (Bank of America, Wells, and JP Morgan). So, what makes this so complicated is what do they do with all four and the consequences of a credit event on CDS counterparties exposed to those holding insurance on these guys. How will market react? Will it destroy the system or be a Black Monday that we can recover from? Will it cause runs on other banks?

I feel like we are all waiting for this to just happen already!

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How IN is Gold, huh?

A: You gotta love it. Gold is clearly outperforming all other asset classes at a time when deflation is becoming a household name. It seems to be the only trade that doesn't have that 'big worry' or liability attached to it. The only other asset class I can think of that is even close is US Treasuries, and even that trade has its valid bear arguments. The only word on the street that I am hearing to bring down the gold trade, is that it's getting 'crowded'; a trading term based on too many players holding/buying the asset raising the concern that a 'rush for the exits' sell order may be looming. My deep down opinion is that gold is performing how it should, at a time when general confidence in fiat currency is declining. In my humble opinion, the gold trade is not a hyper-inflation trade right now, but more of a lack of faith in paper money/fiat currency trade that ultimately could test its inflation adjusted high. Those in it now for the inflation hedge, are along for the ride as the world united battles deflationary forces. Lets discuss.

For those new to UrbanDigs, this may sound like I'm only now jumping on the gold bandwagon. So, before you read this please consider that I have publicly stated how 'I am very bullish on gold' in my 2008 predictions written DEC 2007, 'loved gold' in my JAN 2008 discussion on fed policy/ratings downgrades, and that I expected 'precious metals to outperform' in my 2009 predictions written DEC 2008. This streeteasy discussion forum has some tasty arguments supporting the gold trade as well.

Right now, this is a global debasement of fiat currency trade, way more than it is an inflation trade; as gold is being viewed as money without the debasement of government interference. Below is a chart of the nominal and inflation adjusted (in SEPT 2007 dollars) price of gold since 1913; courtesy of InflationData.com:

For the next few years while global fiat currencies are systematically debased, via central bank printing to counteract local slowdowns, the future whiplash-inflation trade (maybe 2012-2013) will be slowly building as the Kondratieff Winter plays out. It seems logical that the gold trade is a multi-year trade; if it doesn't get parabolic too early.

THE CORE OF THE GOLD TRADE LIES IN THE DEBASEMENT OF ALL FIAT CURRENCIES TO COUNTERACT THE GREATEST WAVE OF CREDIT DEFLATION SEEN SINCE THE GREAT DEPRESSION

That's how I think. That's how sick I am. Somebody heeeeeelp meeee!

Look at how gold has performed in other currencies, if you question this statement. One big fear I have right now, which happens to fit as a texas hedge with my gold trade, is a sharp selloff in some bond market, in some country, somewhere, at some point down the road. Its a very possible event that could spark a global equity selloff that ultimately earns a color to depict the day it happens on! This is part of the gold trade.

Our fed, and I'm sure ultimately other central banks, have a period of quantitative easing ahead of them - pure money printing. They are purchasing agency debt now right, $115Bln so far, and may have to fill the void and buy longer term treasuries down the road, should our friendly foreign funders decide to lay low, and focus on their own slowdowns for while.

Ray Dalio, chief investment officer of Bridgewater Associates, discussed this in a recent Barron's interview that is a very worthwhile read:

"The Federal Reserve is going to have to print money. The deficits will be greater than the savings. So you will see the Federal Reserve buy long-term Treasury bonds, as it did in the Great Depression. We are in a position where that will eventually create a problem for currencies and drive assets to gold.

You print a lot of money, and then you have currency devaluation. The currency devaluation happens before bonds fall. Not much in the way of inflation is produced, because what you are doing actually is negating deflation. So the first wave of currency devaluation will be very much like England in 1992, with its currency re-alignment, or the United States during the Great Depression, when they printed money and devalued the dollar a lot."

I've discussed the process in which the fed 'prints money' by purchasing assets from primary dealers in exchange for electronic credits - virtual money printing. If your into this stuff, you also may want to read about the Mandrake Mechanism, our fractional reserve banking system, and how our money is multiplied.

Keep your eyes on foreign purchases of US Treasury bonds, as well as purchases internally by the fed. If outside demand wanes, for whatever reason, the fed will be forced to pick up the slack and that is very dollar negative. As Mr. Dalio states so clearly, it will 'drive assets to gold'.

There is no quick solution to the process of debt deflation. It has to just play out. Bad debts need to default and be written down. Leverage needs to come in. Business models tied directly to the old system of credit, need to be completely restructured. Bad models must die out and declare bankruptcy. Consumers need to delever and repair their balance sheets by increased saving and lowering debt load. This has to happen. Purge the excess. And when its done, most of us will be dizzy and wobbly from the multi-year pounding given to us by....in the right corner, and still reigning champion of the world,...De - "Upper Cut" - Flation.................!

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You Worry About ARM Resets, I'm Worried About Recasts!

A: For a while now, most of the credit indicators that traders like myself use to determine the level of stress in the lending world, have come in. A good sign. But you must understand that these indicators came in because of the ginormous policy actions taken by our Fed and our Treasury. If you take a step back you will know that strong economies don't need this level of interference to prevent a systemic financial collapse. Yet I continue to hear words of hope from attorney's (you know who you are), agents, and anyone else I run into that the government is solving all of our problems and the world in the near future will be filled with candy canes and roses. Keep dreaming. 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! Let me explain for those who think every Option ARM is about to reset lower and help borrowers meet debt requirements.

First, let me define the difference between these two real life forces for anyone with an Option, Pick-A-Pay, NegAm ARM loan product:

LOAN RESET - when the RATE on your loan adjusts from an initial teaser level

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.

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

This makes me especially worried about Wells Fargo, who acquired World Savings Bank (aprox $122Bln of option adjustable mortgages) - which was acquired by Wachovia in 2006; both with huge holdings of Option Arm, Pick-A-Pay, and other NegAm loans on their books. Now Wells has it all.

Rolfe Winkler, who publishes OptionARMageddon.com, chimes in:

When recast happens, the interest rates may or may not be more favorable but all of a sudden you're forced to make a FULLY amortizing payment on a loan balance that's 15-25% larger than the one you started with!

90% of Option ARM borrowers make the minimum payment, which doesn't even cover interest. Regardless of where interest rates are, the recast to a fully amortizing payment will be much higher than the minimum payment the borrower has been making.

Payment shock = instantaneous toxicity. Can't refi because loan balance is higher than when you started and the home price is WAY below what you originally paid. These things default like none other.

Rolfe isn't the only one talking about this. The late, great Tanta of Calculated Risk discussed the recast problem in depth a number of times, in her attempt to educate readers of the dangers lurking in our future. Here is one of Tanta's discussions from AUG, 2008:

As far as I'm concerned, a large part of the confusion here is that our friends in the media are not very careful about using the terms "reset" and "recast" consistently, like us UberNerds do. "Reset" refers to a rate change. "Recast" refers to a payment change.

On a normal fully-amortizing ARM, the interest rate resets on what is called the "Change Date" (five years out for a 5/1 ARM, three years out for a 3/27 ARM, each year thereafter for the 5/1 and every six months thereafter for the 3/27, etc.). The payment recasts exactly one month after the rate resets. Mortgage interest is paid in arrears, so first you reset the rate, then the following month you recast the payment. "Recast" is really just a shorter word for "re-amortize": you take the new interest rate, the current balance, and the remaining term of the loan, and recalculate a new payment that will fully amortize the loan over the remaining term.

By and large, the biggest danger for Option ARMs and IO ARMs is the recast date, not the first or subsequent rate reset dates.

So, how many loans are set to recast? Look at this Barclay's report displayed in the WSJ last year to see the wave about to hit, right as the banks lie wounded on the ground:

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!

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Zombie Condos Part II - Day of The Charge-Off

So what's going to happen to all those partially built buildings around the city and the boroughs? I am afraid the prognosis is not good unless the developer has deep pockets....and who has deep pockets these days? Even those who do are up to their pockets in alligators right now. But let's go through an example of what happens to a real estate project when it fails to achieve its original highest and best use.....I'm warning those of you with weak stomachs that it ain't pretty.

But first, an explanation of highest and best use. Highest and best use is an appraisal concept, but it's a really good way to think about how land is utilized. Simply stated, the highest and best use of a piece of land is its maximally productive (most profitable), legally allowable, physically possible and financially feasible use. So, for example I may have a piece of ocean-front property and I may want to build a casino on it, but if it isn't zoned commercial, isn't in a place where gambling is legal and the flood and wind insurance is ridiculously expensive, I'm probably not going to be able to make much money trying to do it and therefore probably won't be able to, period.

In general, certain locations will best support certain kinds of development depending on zoning, traffic, supply/demand etc. In the last number of years the highest and best use of land in New York City in areas zoned for residential development (and even in some that aren't) was condominium development. Residential real estate prices were high and rising, supply was reasonably tight, financing was available on good terms and condominiums can be sold out quickly, allowing the sponsor to pay off their debt and extract their profit quickly. At the tail end of the real estate boom, when condo prices started to stall and financing condominium projects got hard to justify, hotel development became the highest and best use in many areas (even those zoned for residential) because the hotel market was very tight. The near 90% occupancy (which is about as good as it gets because they have to change the sheets some time) and high and rising room rates, appeared to support new supply additions. Hotel development should naturally have a high return because unlike office or retail properties which may be rented for five or ten years with rents indexed to inflation, hotels have very volatile/unpredictable cash flows. They are an overnight leased fee business, so you never really know what your cash flow will be tomorrow (yes, reservation systems give you some visibility, but you get my point) and you have to really manage them; they are probably the most management intensive real estate asset, followed by multi-family.

Now, land sellers are not stupid. They know that their land is going to be bought by a developer building condos who thinks he's gonna sell out at $1,400 a square foot, or a hotel builder who is going to get $600 per key for his hotel in an acquisition; and they price their "PRIME HOTEL DEVELOPMENT SITE" accordingly. This is where the trouble starts. Developers, whose job is to develop stuff, buy this premium priced land, which already has a bunch of the developers' profit baked into the price because to develop stuff you need land. They then race to get the building built while the market is still good. That's unless they are the deep pocketed/experienced guys who buy up cheap land in a downturn, or when a neighborhood is bad, and sit on it until they can see that in two or three years when they finish building the market will be primed to take up the space. Read here about how even these very experienced, professional and deep pocketed types are being vexed by the current environment.

Okay, now you get the picture of the challenges that developers face, but usually can surmount when prices are going up, up, up. Now I will share with you an example of what happens when things go wrong going into a downturn. Names and other details have been changed to protect the subject.

I recently came across a project in an emerging market of New York City, where the developer built a very nice condominium building and ran out of construction funds when he was about 85% done. He had some delays and construction problems, resulting in cost overruns, and the bank refused to give him any more money. He had already used some mezzanine financing and could not access any more debt. Now this guy, unlike so many of the New York City developers who were buying land in the last couple of years, paid only a couple million bucks for his land 15 years ago and could have sold it for $10 - 12 million 2 years ago, but decided to develop it. Note for those who have not seen my previous comments about the New York City land bubble, here is a chart of data from the New York Fed, from about 9 months ago. The chart doesn't look like this anymore...LOL.

Unfortunately, he chose to build, and he actually had pretty good luck in pre-selling the units. He was able to pre-sell maybe 55% of the units for $900 per square foot (reasonable for the fictitious neighborhood), implying a value for the project of about $60 million. His construction loan was $25 million and he had $2 million of mezzanine debt. He needed an additional $6 million to finish the project. There is a school of thought that would say, despite all the financing challenges in the market and the decline in the value of these units since pre-sale, if you really put your back into it, you could blow these condos out in the next 6 mos. for $650 per square foot on average, leaving a project value of $46 million and a profit even after the additional construction cost of maybe $10 to $13 million.

The 'take in a partner - finish the building - and blow out the condos' option doesn't actually exist in this environment. No investor wants to take that kind of risk, regardless of how much of the $13 million profit you offer them. Here's where it gets ugly.

When a bank used to underwrite a condo deal, they wanted to know what it would be worth if they ended up owning it (they have revived this practice in the last 12 months, but they aren't really financing anything anyway). To be conservative they would value the building based on its use as a rental property, which the bank would own and rent out, until it got its money back, just in case the sale of condos was somehow precluded. If you read some of the recent press out their about Zombie condos, you will see that many have been going rental. So that is how this fictionalized property is currently being viewed by potential investors.

Valuing the property as a rental, where the initial investment is recouped through years of rental income (which is very tax efficient, but slow) produces a current value of approximately $27 - $28 million. You see multi-family rental is not the highest and best use of a building of this type, even in today's environment where condo prices are down 15% plus. Even if it were, it's a way less valuable use than condos were a couple of years ago when the construction financing was put in place.

As a result, we have to take the $28 million rental value, back out the $25 million construction loan, $2 million mezzanine debt plus the additional $6 million the bank would have to spend to finish the building and oops, this thing has negative value. In truth, the developer's equity is totally wiped out, the mezzanine debt position is worthless and the bank will likely take a loss even if they finish it themselves and keep it for five years. Since the bank isn't in the business of throwing good money after bad and managing multi-family buildings, they will probably look to sell the loan for a haircut. An investor looks at this and says, well the building is worth $27 - $28 million, but I need to spend $6 million to finish it and then I will have the carrying costs of marketing it and getting it rented up and maybe some interest cost, plus I want a good return. So, I'm only willing to buy this thing for .......drum roll please! Maybe $17 million. That's right, the project, which originally was selling out at an implied value of $60 million, will be sold for $17 million, with the bank taking an $8 million hit.

Now take a look out your window at all those half built condos and hotels....OOOH that's gonna leave a mark. Understand as well that before the actual charge-off of the bad loan and sale to an investor at a price where something can be done with the site, the bank will have to foreclose on the borrower, who may try to declare bankruptcy to forestall the process/allow for some kind of debt restructuring, all of which can take a year or more. You can read about how messy these battles can get here. The one positive fallout is that land prices are going to continue to be crushed, which will eventually help make new development sensible again.....eventually.

From The Blogosphere:

Bank Insolvencies Tips & Tricks: Don't Feed The Zombies!

Half-built Sites Cast Shadow Over NY Economy

What's With All These New Hotels?

Hilton's Huge NYC Hotel Sale

Quinn:Unsold Condos Would Make Great Middle-Class Housing

In Distress They Invest

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LeFrak: "If You're Highly Leveraged, See Ya!"

A: Great segment on CNBC this morning with Richard LeFrak, President of The LeFrak Organization. The whole interview is worth the 9 minutes, where he starts out discussing our local real estate marketplace and who really drives the market ('the buyers!'), and gets into the trouble in the credit markets and the process of deleveraging that is occurring now. If I can sum it up in one phrase, here it is: "we are in the process of returning to a new, less sexy NORMAL!"

I love how Mr. LeFrak went into the how the savings rate was rising for the first time in decades. This is exactly what I took a few precious minutes of Inman Conference Panel time to talk about on January 7th:

"Also, what nobody is really talking about is the savings rate. For the first time in 20+ years, the savings rate is spiking. This is very interesting. We went from a negative savings rate a year ago, to about 3% right now. People are getting very frugal. Consumers are buckling down, everybody is buckling down, they see friends losing their jobs, they see their net worth & homes go down, their portfolio go down and they are starting to save. Now think about the adverse feedback loop that a higher savings rate has on corporate America. If people aren't spending for products, what is going to power corporate profits or power corporate stock performances?"

Seeing the savings rate rise is like watching our culture start the shift from 'buy now, worry later' and EZ-money, to 'pay down debt' and 'hunker down'. Everything contracts, everything delevers (Jeff's piece on "De-Leveraging Will Be Televised" is a must read), everything slows down, and we are heading to a new normal! That new normal is going to be more boring & less sexy as consumers/corporations/private investors/banks absorb the shock and pain of the deflationary process. This is a healthy adjustment to purge the excesses taken in the old system. When we get through it, we will be in a better position to build the platform for longer term sustainable growth; although at a slower pace as well!

Click on the video below to watch:

Some points that Mr. LeFrak makes on Manhattan real estate:

Prices have come down, transactions have slowed, the time its taking to sell apartments is longer, and reality will come in. The ASK will come down.

The BUYER sets the price BUT the SELLER writes the check and the SELLER is really the one in the end that sets the price. **

Big increase in office vacancies because the financial service industry was the engine that was driving this bus, and it will take a while to adjust

We're adjusting, rents are down, and that's the reality of it, and if you are highly leveraged, SEE YA!

Not that much supply coming on the market

Halfway through the commercial adjustment

** I think Mr. LeFrak misspoke on this statement. I think he meant to say the SELLER sets the price BUT the BUYER writes the check and in the end it is the BUYER that sets the price! Now ultimately, the seller chooses whether or not to accept a bid or not, but in the end, the property is worth only what a buyer is willing to pay for it at any given time.

EXAMPLE: Seller sets asking price at $1M, bids come in at $875K. Seller accepts. The seller set the original asking price at $1M, the buyer bid what they feel its worth at $875,000, seller accepted that bid and the buyer writes a check for the transaction.

In a side note, CB Richard Ellis just reported net income down 94.7% and decided not to issue a 2009 profit forecast. It seems LeFrak is spot on in regards to the commercial sector.

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Manhattan Inventory Crosses 10,000

A: Ding Ding Ding....And here we are! I remember when I first got the widget up here on UrbanDigs in an attempt to make this residential marketplace more transparent, and total inventory was around 5,500 or so. All it took was the dismantling of wall street, the worst credit crisis since the depression, ZIRP fed policy, a $700Bln bank rescue plan, the failure of Lehman/AIG, the nationalization of the GSEs, life support for Citibank/Bank of America, shotgun marriages for Countrywide/Merrill/Bear Stearn/Wachovia/WaMu, two fiscal stimulus packages totaling over $1Trln, a 76% drop in the price of oil, 40% plunge in equities, and well that's about it! We are at now now, and while anecdotal reports suggest a counter-trend surge in activity, it is yet to show up in the trends.


Don't you just love that widget! Thanks to the crew over at Streeteasy.com for powering the data for the widget and working with me to apply some rules to fine tune the raw data for a more accurate picture of what Manhattan real estate is doing real-time!

A quick guide to the data, and how the widget works:

data is updated daily every morning AFTER streeteasy performs their wee hour web crawls and updates their systems

in the widget, the NEW LISTINGS / PRICE CUTS / CONTRACTS SIGNED #s that show up in the 7DAY/30DAY brackets are cumulative totals

for the charts, the NEW LISTINGS / PRICE CUTS / CONTRACTS SIGNED are shown as a weekly average (this will be updated to a 4-week moving average soon to smooth out the trendlines) - the reason for this lies in the minimal activity over the weekends that cause a spikey chart when plotting daily updates

in the widget, the TOTAL INVENTORY # is logged daily after the streeteasy system performs their updates, and is averaged for the 7DAY/30DAY #s

data is ONLY for the island of Manhattan, excludes listings without an address, excludes duplicates that may arise from brokerage switches, and includes all co-ops, condos, & townhouses

As a broker/blogger, I strive to provide the most real time reports for you guys and at the same time mix in my thoughts/experience following changing macro trends to put the pieces of the puzzle together, AS I SEE IT! Since about the fall of 2007, that picture has been quite negative, as readers of this blog know. Anyone can look in the rear view mirror and re-iterate what has just happened, but to put the pieces together and use some vision/logic to assume what may happen in the near term is a bit more difficult. I do the best I can and this blog is simply a window into my thoughts on the markets and Manhattan real estate; so interpret at your own risk.

The only real time report I can add for what I see in Manhattan is that there IS an uptick in activity, I am submitting bids for my buyers, and I am getting new listings to market. I tend to shy away from reports on foot traffic and buyer calls because that doesn't really mean anything. What is meaningful is whether or not deals are happening, contracts are being signed, where those contracts are being signed, and are those deals closing! Thats the important stuff. Everything outside of this is anecdotal and a surge in open house traffic doesn't mean the market just got infused with thousands of willing & able buyers ready to pull the trigger on a moments notice!

I want to see the DATA! For now, we simply hit a comfort zone where buyers are comfortable placing bids for products some 15-25% below peak prices. So, where was peak? I put peak at deals signed in early - Fall of 2007, and closed 2-3 months later or so. But if you find a comparable unit that closed in the summer of 2008 (meaning the contract was signed a few months earlier), it's a good bet that bids will be coming in around 20% below that level; properties with unique sell side features that are not in the high end should be cushioned a bit. This really is a high end recession here as the core of the problems we face are on wall street; and between the destruction of net worth, hit on stock options held, negative wealth effect on overall portfolios, loss of high paying jobs, loss / reduction of bonuses, tightness in mortgage markets, etc., it's the high end that is adjusting the quickest.

I just did an audiocast for The Real Deal, that pretty much sums up my feelings on where we are right now in the Manhattan real estate cycle, here are some tidbits from that interview:

a) we are in the initial snapdown from peak, after the market rolled over and bids disappear. Since Lehman failed, the market became very illiquid. Deals are probably being done about 15-25% from peak right now. Certainly the inventory and contracts signed trends doesn't show this yet.

b) I don't see mass strength anywhere, but I do see an uptick in activity and I am hearing colleagues discussing an uptick as well. Call it a counter-trend surge in activity, embedded in a bigger longer term correction.

c) nothing goes in a straight line forever, there are deals at every price on the way up to peak and on the way down to the ultimate bottom. Right now is a far cry from the illiquid 4th quarter, which was totally dead.

d) I am not a fan of the stimulus package. They are not letting the market work naturally, and for defaults to happen, and for companies to fail and consumers to puke up debt. They need to let the market do what it needs to do to cleanse the system - purge the bad debt. Government is not an efficient use of money, it will not equate into job creation right away, and they keep pouring more money into the banks without letting price discovery occur and hits to be taken. If they have to issue bonds to fund these bailouts/stimulus, what happens when our friendly funders aren't friendly anymore? We can see rates surge and that can come right when Manhattan is in the middle of the correction.

e) High end is getting hurt a lot faster than the studios/1BRs. I don't like to talk about bottoms or recoveries yet when fundamentals are still so negative.

f) I'm seeing an uptick, like everyone else, but I am not seeing deals signed everywhere. I am submitting bids, and I am seeing a lot of action on the sell side which is quite telling for me. There is still a bit of a disconnect between what sellers think their place is worth and what a buyer deems it's value on the open market.

The entire audiocast is about 9 minutes. Enjoy!

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The Death of NYC Multi-Family Rent Regulation Arb?

If you pay attention to the commercial real estate market in New York City, there is no doubt you have seen the recent articles on Larry Gluck's Riverton Houses apartment building investment. The Real Deal recently reported that the property will be foreclosed on February 20th. Even if you never heard of Gluck's Stellar Management, you would most certainly have heard of a little firm by the name of Tishman Speyer and would probably be aware of their investment in Stuyvesant Town and Peter Cooper Village, which is now also on death watch. If you have not heard of the Stuy Town deal you are missing out on a little piece of history, as in my opinion, this one will go down with AOL/Time Warner in the annals of top marking value destroying transactions. But don't feel bad for either the Glucks or Tishmans, they have deep enough pockets to absorb the hits.....or save these deals if they really wanted to. Neither put up very much equity in the deals, relying on the largesse of truly stupid banks/CMBS buyers and not very swift partners to allow them to capture big potential upsides with little risk. In the case of Riverton and several other large deals of similar ilk by large institutional sponsors like Praedium and Apollo (now Area) Real Estate Partners, the sponsors were able to refinance their original purchases and take out their original purchase prices and a huge profit when initiating their current financing. The valuations the banks were willing to place on these properties and the assumptions of future rent growth implicit in these valuations were nothing short of stunning. Oh if only it were just the sharpies who took out these highly levered loans with visions of institutional slum lordship fattening their golden calves. Alas, visions of grandeur actually swept across the entire New York City rent-regulated multi-family market.

I chronicled this veritable tulip mania in prior pieces entitled "NY City Rental Property as Good as T-Bills?" and "NY City Rental Property - As Good As T-Bills - NOT!" In it I explained how the rent de-regulation arbitrage game was played, saying

Rent regulated buildings have been a magnet for investors the last couple of years; you see clever real estate investors in New York realized a long-time ago that the market is distorted by the lack of buildable airspace and the existence of rent control regulations. With regard to the latter, they figured out that there was embedded value in all rent controlled buildings that was not expressed in the current net operating income generation of the buildings. Over time, attrition combined with several aspects of rent control regulation would allow rents on rent controlled or stabilized units to rise from synthetically depressed levels to market levels. Owners of rent regulated buildings were in a position to capture this upside, with very little risk due to the high occupancy of New York residential buildings. You see, as one would suspect, the holders of rent controlled or rent stabilized apartments try to hang on to them as long as possible and not get thrown out for missed rent payments or any other reason. So in a rent controlled/stabilized apartment, you essentially have a tenant base that tries very hard not to get thrown out for non-payment, coupled with very high occupancy, but natural attrition (death and major life changes) that would translate to a certain number of people leaving every year and certain regulatory thresholds that de-regulate your apartment base over time. It's all good.

The only problem is that these types of investments include a perverse incentive to try to expedite this natural attrition rate, thereby raising your return on investment, This incentive is heightened if the landlord pays a high price for the properties purchased and uses lots of leverage. I'm not saying any tenants have been prematurely sent to the next life by avaricious landlords trying to get them out, but landlords have incentives to make current tenants of rent- controlled or stabilized units less than comfortable, shall we say, thus pulling forward their move out dates.

I cited an emerging backlash against rent regulation arbitrage players as posing a risk to this business model. A model which, by my reckoning, was the motivation for the purchase of roughly 1,500 apartment buildings in the Bronx, Brooklyn, Queens and Manhattan between 2003 and 2008 (not including those sold in large building packages or those worth less than $5 million). In my follow up piece I reviewed the egregious prices that investors were paying to play the de-regulation arb game and the stupidly leveraged basis on which they were doing it. I also mentioned that this was across the spectrum of larger and smaller players and buildings. I don't think I warned explicitly about the coming refi crunch that is going to strike as the popular 5 year balloon loans used to finance these deals start having to be rolled over....right about now. So you can put me on the record now - a refinancing debacle is coming. You see the players wanted to get in, turn over tenants, rehab units and jack up rents quickly, then in 3 or 4 years when their prepayment penalties were rolling off, refi the properties and taken a slug of cash out for their troubles. The only problem is they paid too much, levered too much and now the projected growth in net operating incomes they expected aren't coming to fruition due to higher energy costs, difficulty turning over tenants and pressure on rents when they do go free market. Yeah, energy costs will get a bit better when passed through next year - but notice how everyone is trying to convert to tenant paid electricity

If all of the above was not enough now comes the coup de grace. The passel of legislation that was bouncing around the halls of the state capital in Albany have now emerged from the assembly as a coherent package. Now thus far the media have only focused on a couple of the bills in this package, one that doubles the income level required for a tenant to be thrown out of a rent controlled apartment and a limit on rent increases to a maximum of 10% from 20% when an apartment turns over. In truth however, the package looks as if it is aimed at closing every regulatory device provided by the Giuliani administration to allow rent de-control. You can see the press release put out by the assembly here and it has links to all the related bills. The bills would cut the amount of a rent increase catch up when a tenant vacates an apartment to 10% from 20%. They would also increase the ceiling level rents have to get through by way of Rent Guideline Board sanctioned increases (or other methods) from $2,000 to $2,700 before an apartment can make the jump to market rates. Additionally, rent hikes would be limited to one per year, through any means. The bills would also freeze rents on buildings "bought out" of the Mitchell-Lama subsidy program and elongate the period over which landlords can charge back the cost of apartment upgrades through rent hikes. They would also raise the threshold for tenant incomes to $240,000 per year, before forcing the surrender of a rent-regulated apartment. In the most amazing bill, the city would also be able to claw back into the rent regulation system any apartment that was ever used under the Section 8 federal housing subsidy system (going back to 1974). Lastly and rightfully so, one bill would increase the fines that can be levied for tenant harrasment, since the fines have not changed in 10 years.

In short, it's the full monty. The death of the rent deregulation game. Don't pass go, don't collect $200, go straight to your bank and drop off the keys, cause the gold in them thar hills has turned to coal. Now I am not feeling sorry for the knuckleheads who egregiously over-paid for NYC multi-family assets, or their dim-witted financiers. Neither am I a fan of rent regulation and the twisted incentives it creates. A debacle was already fait accompli in my book due to over payment and abuse of leverage. But I do want to point out that in my opinion, this legislation, if it makes it through the State Senate is potentially the road back to "The Bronx is Burning." While we probably don't agree on everything I do agree with Joseph Strasburg, President of the Rent Stabilization Association, a powerful landlord group, who was quoted in a recent New York Observer article saying. “You have total chaos in this city when you have large complexes being foreclosed on.” Considering that of all New York City residential units 52% are rent-regulated apartments (per the Housing and Vacancy Study of 2005), this would be bad news for all residents of New York City as the impact on the quality of life would be horrific.

If this stuff is really interesting to you drop by Guild Partners' web site and send us a request for a copy of our 50-page report on the New York City Multi-Family market. It goes through the different strategies investors have used to transform rent-regulated apartments to free market rents and its chock full data on the excessive prices paid and tenuous financing structures used to acquire these properties, as well as supply and demand stats for the New York City multi-family market.

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Elliman OR Ebay? That is the question...

A: And things get weirder and weirder! If your looking for an East Village converted two bedroom, you can either call the broker at Elliman or place your bid on ebay! The choice is yours and I wonder what the reserve is? From silent sales & rental auctions to no reserve ebay auctions, I thought I have seen it all. But if there is one thing I know about Manhattan, it's that this city is never short of surprises!

MINIMUM BID OF $350,000 HERE ON EBAY....

OR, ASKING $425,000 AT ELLIMAN...

Only two days left for the auction and already there is a nice round bid; hmmm, I wonder if the seller placed that first bid just to get some action going.

But WAIT!! There's more.

Check out 438 W 49th street on EBAY HERE and on ELLIMAN HERE! This time the ebay starting bid is $40,000 lower than the brokerage webad.

Any takers on whether or not we see these listings in contract by this time next week? Might as well have fun with this. I can see the brain stormers pondering away the new Manhattan auction real estate brokerage site already. We can call it, e-hattan.com!

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Is the Bond Market Cooked, as Endgame Starts Early?

A: Hmm, tough call but I honestly don't think so - especially when the fed can talk up purchases of treasuries and change investor sentiment on a dime. This doesn't change my longer term thoughts on the bond market though. Remember that nothing goes in a straight line, but if a market is about to roll over (like oil, dot com tech stocks, etc..) you will see bids disappear real fast as the initial plunge is always both surprising & shocking. Longer time readers of this site caught my multiple mentions of endgame, and the likely reversal of the secular bond market rally that has lasted about 27 years. While consumers, corporate exec's, and traders cry for bailouts so that their stocks would rise faster, few out there talk about the unintended consequences of the path our decision markers are putting us on. The latest comes from the stimulus package's 'Buy American' talk and new Treasury Secretary Tim Geithner's 'fightin' words against China!

With the treasury about to embark on a major fund raising campaign via bond sales to help pay for all this stimulus, I'm not sure now is the time to:

1) have the latest stimulus package include a 'Buy American' order
2) have our new Treasury Secretary / President pick a fight with China, claiming manipulation of currency

...whether or not these are the things that both should happen and have been happening, is another issue. Bonds already had a big rally, and now it seems to be reversing:

You don't start a fight or place protectionist trade barriers with the people who have been funding our debt for so long, hold tons of treasuries, and who we hope to continue funding our debt moving forward! Is this just me here? Are they trying to pop the treasury bubble and send rates skyrocketing? Do they not understand the unintended consequence of these actions? Somebody help me, please!

Now, to understand the worry here you need to understand the situation we are in. Since the beginning of this debt-deflation adjustment, money has come out of stocks & commodities and went into treasuries as a safe haven play.

Today, we are about to pass an enormous $827,000,000,000.00 stimulus package to deal with this severe recession, we hope to raise these funds by selling bonds! The bond market capped off a 27 year secular bull rally with an amazing bubble like run to close out 2008. As stocks plunged and fear rose in the 4th quarter, more money poured into treasuries sending rates uber low and bond prices surging. But what if this money starts to pour OUT of treasuries, right before the massive supply to fund the stimulus package is about to hit the market? What if our friendly funders, become not so friendly anymore and do the unthinkable to deal with their own crisis - what if they sell their treasuries? What if the bond market rolls over?

I may not be right all the time, but at least I'm asking the right questions! Now, I don't think this is going to happen just yet and I think the latest bond selloff will ease a bit; but in this market, you just never know what could happen!

If the bond market does roll over, we will see a mad rush for the exits as everyone that is long treasuries with the expectation of holding the asset for a trade, sells out. This will send yields surging. And if yields surge, the cost of money will s