Measuring UP Square Footage - Is Regulation Needed?

A: This is a topic I touched on a few times here, and is an old story that gets replayed every 10-12 months or so. Just how 'off' is Manhattan square footage? To be honest, its way off but I think this marketplace has evolved past the point of really caring anymore. Everybody knows that co-op apartment sizes are estimated and I rarely run into a broker anymore that actually quotes some odd total size. They'd be foolish to say something like that given that only condos have the marketable square footage clearly documented in the offering plan filed with the AG's office. Brokers learned, and as a result, so did the consumers that for co-ops the 'how large is this apartment?' question always comes with a roughly estimated number followed by a very clear disclaimer on accuracy! In this day and age, buyer's know they have to take matters into their own hands.

The Real Deal discusses how the "Inexact science of square footage causing inaccurate appraisals, unhappy buyers":

"When it comes to square footage in New York City, it's the Wild West," Bill Staniford, the CEO of real estate data Web site PropertyShark. "It's measured in so many different ways."

And in the current downturn, the difficulty of determining square footage is contributing to a number of other problems, from low appraisals to ruined deals. Staniford, who constantly fields questions from brokers about inaccurate square footage data on file with the city, said using price-per-square-foot as a measure of value is "totally pointless."

The market knows or at least learns very quickly, that marketable square footage is if anything skewed to the upside. Which brings up a very interesting question --> You know those quarterly market reports that we all spend so much time analyzing? How accurate could price per square foot trends really be if the marketed size for 70% of our housing stock is estimated? I guess over the long term one can argue that the trend filters out some of the noise of the inaccurate data.

Condo's are easy as the marketable square footage is stated in the offering plan; all but eliminating the question of size and making it foolish for the seller or broker to try to artificially inflate! But co-ops? Co-ops take up 70% or so of our housing stock and total size is not listed in the offering plan...and with every co-op sale is a buyer that attempts to value the target property in order to figure out how to bid. Therefore, how do we value or price these things if the listed size is off? Maybe we should start using the # of shares allocated to the unit as a price per share valuation tool? Maybe REBNY needs to implement some regulation on the sell-side that requires every new Co-op listing from a member firm to use an outsourced contracting agency to measure the floorplan/size accurately for marketing purposes?

The solution MUST encompass most of the market to be worthy - which is why I say that any regulation needs to come on the sell side and not the buy side. I recall being charged about $150 for a professional floorplan to be made by OLR Digital who physically sends someone to the apartment to measure up everything. Is this cost really breaking the bank? What if REBNY required all new listings to be properly measured prior to listing?

In a commission based industry where the brokers don't earn their cabbage until after the closing, the environment is set up to result in flaws and discrepancies for marketing. Why? Because the broker and the employing brokerage firm doesn't know if they will ever get paid on the sale. That's no excuse, I know. So, maybe REBNY needs to make the employer brokerage firm responsible for professional measurements without penalizing the agent's ad budget? Possible, but not likely in this world.

My main concerns of this topic are over individual co-op unit valuations and the quality of analytical data for the entire marketplace - if in fact the majority of estimated co-op square footage is artificially inflated. This lowers my confidence level in Price Per Square Foot data trends and calls into question how one may value a target property based on a different apartment line whose total size may have been inflated. Exactly what Bill Steniford talks about in The Real Deal article.

When I do a property valuation I always look for in-building comps in order of the following priority:

1) SAME LINE SALE w/ SAME FOOTPRINT - this is the first goal. If my buyer's target property is an 'A' line, then I look for similar 'A' line comparable sales in the same building to do an analysis on. If I find a recent 'A' line to compare to, I just double-check the floorplan to make sure the footprint of the two apartments are identical. This eliminates any flaws in only doing a PPSF breakdown where one of the properties being used may have had its size inflated. I have the same layout, the same line, the sale price and the sale date. Forget the price per square foot method - I'll make my own adjustments for market conditions, renovations, and floor premium or discounts.

2) SAME ROOMS/BEDS/BATHS - this is the second goal if I can't find a same line to compare the target property to. I always stay in the same building unless the data is non-existent for an analysis. If my client's target property is a 6/2/2.5 (the format of this is generally Rooms/Bedrooms/Bathrooms) apartment, then I look for different lines that may have these exact property features - all in an attempt to compare apples to apples. As you start changing apartment lines, you start changing layouts/views/exposures/natural sunlight/etc..and the valuation becomes slightly compromised and more difficult as the open market value of these types of features in this market are highly subjective on the buy side.

3) SAME BEDROOMS/BATHS - If I can't find the same r/b/b to compare to, I eliminate the ROOM part of that equation and look for a comparable in the building with similar Bedrooms & Bathrooms. If the size of the both apartments are provided and there is a gap between the two total sizes, I can account for that by taking the sale price per square foot of the SOLD property and multiply that by the gap in size to the TARGET property and add that total to the comparable being analyzed so I have an equal foundation to do an analysis on. Of course the major flaw in this method is whether the SOLD or TARGET property's square footage was artificially inflated. I'll provide an example:

TARGET PROPERTY --> Apt 14A is a 1,350sft, 5.5/2/2 apt, and is asking $1,595,000
SOLD PROPERTY (same building) --> Apt 6D was a 1,250sft, 5/2/2 apt, and sold for $1,350,000

There is a 100sft difference in the two properties, different property line, and an 8 floor difference. If you read my technique for Valuing Manhattan Property you will know that I don't do PPSF valuations and rather I will adjust the two properties to be of the same size if I can't find a similar line to compare to - after this size adjustment, I will do the following adjustments to complete the analysis:

a) market conditions
b) light/view/exposures of different lines (floor premium)
c) renovation differences

First lets get the SOLD property and the TARGET property of equal sizes by closing the gap using the PPSF of the comparable sale:

100sft x $1,080 = $108,000

Since the SOLD property closed for $1,080/sft and the TARGET property is listed as 100sft larger, lets ADD $108,000 to the sale price of 6D and then move on to the other adjustments:

$1,350,000 + $108,000 = $1,458,000 as a starting point

The hope is to avoid this 3rd option for a comps analysis and to use a similar line.

Back to the discussion. The problem is that this is a very solvable problem but I don't think the powers that be have the motivation or the will to put a proper resolution in place that may cost brokerage firms more money to adhere to. It's a man-eat-man world out there and Manhattan buyers learned to fend for themselves. Brokers out there MUST use caution when quoting the total size of co-ops and it might be worth that $150 to simply hire a professional floorplan from OLR to get the exact measurements before the new listing even hits the market.

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Handling Multiple Offers in Today's Market

A: Whether you question the sustainability of it or not, you can't deny that some well priced properties out there are receiving multiple offers in the past 4-6 weeks or so. However, that doesn't mean each will end in a bidding war! In fact I find that while sellers love bids competing with each other, almost all buyers and many brokers out there hate them - it just "complicates things" they say! They call it a war but it's not really a bidding war; which I would describe as a situation in an auction where two or more bidders aggressively battle each other in a transparent manner sending the final price for the item much higher - each buyer knowing what they are up against with each move. For highest & best situations in Manhattan, interested buyers are simply provided a deadline with which to provide their most aggressive offer for the target property. In the end, the seller broker and seller review all bids submitted and choose the highest and best one to proceed with! However, "highest & best" situations are often perceived as bidding wars and that alone could scare many qualified buyers running for the hills!

Disclosure: I no longer work with sellers and currently spend my time servicing buyers only. This is a big no-no in regards to building a successful broker business model. The proven broker model is to establish a successful sell side business and to the best of your ability, recycle business (buyers) as traffic comes in - the team approach allows for this and the power in numbers adds to production volume which increases the split distribution with your employing brokerage firm. Then, the team continues to work the referral base expansion aspect of the business. Since UrbanDigs LLC became a member of REBNY, I have been working only with buyer clients as it fit my niche target audience, business model, and compliments my ongoing vision for where I see UrbanDigs.com in the years ahead. You will soon see where I am going with my vision.

The most important thing every buyer should understand about a property that declares a highest & best situation is that you only have to bid what you are comfortable with bidding!! Nobody is forcing you to get into war with anybody and since you are not told the competing offers, there is no back & forth for you to ponder whether to up the ante a bit more! It's basically a one and done!

Now, as I wrote in my "How To Handle A Bidding War" piece almost three years ago:

It is very important to note that the intended seller strategy of a bidding war is to encourage a sense of urgency via potential property loss and NOT to install fear into the prospective buyers. I can't begin to tell you how important this is. By installing fear into the bidders rather than encouragement to participate in the bidding war, chances are you will 'scare away' and lose one of the bidders messing up the entire goal of the war.

The ultimate goal of the bidding war is to procure the highest & best bid that generates a signed contract for the seller!

The key is knowing when the situation is ripe for a 'highest & best' declaration, as many brokers and sellers with minimal experience in Manhattan real estate transactions may get a bit excited and ahead of themselves. The ideal situation is when the listing broker receives BOTH of the following:

1) Two or more ACCEPTABLE offers - the offers must be in the realm of acceptability by the seller. There is no point in calling for a 'highest & best' situation when the seller is asking $1M and you receive two offers below $800,000 that the seller has no intention of accepting due to price alone! The buyers' terms must be acceptable as well...

AND...

2) Two or more QUALIFIED offers - the two or more offers must be financially qualified to both be able to secure a loan commitment and to pass board approval; assuming it is a co-op.

Simple. Clear. Easy enough. Now, every offer has its own variation of terms that must also be considered by the seller in these situations - closing dates, inclusions/exclusions, gifted monies, inspection requests, etc..

Assuming your property has procured both of the above, you now have a choice to make on what to do - but before I go into the choices I want to discuss the concept of 'gap-up' bids.

Gap-up Bids: this occurs when a very interested buyer deals with a highest & best situation by going all in in regards to aggressiveness! Let's say you got a property asking $2,895,000 that was priced such that it received multiple offers; a highest & best is declared and deadline for submitting offers provided to all interested buyers. To ensure they get it, one buyer decides to bid $3.1m, well over ask! I consider this a gap up offer that may not have come in like this if negotiations were privately held. I believe this actually occurred for 35 Bethune Street, Unit 2/3A...which is in contract now awaiting closing - let's revisit this discussion in a month or two when we see how far over ASK the winning bidder went to get that desirable duplex! Another example of a gap-up offer was 37D @ 115 East 87th street at the peak of the market, closing some $600,000 over ask after a best & final environment was set by the broker!

Gap-ups don't always happen for highest & best situations, but the environment certainly exists for one to occur. Moving on, when multiple qualified & acceptable offers are submitted the seller has two choices on how to proceed:

a) Handle Independent & Private Negotiations

Pros: Allows you to continue marketing the property and continue the negotiations back & forth for as long as the seller likes or as long as the buyer(s) participate, less chance of scaring away buyers,
Cons: Limits the gap up potential of a highest & best, time may allow for a competing property to come to market and steal one of your buyers

b) Declare A Highest & Best Situation

Pros: Increases the gap up potential in a bid, usually ends the process fairly quickly, usually keeps the sense of urgency on the most interested and the winning bidders to produce a signed contract
Cons: may scare away some potentially strong buyers who 'don't do bidding wars', the situation is usually not handled correctly by the broker or seller, if it fails to produce an executed contract from the interested buyers it could leave the seller in a bad position

Both have its pros & cons and I don't have time to think about and list them all. Experienced brokers will know when to advise a seller which path to take; there is a feel to it that good brokers are quick to pick up on. Handling this situation the wrong way can end with no deals done, no bids left, and a listing that lost all control after being in the driver's seat going full speed ahead.

For newer agents that don't know how to handle this kind of situation, go back and read my article on handling multiple offer situations. In the end, experience will be your best lesson on how to handle similar situations in the future; so when you encounter this environment be sure to focus on how you handled it, how the buyers responded and reacted, and how everything played out! Learn from your mistakes so that next time you don't make them!

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A revolution or Non-Event? Breaking Down The VOW!

It’s been touted as a consumer-empowering trend, a revolution, a win for buyers and a loss for agents … VOWs – Virtual Office Websites.

It all started with a lawsuit in which the Department of Justice sued the National Association of Realtors in 2005 for additional transparency in property listings on IDX (a data-sharing listing service). The settlement in 2008 was intended to make it a playing field for internet-based brokerages as they compete with traditional firms.

Now, the big hooplah comes from the media as it looks to large NYC brokerages who are adopting VOWS and allowing other brokers’ listings to be listed on their sites, with Halstead being the first. Basically, buyers can now see listings from Corcoran, Elliman, etc. on the Halstead site. Other firms are also jumping on this bandwagon, all under the same banner of this being the wave of the future.

Some are calling it a revolution, and big win for the little guy in the age of the Internet. Crain’s has picked up this story several times (here and here) with such attention grabbing headlines like “Brokers lose grip on their listings”.

Did I miss something? Have we not had Streeteasy and Property Shark? If I were to break down buyer’s behavior, I would say that any do-it-yourself or research-driven buyer out there will go straight to Streeteasy to do their research. Why go anywhere else? It’s as if the current dilemma has been the necessity of having to go to each and every brokerage firm’s site to conduct property due diligence; that’s not the case. Further, unlike SE or PS, VOWs adopted by the big brokerages will require a user to register in order to view the listings, an extra step in an otherwise straightforward process.

[Disclaimer: I’ve always had a bit of a philosophical problem with brokerage firms touting a huge online prowess and fancy features; those bells and whistles are supposedly targeting those do-it-yourselfers, those buyers who have chosen not to engage buy-side representation (all of 5% or so, in my experience). It’s meant as a pitch to sellers for exclusivity and touted as a differentiator in the race to attract as many eyeballs as possible. I guess I’ve never bought into it, as I feel that those 5-10% of buyers are aware of Streeteasy and PS already.]

The more fruitful idea, if we’re talking about market-leveling efforts, would be to create a true competitor to Streeteasy, with additional value-add features, rather than to transform each brokerage firm into a Streeteasy derivative. … ‘Just a thought.

I’d love to hear from the UD community on this topic:
• For those do-it-yourself buyers, where do you go online to dig?
• How often to do you visit the big brokerage websites? In which instances?
• How significant do you think VOWs will be in the NYC market?
• Sellers, how important is your chosen firm’s online capabilities to you and why?

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Pending Sales / 90-Day MA Closings / Q1 2010 Preview

A: I'll try to get right to the point here for you guys. I continue to see Pending Sales stay at healthy levels after a short adjustment down from the surge we saw in contracts signed starting around mid 2009. My data shows Manhattan Pending Sales hovering around the 4,356 level right now; pending sales are contracts that were signed and are awaiting approval to close. This suggests a fairly strong upcoming y-o-y comparison when the Q1-2010 market report is released in early April. In addition, the 90-day moving average for closed sales clearly shows both the plunge and improvement this market experienced over the course of the last 18 months or so - that is pulled directly from ACRIS and is public record.

The data doesn't lie and it certainly does paint an interesting picture when you filter out the noise properly from the source data and assign the right rules to calculate different metrics worth following in the Manhattan residential real estate market.

Below is a chart comparing the trends for Manhattan Pending Sales (orange) vs. the Closed Sales 90-Day Moving Average (green) the past 4 years:

Consider this another sneak peak at what's to come here on UrbanDigs in a month or so. So what is this chart telling us?

1) First off, in my eyes, the 90-day moving average for closed sales (taken from a direct feed with Acris) clearly shows the roller coaster ride this market experienced starting in mid 2008. The plunge in sales was dramatic to say the least and if you want to really blow your mind you can do some digging into the plunge in DOLLAR VOLUME this market experienced as a result of the higher fear and mortgage market freeze up surrounding credit crisis at its peak; both for residential and commercial sectors.

You will notice the slight lag between Pending Sales and this 90-day sales trend due to the lagging nature of the sales process from contract signing to closing.

The improvement in the sales trend shows you the sustained increase in deals being signed since May/June of 2009 or so - I like to look at it as this market pricing IN fear leading up to early 2009 and pricing OUT fear over time as the reflation mentality took hold.

2) Second, pending sales dropped from about low 7,000s to about mid 3,000s in about 7-8 months time at the height of the crisis. The plunge was dramatic, the adjustment was dramatic, and it had a fierce, uncertain, scary feel to it. When it was happening nobody knew how far it would go or how long it would last before stabilizing. In hindsight, the % drop from peak varied across price points and took about 8 months to find a comfort zone; as noted right here on UrbanDigs in February 2009.

As sales volume started to rise with time, we topped out around the August-November period with pending sales hovering in the low 5,000s - we are now seeing these deals close and be captured by quarterly reports. The slight move down in pending sales was more a function of seasonality in December around the holidays then a new trend to the downside in sales volume - recall that in June, July & August we were averaging about 1,100-1,200 or so contracts signed a month as buyers swooped in with the fierce adjustment in price action. It shouldn't be a surprise that we could not sustain that level of activity for long. Over the past 30 days my new systems show 971 contracts signed and that was closer to 785 or so about 6 weeks ago reflecting the seasonal slowdown in December.

With pending sales holding at a healthy level I think its safe to say that when the Q1 2010 market report is released to the public on April 1st, we will see a stunning y-o-y improvement that could have some 'headline effect'. Just be prepared for it as it will be a function of an improving marketplace being compared to the report that marked the worst period of sales in the past decade or so; recall that Q1 2009 recorded only 1,185 sales, and I would not be surprised to see Q1 2010 sales come in around the 2,400 - 2,600 level! Let's see how close I get!

For now, as I attempt to setup appointments for clients I get these types of responses about half the time:

I have the tools in place to track these CONTRACTS OUT & OFFERS ACCEPTED broker status changes but unfortunately many brokers do not bother to update a listing's status to these "in between" settings in their respective broker sharing systems. The natural progression in regards to how a broker handles a new listing that stays on the market and ultimately closes is NEW ACTIVE --> OFFER ACCEPTED --> CONTRACT OUT --> CONTRACT SIGNED --> CLOSED. It would be great if all brokers updated their sales listings as this progression took place in the real world, because having a listing whose internal status is set to OFFER ACCEPTED or CONTRACTS OUT doesn't change a thing for the active webad. For all intents and purposes, that listing is still ACTIVE in the public eye. But its clear that very few brokers update each stage as it happens which gives me less confidence to those metrics for trend purposes.

Now, even though well priced apartments are seeing strong demand I continue to question the sustainability of this pace of signed contracts! That's just me as I continue to have macro concerns and worries over the withdrawal of stimulative policy and programs. I won't deny its happening, but I do question how long it will last.

GOOD PRODUCT w/ DESIRABLE FEATURES + PRICED RIGHT = STRONG DEMAND OUT THERE

Simple - so don't interpret it as anything other than this. No, you can't price at peak levels and expect multiple offers. No, you can't have a property priced high and in need of a total gut renovation and get multiple offers over ask. And No, you can't have a property with no light or view fetch top dollar and sell fast today! If you price high and test the market or have a property with features that make it a hard sell (low floor, undesirable location, lack of sunlight, lack of view, in need of major work), you will find the market may be very different than what I am describing here. My business has been quite active for about seven months or so with about $4.1m in closings the past four months, $4.4m or so in contracts signed pending closing, and another $7.8m or so in active negotiations across varying price points in Manhattan right now. All of my deals seem to fit in with the updated range of where I see this market trading right now. I leave it to you guys to tell me if you see something different!

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Where the Deals Are Happening Jan & Feb 2010

Christine Toes here. I saw Noah's post a few days ago citing that the market had really picked up lately. Here is what I have seen in my own business:

201 E 28th, large one bed co-op with outdoor space/views, asking $799K on 9/1, reduced to $749K mid Oct, contract signed early January at ~6% below ask.

77 Seventh Ave (14th St), renovated, converted alcove studio co-op w/ views asking $525K, in contract just below ask. Multiple offers. First open house 1/17, contract fully executed 1/27.

115 East 9th St, updated, one bedroom co-op w/ views. On market 2/7, first showings 2/12, 52 buyers viewed property between 2/12 and 2/15. Four offers at best and final. Cash offer accepted over asking price, 1/15. Two bidders were putting over 50% cash down. Two of the bidders had just lost bidding wars on other units, came to view the apartment during a blizzard and came in strong with offers the next day.

101 W 23rd St, renovated, converted one bedroom in a landlease co-op building. In contract at asking price after being on market since 9/2009. Price drops in Oct & Nov, then with reduction from $275K to $260K on 1/4, OFAC within ten days.

Week of Feb 7th, 2010 - Williamsburg, Brooklyn new development condo - Under $500K One bedroom, contract out at 10% below asking price.

Week of Feb 7th, 2010 - Williamsburg, Brooklyn new development condo immediate occupancy, 85% sold and closed. $830K two bedroom w/ city views, buyers wanted 15% below ask, developer would only do 10% citing market pick up. No deal.

Week of Feb 15th, 2010 - Williamsburg, Brooklyn new development condo, 60% sold and closed - $850K two bedroom w/ city views, buyers wanted 15% below ask (prices already reduced 19% since offering plan filing), developer would only do 10%.

Week of Feb 15th, 2010 - Upper East Side one bedroom co-op with outdoor space, ask $560K, on market for three open houses, contracts out at less than 5% below ask. Buyer putting 50% cash down.

Week of Feb 15th, 2010 - Chelsea one bedroom co-op asking $650K, thought customer had it for $615K, contracts went out, higher all cash offer came in, buyer lost apartment, continuing to look.

Toes says: Inventory is way down and transaction volume is up, especially in the studio and one bedroom market. Apartments that sell the fastest have something special about them - renovations, views, outdoor space, etc. The below 23rd Street and above Canal Street market is alive and well.

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Junk Bond Spreads Widen on Sovereign Debt Concerns

A: Yes global market forces and sovereign debt concerns do matter. They just matter before any ripple may ultimately come our way, so its worth keeping your eyes on. After the huge rally in all assets for much of 2009, the search for yield now comes with great risk and you are seeing signs of risk aversion these past few weeks. Will the equity markets once again lag and follow the credit markets?

According to FT's, "Investors Abandon Junk Bonds" (via Yves over at NakedCapitalism):

Spreads – the difference between the yields on junk bonds and US Treasuries – have widened more than 100 basis points since January 11, and stand at about 700bp, as measured by the Bank of America Merrill Lynch index.

“If the result of sovereign problems is fiscal tightening and higher rates, a double-dip recession becomes an increasing possibility. This outcome would dent, if not fully derail, the positive trend in corporate ­fundamentals.”

Junk bonds, issued by com­panies with credit ratings below investment grade, soared in price last year as investors poured more than $30bn into bond funds, in search of higher returns at a time when official interest rates were at all-time lows. This demand for higher yields led to record bond issuance, allowing even cash-strapped companies to refinance. However, in the past week, US high-yield bond funds and exchange-traded funds saw outflows of $984m – the highest since the week of September 28 2005, according to Lipper. The redemptions pushed the trailing four-week average sales figure to an outflow for the first time since March. The net asset value of bond funds tracked by Lipper fell $1.6bn in the week, because of market declines, the largest such drop since November 2008 in the thick of the downturn.

Junk bonds soared in 2009 (reuters states HY bonds soared a record 57.5% in 2009) as the search for yield was the name of the game. Now, after that huge move the search for yield comes with a high price: higher risk, as investors demand higher yield to own junk bonds rather than risk free US Treasurys of similar maturity. As market junkies know all too well, investors hate uncertainty and risk.

Sovereign debt issues & tightening in China now seem to be at the forefront of investor concerns, causing a flight to safer assets (mainly treasuries and US dollars) and that is causing a ripple effect to start an unwind of a huge dollar carry trade that built up for much of 2009 behind Fed ZIRP and guarantees on everything and anything. The buildup of such a crowded trade usually leads to an exaggerated unwind when confidence and perception changes; the challenge is timing and pinpointing the exact spark as you never know what the market will deem worthy of reversing the trade and not. For example, Dubai's default was all but a case of fleas that markets quickly shook off. Greece and other concerns over the PIGS, however, are a different story today. It's still a bit too early to tell if this is simply a healthy adjustment after a huge move in 2009 or something else that will lead to a more extreme adjustment in global markets; either way, our eyes should be open!

As I said before, its possible a future double dip is the result of fiscal/monetary tightening as an unintended consequence of actions taken to stem the crisis we just went through...China began already, time will tell when we do the same.

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The 101 Guide to Getting an Investor Deal Done

We thought we would share a bit of what we’re seeing on the investor front at this time. In this market, we’re speaking with lots of groups with cash galore (particularly foreigners), looking to capitalize on this “depressed” market that we’re in. News are a’buzzin’ over in their respective countries that Manhattan is THE place to buy right now, and all of them want to get in on the action before their competition does. We’re finding that many of them are stepping into the NY market for the first time based on this buzz, with little local experience and much hearsay upon which they’re hanging their hats.

The issue is that many believe that they can purchase property at distressed prices and still get out of the investment in the next few years. While this can happen, it is far from the norm, with the plan generally executed by heavy hitters versus first time investors. Further, many are looking for “opportunity”. Who isn’t? It quickly slides into a question of which came first: the chicken or the egg?

The conversation usually goes something like this:

Agent: What are you looking for in terms of an investment?
Investor: I want to see properties that offer great value.
Agent: What does that mean to you?
Investor: You tell me, where is there opportunity in this market.
Agent: It depends on your needs, financing and exit strategy
Investor: We are in this to make money, and will tailor the strategy according to the opportunity.

So for those of you looking to wet your feet as a newbie investor, (or merely if you’re interested in that side of the coin) here is what it takes to make a deal happen today.

Keys to getting a deal done:

- Understand the basics: let’s look at very round numbers to make the point. Assume that you’re looking at a $300-$500 sq. ft. purchase price to acquire a building. Add on to that another $350-$400 in construction costs. Add on 5%+ in transaction costs. We’re now already nearing the $900/sq.ft. mark, and this doesn’t even take into account other soft costs associated with completing the project. Considering that condominium apartments are selling at an average of $1000/sq.ft. in the city, we’re talking razor thin margins for a re-sale opportunity, and long time-frame for renting the apartments out. Compare this to the ability to purchase in bulk new construction at less than $650/sq.ft. and you have to really wonder.

- Realize that it’s all scalable: “Yes but what about Harlem, Brooklyn or LIC?” you ask. Sure, most of the related costs are scaled down to be cheaper, but so are the prices on the way out, meaning there’s only a slight marginal benefit for investing in less expensive neighborhoods for the near term.

- Have your financing lined up: Understand that financing for acquisition needs is a max of 50%, and for development it’s close to non-existent. No longer can you rely on leverage to make a project worthwhile, refinancing just one or two years down the road as your exit strategy.

- Know your investment strategy: what does “opportunity” mean to you? Yesteryear’s mom-and-pop developers are this year’s vulture investors. You are not alone in trying to find a deal; chances are the bigger players have already scoured through the existing market opportunities. What is your time horizon? How realistic is it? Be disciplined about what your needs are, and then diligently work to find situations to meet your needs. If you do happen to work it the other way, be ready to work quickly and with all cash (further about that below).

- Are you an investor or not? We find it interesting when so-called investors get wrapped up in location, views or the quality of finishes. Unless you have a large portfolio you are trying to diversify, what should matter most to you is your return on investment. There is a buyer or renter for every apartment out there; don’t use individual standards to judge institutional opportunities.

- On the down low: As banks continue to extend and pretend, and developers maintain their pain, no one wants to make distressed opportunities too public. Most of the good deals taking place happen via relationships, conversations and quiet negotiations. Don’t expect to have 10 opportunities in front of you at any point in time. You need patience to allow the opportunities to surface; any public deal with readily available information is likely not going to give you the returns you seek.

- Speed: parlaying on the above, when deals do arise, be ready to move quickly. Speed to closing is absolutely key, and making the process easier on the bank or distressed owner/developer will be a significant competitive advantage to you. The window you will have to move on the deal will likely be tight, which is why having your ducks aligned in terms of your required returns is so important. That will NOT be the time for you spend weeks upon weeks determining if the deal makes sense or not. You will need a turnkey system in place, along with a team of trusted professionals, to help you quickly ascertain the situation to be able to jump on it.

- Cash rules: ‘nothing new here, but we couldn’t emphasize it more. All cash deals enable you to have the speed and ease of closing that any distressed seller will be looking for.

- Have realistic market expectations: don’t expect to get out of the project in the next 1-3 years; although the flip mentality should be long gone by now, many investors still believe that they can enter an exit an investment in the blink of an eye. Long term money may well be waiting to be made, but the short term bets are riskier than ever.

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Understanding The Lag w/ Quarterly Reports

A: Thanks 'jjfashion' for your comments to yesterday's discussion on real time broker status updates to Contract Signed and how the market was faring after the first month of the new year. To hear this guy say it, "To suggest anything other than what is supported by closing data is low integrity unless you disclaim it explicitly...". Now I wont disclaim the quarterly market reports, which happen to consistently vary from one brokerage firm to another, but I will continue to defend how lagging these reports are and how one of the mission's of this site has always been to try to close the gap on what is happening out in the market today and what the lagging reports tell us. In the end, the best information we can get on current market activity and strength is where these contracts are being signed right now and how the pace of contracts signed changes with time!

If you guys know a better way to consistently find out where contracts are being signed today, I'm all ears! The only ones that know this information are the buyer, seller, brokers, attorneys, lender, managing agent that processes the purchase application and the board that will ultimately approve the purchase. It is true that I am just one man and that discussions on this site are taken directly from my business in the field, putting bids in on multiple properties for clients, talking to my colleagues after they go to company sales meetings, talking to sales managers I keep in touch with, and interpreting the real time data I get updates for about 6 times a day directly from one of the distributors of the REBNY broker sharing system. As I stated clearly yesterday and many times before:

"For now clearly buyers and sellers are agreeing somewhere out there - I'm just trying to figure out where!"

Now, lets move on to understanding the big time lag with these quarterly reports whose data is based on a collection of closings captured by public record - to get there a number of things have to occur and as readers of this site know I focus on WHEN THE CONTRACT WAS SIGNED as the snapshot in time that defines how the market was doing when the deal was made:

LAG #1: Broker Status Updates - The data is only as good as the agent that updates and maintains the listing. As good as Streeteasy, NYTimes, and Broker Sharing systems are, if the agent does not change the status of a listing from ACTIVE to CONTRACT SIGNED, we will not get that update! So the first lag is the one directly from the agent servicing the listing who is in charge of updating their webad using the broker sharing system provided by their employing brokers. Corcoran uses TAXI, Elliman uses LIMO, and Halstead/BHS/Sothebys uses RealPlus. Other firms use OLR. In the end, the updates are supposed to be immediately shared with all REBNY member brokerage firms and their agents. I find there is usually a 1Day - 14Day lag between when a contract was actually signed and when the broker updates their listing to be shared.

LAG #2: Purchase Application - Generally, Co-op purchase applications are a bit more tedious and time consuming than ones for a condo. Since condos have a 'right of first refusal' board process as opposed to a stricter 'review and interview' process for co-ops, I find co-op buyers spend more time making sure all requirements are exactly as requested and the package is as meticulous prepared as possible. This takes time to gather business and personal references, tax returns, all statements to verify assets, landlord/mgmt letter, employment letters, complete purchase application, etc..

LAG #3: Loan Commitment / Aztec Forms - As we all know, the underwriting process is quite different than it used to be; banks actually check everything and verify that you can qualify to secure financing for the transaction. Additionally, recent HVCC code changes require outside appraisals rather in house ones. All in all, the goal is to get that commitment and aztec forms (for coops) as required if there is financing in the deal; which most deals have. Since there is an overlap with LAG #2 during this part of the process, usually the loan docs are the final piece of the purchase application needed to complete the package for processing. I am seeing loans take anywhere from 3 weeks to 6 weeks these days to come in.

LAG #4: Management Processing - Everybody wants the managing agent to process their package fast! But we all dont get what we want. I find it takes anywhere up to 2-3 weeks for management to fully process a purchase application and send it over to the board for review.

LAG #5: Board Review - In a perfect world, the purchase application will be reviewed within days of receipt by the condo or coop board. But this world is far from perfect. Depending on how your board handles purchase applications, you may have to wait for the next meeting for the package to be reviewed. I find this board approval process to generally take anywhere from 10Days-4 weeks upon receipt of the fully completed and processed package. If I get a package reviewed and approved within 10 days of receipt, I find myself lucky!

LAG #6: Closing - After the co-op approves the deal or the condo waives their right of first refusal, the attorneys will start to work on coordinating a closing date. This date must be agreeable by the purchaser, the seller, the buyer's lender/seller's payoff bank, and the managing agent handling the transfer. Either buyer or seller can also delay the closing a bit if that is preferred before one of the attorneys issues a TOE to get things moving. Generally I find that my closings take place about 1-2 weeks AFTER the approval comes in from the board to close the deal.

LAG #7: Public Record - The final lag for the deal to be captured by the quarterly report! This can take anywhere from weeks to months! If public record happens to capture and record the sale right after the cutoff date for quarterly report inclusion, well then it needs to wait for the next quarter's report!

All of these forces contribute to the lag it takes for a listing to be captured for inclusion into the quarterly report that is released to the public and interpreted as conditions that exist today. That is where I try to come in and explain the flaw.

But don't take my word for, MillerSamuel's Methodology site clearly explains this Public Record lag to you:

Quarterly Manhattan Market Overview: A quarterly analysis of co-op and condo sales in Manhattan. Unlike the stock markets, apartment sales data continues to fall in the prior quarter as it becomes available because sales are usually not recorded at time of closing and may lag the closing date by several weeks or months. However, in order for the report to be useful and timely, the report represents a reliable analysis of market conditions during the quarter based on the sales data obtained by the end of the quarter.

But if you want me to make it even easier for you, let's take one of my recent closings as an example; with my client's blessing of course:

67 Riverside Drive - Apt 9A

So, here we have a transaction that was signed into contract October 26th after a 2 week attorney diligence review period that due to the lags mentioned above will not be included into the Manhattan Quarterly Reports until Q1 2010 is released April 2nd, 2010! So, when the report is released in April it will contain this one transaction that was representative of the market conditions in mid October, 2009, some 24 weeks earlier!

Is it possible that where contracts are being signed in March right before the Q1 2010 report is released, have changed a bit from when this deal was signed? The answer is YES! But this is all we got right now and what many are using to analyze and interpret where bids for Manhattan property seem to be coming in today! This is the gap I am trying to fill. Apparently, some people cant take it and say that to ignore these reports as indicative of today's market is to degrade my integrity! Okay then....

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Manhattan Markets: Things Keep Moving Along....

A: Trying to keep it real here guys, unbiased and all, and continue to separate my bigger picture macro thoughts and concerns with what is happening out there in the Manhattan residential real estate market right now! In the last week alone, my new backend systems see about 222 new contracts signed telling us that the market continues to move along. This pickup comes after a brief 5-7 week slowdown in signed deals as we entered the end of November and the holiday season. Let's discuss along with a few sneak peak charts from the upcoming new UrbanDigs Analytics!

The data doesn't lie and as always, you have to understand that every property on the market is viewed and valued differently by the prospective purchaser. With that said, I can't deny the action out there and the numbers are showing it.

What is interesting is following listings that had a hard time selling even as sales surged in June, July and August of 2009 following the plunge in sales volume from the adjustment we had. The main reason is that bids did not improve as much back then as they did to today's marketplace following the March lows ---> rather, the improvement was progressive in nature:

"The reflation was slow to start and progressive in nature. It did not all occur at one point in time. Rather, it started in the lower end around May/June and trickled to the higher end over time. It was progressive in nature meaning the improvement in bids occurred as time went on, to where we are today!"

490 WEA, Unit 10D ---> 325 Days on market, no price cut since last June, entered contract yesterday

171 West 79th, Unit #41 ---> 150 Days on market, price cut 8% on Nov 1st, entered contract few days ago

625 Park Ave, Unit 1B ---> 449 Days on market, price cut last April, entered contract 3 weeks ago

77 Park Ave, Unit 15E ---> 210 Days on market, price cut 6% on October 10th, entered contract few days ago

925 Park Ave, Unit 11/12 ---> 345 Days on market, price cut 6% in early December, entered contract a week ago

35 Bethune St, Unit 2/3A ---> 40 Days on market erupted into bidding war

1035 Park Ave, Unit 9A ---> 117 Days on market, price chop 11% in late Oct, entered contract less than 2 weeks ago

30 East 76th, Unit 5A ---> 175 Days on market, price cut 6% early November, entered into contract about 10 days ago

...you get the picture. The point is there is action out there. Not everything sells at once and to see weekly contracts signed trends at or above 225 or so is very healthy! Recall that Manhattan averages about 8,000-9,000 closings a year (around 708 contracts signed a month) and it was only the euphoric peak year of 2007 that saw over 13,000 closings (or about 108 contracts signed a month on average). Given the seasonality of our markets and that we are in the active time of year, its healthy to see this level of activity this time of year. This is especially true when considering where we came from and the delayed seasonality effect that we experienced due to our markets adjustment process late 2008 into early 2009.

Now please don't mis-interpret this discussion to mean bids are coming in at peak levels again, they are not - or that every development is saved and no good deals are happening! Rather, we can't deny the progressive improvement in bids over the past 11 months and the fact that desirable properties that are priced right are moving in today's market! I wouldn't expect this pace of sales to sustain itself for that long, maybe a few more months because if sell side optimism starts to outpace buy side confidence, well then us brokers will find deals harder and harder to put together. Time will tell. For now clearly buyers and sellers are agreeing somewhere out there - I'm just trying to figure out where!

Here is a sneak peak into one of the new UrbanDigs charts on Pending Sales for Manhattan Real Estate:

You can clearly see the steep plunge in sales volume around Aug/Sept of 2008 and the bottoming out of that freefall around February/March of 2009! Interesting stuff isn't it! The rise in sales volume after the March lows really gathered steam around June and July of last year and maintained that pace for a few months before adjusting down a bit prior to the holidays. I now have pending sales at the 4,416 units level which means when Q1 2010's report is released in early April you will see a whopping surge when compared to Q1 2009's level!

To feed the curiosity in you a bit more, here is another sneak peak into Total Active Inventory trends for Manhattan going back the past 4 years:

Again, you can see the sharp rise and fall of our inventory levels before Lehman failed and after the March lows when sales volume started to surge. The latest tick up shows the new listings hitting the marketplace in the past 3-4 weeks, as Active Inventory currently stands around the 7,833 level. So, even with the strong sales pace lately we are starting to see inventory levels tick up - telling me that more listings are entering the market and coming back onto the market these past few weeks, then are being excluded due to contract signings or temp/perm removed from the marketplace! In short, YES the market is active and moving, and YES new listings are coming back on!

Transparency is good and you guys are about to get a ton of it in a few months!

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Short Term Treasuries Telling Us Something???

A: When 1-Month Treasury yields turn negative it makes me wonder why investors are parking money for the very near term into vehicles that protect the full principal? Its generally a tell tale sign of risk aversion. As money pours into the short term protection of 1-Month Treasuries, yields once again fell to negative for the first time since March 2009. Something worth keeping an eye on although we can't read as much into it when the fed continues to maintain a zero interest rate overnight policy.

You can take a look at the chart to the right showing you the yields on 1-Month Treasury bills for the past year - noticing the move to -0.01%. According to Bloomberg, "U.S. One-Month Bill Rate Negative for First Time Since March":

“There’s some flight to quality with concern around sovereign risk around the globe, like Greece,” said Anshul Pradhan, an interest-rate strategist in New York at Barclays Plc, one of the 18 primary dealers that are required to bid at Treasury auctions. “Secondly, the bill universe is likely to shrink as the Treasury continues to term out debt, tilting the balance further toward demand.”

Greece’s 10-year bonds fell, pushing the premium investors demand to hold the securities instead of benchmark German bunds to the most since the inception of the euro, on concern the nation’s finances will worsen.

Bill rates turned negative for the first time and note and bond yields reached record lows at the end of 2008 as investors sought refuge in government securities after the collapse of Lehman Brothers Holdings Inc. and a freeze in global credit markets.

Treasury sold $10Bln in 4-week bills yesterday with investors only getting their principal investment back in return. Considering where we came from, when fear changes investor attitudes from chasing risk to simply getting their initial investment in full back, it's worth watching as an anti-risk trade might be setting up. This also tells me investors absolutely expect the fed to maintain a ZIRP policy. With a ZIRP policy in place, we can't read too much into short term yields turning negative but it still is something worth watching for in the near term as a risk aversion trade.

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Morgan Stanley: 'The Tightening Has Begun'

A: Interesting comments out from Morgan Stanley's European equity analyst Teun Draisma this morning regarding the future reality of tightening policy. The main point of the comments is that tighter policy will 'intensify' as 2010 rolls on, shaping up more like '1994 and 2004'.

From Business Insider, "Morgan Stanley: Sell Into Strength, The Tightening Has Begun":

Morgan Stanley analyst Teun Draisma:

Sell into strength, as authorities have switched from "all out stimulus" to "let's start some stimulus withdrawal". Tightening measures are coming in thick and fast around the world. We always thought that the start of tightening was not the first Fed rate hike, but could be many other things including higher taxes, less spending, more regulation, Chinese/Asian tightening, or Fed language change. Recent initiatives include Obama's banking initiatives, and several Asian tightening measures. In the next few months this theme is set to intensify, and we expect positive payrolls, a Fed language change, and the start of QE withdrawal. This willingness of authorities to move away from crisis mode is an important change and means that the tightening phase in the broad sense of the word has now started. Thus, indeed, 2010 is shaping up to be like 1994 and 2004, as we expected.

The start of tightening is hardly ever the end of the growth cycle, and normally the accompanying dip needs to be bought, but it typically is a serious double-digit dip lasting 2 quarters or more. The sector rotation has of course already started in October-2009 and is set to continue. As a result we move 2% from equities to bonds in our asset allocation, going to +5% cash, -2% UW equities, -3% UW bonds. We think short-term strength is quite possible, and we have not quite gotten an outright sell signal on our MTIs either, but the 6 month risk-reward of being long is worsening, and we recommend to sell into strength. Our 12 month MSCI Europe target of 1030 implies 6% downside.

Meanwhile. Goldman Sachs says, "It'll Be a Disaster If Bernanke Raises Rates", and calls for a 'gradual exit' from the current accommodative policy:

"On the surface, the backdrop for the Federal Open Market Committee meeting next week looks quite encouraging for members pressing the case for a gradual “exit” from the current accommodative stance.

We also are not sure that Fed officials will need to raise the discount rate in order to facilitate draining excess reserves. It is unclear whether—and if so when—they will actually decide to undertake such a drainage operation. Our own view is that the volume of excess reserves does not have important effects on the broad financial system and the economy, at least now that the payment of interest on reserves enables the FOMC to raise short-term interest rates without having to match the demand and supply of reserves. Moreover, even if Fed officials do introduce a term deposit facility that is priced attractively enough to mop up a significant share of the current $1 trillion excess, the rate on this facility would likely be well below 0.5% given the current slope of the yield curve. This would make arbitrage unattractive even without a higher discount rate.

The argument that a higher discount rate would be a signal that liquidity conditions have normalized is therefore similar to the phasing out of the other emergency facilities. But against this, it is important to consider the potential tightening in financial conditions if markets view such a step as a precursor to a hike in the funds rate. Especially at a time when the economy clearly needs all the monetary stimulus it can get, this risk should not be overlooked."

2010 will likely not disappoint in terms of volatility and surprises. It's always something from left field that nobody expects that comes out and changes the world as we knew it - its just timing it and predicting exactly what that will be that is a constant challenge! It is very possible that any double dip in our future is a direct result of the fed purposely tightening policy to control unintended inflationary consequences from the massive stimulus applied to stem the severe deflationary episode we just experienced. That, however, could be years away.

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MortgageMan's Update on Mortgage Markets

First and foremost, apologies... Haven't had much time in the past half a year or so to post anything. Much of it had to do with the refinancing boom of 2009 and me taking my mortgage career to the next level and switching lenders.

That said, it is nice to be back and I truly look forward to posting here on a regular basis and reading your feedback.

So lets backtrack a little bit and let me give you a little update as to what has happened in the mortgage market since my last post:

1. RATES: We are hovering around the 5.25% area for the 30 Year, 4.25% on the 5/1 and about 4.50% for the 7/1 Conforming products. The Jumbo 30 year is around the 5.75% range and the 5/1 JUMBO ARM's are in the high 4's.

2. LOAN LIMITS : Might be a bit of old news but the extended loan limits of '08 & '09 were extended to 2010. Take advantage of the High Balance Conforming $729,750 while you can.

3. NEW DEV FINANCING: Still require a 71% presale for New Construction before banks can step in to provide lending. FHA can sometimes go into a building for a spot approval and issue a 51% approval. Also some regional banks (Astoria, Emigrant, Apple) that don't sell the loans off their portfolios may have a lower threshold...This may go down to 51% once HUD declares Manhattan a non-declining market.

4. RESPA GUIDELINES: By far one of the most significant changes of 2009/2010 is the new RESPA regulation imposed by HUD. Basically it boils down to a completely brand new Good Faith Estimate that is supposedly easier to understand and shop around, as well as full disclosure of ALL fees and a limit by the government on banks charging various processing and underwriting fees.

The RESPA guidelines require full disclosure of lender, buyer, seller, and title fees. There is a tolerance of 10% by which certain individual fees can increase on the HUD-1 Settlement Statement (the piece of paper you get at closing listing ALL your fees), from the originally quoted GFE. The GFE can only be changed under very stringent circumstances or instances where it is out of the lender's control. For instance if the rate needed to be extended due to the seller not being able to set a closing on time, and as a result points needed to be charged for the rate extension.

5. LENDING RATES & 10YR TREASURY NOTE: From 2007 to 2009, it seemed that rates weren't affected as much as they were by the TNX or the 10 Year Treasury Note, and at one point in 2007 Noah wrote an article on the comparison of rates and the 10 Year. It showed very little correlation between both.

As a result, many lenders started following Mortgage Backed Securities and trusted it as a gauge for predicting where rates were going. Obviously I am not going to discount that the MBS is not an indicator of where rates are or where they are going, but in the past couple of months I do see some trends relating to mortgage rates and the 10 Year Note once again... Down to a point of where the yields drop and rates move down as well.

I am going to ask Noah to research the 10 Year vs. Mortgage rates and post up his findings here.

More updates to come next week!

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Valuing Manhattan Real Estate: Revisited

Sorry for the duplicate entry here, just very busy with clients and UD 2.0 - I know its repetitive but this blog, while becoming more of a part time job, sometimes has to be sacrificed when my time gets taken up with clients. This is a slight re-edit of my July 17, 2009 piece "Valuing Manhattan Real Estate" to reflect todays marketplace.

A: I often get asked how I approach my consulting for my buyer clients. I take it a bit differently than most brokers and like to take on the challenge of 'valuation/bidding strategy' over procurement of property - I find most of my buyers use me to find out what is really going on out there and where a particular product should trade if they are interested in bidding. Given the great strides in overcoming the lack of a MLS system here in Manhattan, consumers can now easily find the bulk of our inventory on their own using sites like Streeteasy.com or NYTimes.com. The Manhattan real estate market is a different animal than most markets outside our crazy little island here. It happens to be a very fast paced market with lots of variables affecting property value and a very diversified and deep buyer pool. Every broker has their own unique way of valuing Manhattan real estate when a client is interested in bidding - from sending simple data based excel tables on past comps to a more in depth property and current market analysis. Here is how I like to do it.

First, you have to have an idea of where this market is trading right NOW as opposed to say 6-months ago. Keeping a mental history of where trades seem to be occurring as time goes on ultimately turns into a gut instinct on where the market seems to be trading today compared to say 3 months, 6 months, or 12 months ago. Imagine if you followed INTEL stock daily for 2 years straight; you would know exactly where the stock is trading today and the relative improvement or decline the equity price experienced over time. Same concept, two very different markets. Manhattan real estate, while much faster paced than most markets across the country, will still be an illiquid and challenging marketplace to keep tabs on.

Believe it or not, most brokers I have dealt with seem to be a bit behind the curve when it comes to what the markets are doing today in relation to where we came from. Its not their fault, its just that they focus more on conducting their business and servicing their clients than to have a trading perspective on our marketplace; that is perfectly fine and to be expected!

Having an idea of where trades occurred from peak levels and how bids submitted changed over time is absolutely vital to consultations with my buyer clients. For me, its a constant challenge that I look forward to; I actually enjoy it! Knowing where you are in the grand scheme of things gives your clients a leg up to be ahead of the curve, not behind it.

Before you go further, it is important to disclose that I look at when a contract has been signed and NOT when a listing closes when doing a property valuation. Its more important to me to see where the deal occurred when that contract was fully executed - as closing may occur up to 2-4+ months later. We can go back in time to explain why this is important:

If you had a deal that was signed in AUG of 2008 yet closed in NOV 2008, analyzing based off the closing date may be misleading as this deal was signed BEFORE our market froze up in mid-September from Lehman's failure.

Understand a few things when it comes to this marketplace:

1) emotions DO play a role on both sides
2) confidence CAN rise and fall in different ways: either progressively over time or at the drop of a hat if a shock hits
3) in a fast paced market when inventory has experienced a notable decline, buyers may act irrationally when finding that perfect place
4) real estate is an illiquid marketplace and not a stock that can be easily bought and sold with little to no effort or costs
5) every buyer values views, natural sunlight, building amenities, monthly debt service obligations, layouts, school zones, location and renovations differently - try not to overestimate the number of people that you perceive as agreeing with your line of thinking; the false consensus effect

With that said, here are the 3 main elements (changes in market conditions, renovation adjustments, light/view adjustments) that I focus on for valuating real estate in Manhattan:

1. MARKET CONDITIONS PREMIUM/DISCOUNT - How has the market changed today compared to the past comparable sale and how does this affect valuation for a product my client wants to bid on? If you are bidding on APT 10A, chances are you will not have the luxury of a 9A sale a week ago to compare to. So, you must adjust for time and if you do, you must know what you are adjusting to.

Contrary to popular belief, I don't only look at the most recent sale to find a unit to use as a comparable for my analysis. Instead, I also like to find a SAME LINE sale or SAME ROOM sale that traded near peak to analyze and do a time adjustment. Some brokers will only look at sales in the most recent 4-6 months discounting anything older as irrelevent; not me. I have no problem looking at a very similar sale that traded near peak (say mid 2007) and then do a negative time adjustment based on where this price point seems to be trading today.

Since smaller units tend to trade at lower premiums than larger units, I like to compare apples to apples; for example, if a studio and 1BR were the last sales in the building and I need to analyze a Classic-6, Id rather go back a year or two and find a same line or another Classic-6 to use instead. I will just adjust for market conditions myself.

That's another thing, I try to compare units of the SAME LINE for valuation purposes. I mean, what is the exact formula for quantifying how much of a premium a Southwest open city exposure should get over say a fairly obstructed North only exposure if all other property features are very similar? I certainly don't know. A buyer will likely value the open Southwest exposure higher than the obstructed North exposure - just how much higher is what the challenge is.

Breaking down by price point, I use the model range of discounts that I often quote here on UrbanDigs to consult for my clients. While finding a very recent same line sale is extremely useful, its usually not available to me. Lately I have been finding that deals signed before Lehman, say between MAR-AUG of 2008, were trading about 3-5% or so off of peak levels - it was only after Lehman that our market froze up and experienced that sharp move down. Here is my most recent snapshot on today's market decline from peak, taking into account the slight progressive improvement from 10 months ago:

HIGH END ($5M+) - down aprox 20% - 30% from peak
HIGH/MIDDLE ($2M - $5M) - down aprox 20% - 27% from peak
MID END ($1M - $2M) - down aprox 18% to 25% from peak
LOWER END (Under $1M) - down aprox 13% - 20% from peak

If I see a perfect same line comp that was signed into contract in March 2009 and closed last June, I would probably expect bids to come in slightly higher today, perhaps 3%-8% based on price point and the quality of property features.

2. RENOVATION PREMIUM/DISCOUNT - You cant just assume that every apartment is in the same condition. So, we need to determine the quality of the comparable sale and how that compares to the unit we are analyzing. In general, anything in the internal system listed at FAIR, GOOD, or EXCELLENT probably needs updating - with FAIR likely being a gut renovation needed. Only if it says MINT or NEW do I assume that the place was in fully renovated condition - pictures play a nice role here if they are available. I often find myself browsing streeteasy.com to go back and check for myself the condition of the kitchens, bathrooms, floors, etc.. of units I determine useful for a comparable analysis. Since you cant just visit a past sold comparable that you are using, this is the next best thing.

Many people have different needs when it comes to renovations. Some buyers have no problem spending the bare minimum for a renovation, while others absolutely must have a kitchen that costs over $60,000 to update with high quality everything. For this analysis, you can't just make up numbers willingly to rationalize the property trading at a lower level. Instead, try to figure out how much money is needed to make the property in question comparable to a past sale worth analyzing.

3. LIGHT/VIEW PREMIUM/DISCOUNT (Per Floor Adjustment) - Tricky, and more art associated with this one. You must give a premium or a discount based on what floor the comparable being used was on in your analysis. If you are about to bid on 3A and you see that 22A sold a year ago, well then you have some adjustments to make.

The general rule of thumb that I use is about 10K-15K or so per floor for existing resales, but it gets a bit tricky because you need to use some art and the quality of the light/view for in this aspect of the valuation. You see, sometimes charming treetop views on the 3rd floor can be just as popular as open city views on the 10th floor that look over the mechanicals of neighboring rooftops - in which case a 105K premium for the 10th floor may not be warranted. Other times, the difference between the 6th floor and the 10th floor is the difference between looking at a building's rear fifteen feet away and having open city views. In this case, a 40K premium for the 10th floor may not be enough.

So you need to use some art here and figure out just how different is the light/view from one comparable to another. The bigger the difference, the higher the multiplier you should use. In Manhattan, buyers pay for flooded sunshine and park/river/city views. I would use a lower formula to compare the 3rd floor with say the 5th floor, in which both have similar views! When dealing with a property that has amazing views or is a dungeon, well you need to tweak the formula a bit to satisfy the demand of this picky yet willingly wealthy Manhattan buyer pool.

New developments tend to give a default 15K-25K premium per floor in asking prices, unless otherwise re-negotiated by the buyer prior to contract signing.

When using these 3 main elements, I usually come up with a nice range to anticipate where the unit being analyzed MAY trade at! I always provide ranges as nobody is perfect and markets are sometimes inefficient - after all, a perfect buyer with unlimited funds may show up at a sellers door anytime; although this happened more frequently in 2006 and 2007 then is happening now.

The items that play a lesser role include:

a) properly discounting first and second floor apartments that are generally harder to sell because buyers are concerned about security, noise, traffic walking by, etc..

b) layout; sometimes a layout can be a hard sell such as a railroad style apartment

c) monthly expenses; general range for f/t doorman building is $1.25/$1.70/sft or so given the additional same amenities offered from the building - anything above this range must be properly compromised for via a lower purchase price and anything above this range should get a slight premium due to affordability

You may wonder why LOCATION is not included. Well that is because I base my consulting on IN-BUILDING TRANSACTIONS where location is static! The key is to make the analysis as simple as possible without introducing more variables into the equation.

In my opinion, using neighboring comps is one way of saying, 'I cant find any useful comps to support this purchase price in the same building that you are buying into'. In-building same line comps are the best, hands down, to use for a property analysis. I only use neighboring/similar comps if there is insufficient data on in-building comps to conduct an analysis - and when I do, you better find the closest property and the building with the most similar set of amenities offered. Once you start changing the variables your valuation technique will get more and more flawed. Even comparing one line of a building to another line of the same building can be argued as flawed because of the difference in layout, level of natural sunlight, and exposures/view that comes from being in a different section of the building. I have seen buildings where the A-line trades at a significant discount to say the C-line simply because of the location and exposures/obstructions of each line.

So there you have it, my summed up method for valuing Manhattan real estate. The parts that can't be taught is the gut instinct that comes from viewing a property and seeing how it compares to hundreds of similar units I have seen over the past 5 years and keeping that mental history of where bids seem to be coming in over time. That's the art of the valuation process that comes with daily experience in the field over the years.

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Leftovers Market Starting To See Some New Listings

A: After going on appointments with six different clients over the past few weeks, the general consensus from these buyers are, 'I'm tired of leftovers, where is all the new stuff'? Funny when I don't say anything to clients as I focus on my business but observe similar statements from different buyers that don't know each other. My response would probably be, yes I can see the market the past 3-4 weeks as being one of slim pickings, or leftovers if you prefer, but be patient because new listings will be coming!

Every year in December we see the usual surge in listings removed from the marketplace for seasonal reasons. This time around saw the very same trend. My new data source shows around 1,100 existing listings or so removed from the marketplace in December alone - again, nothing abnormal here. Here's the rub: Active inventory was around 8,950 or so at the end of November and is lingering around 7,205 units right now. Factor in the 1,100+ listings removed over this time period and you see about 650-700 contracts that were signed and now off the market as well.

That pace of contracts signed is lower than prior months but fairly strong considering the usually slow month of December; with the holidays and all the lost time attorneys had a smaller window to get deals signed. Since, this pace has ticked up again as we got into the first few weeks of 2010. The continuation of deals being signed and listings removed for seasonal reasons brought inventory to the lower levels that we see today. I see Streeteasy.com shows about 3,163 listings IN CONTRACT right now for all of Manhattan (I have pending sales higher around the 4,224 level) - think about this pipeline of pending deals that will close in Q1; Ill discuss this in another post! This is why buyers feel that only the 'leftovers' remain after seeing more desirable properties get signed into contract over the past 2-5 months.

But not to fear, I already am starting to see new listings tick up and colleagues I talk to are telling me that they are going on multiple sales pitches that are expected to sign listing agreements shortly! This is about the time when I would advise new sellers to come to market or re-list after a brief time off if the property didn't sell before. As usual, pricing is the most important! With traffic levels solid and ready, willing and able buyers out there, new sellers should take advantage of the action while its here and resist the urge to price high and test the market. That strategy will only help your competition to sell faster and before yours! For the record, I see this market remaining active for another few months before slowing down again from market forces discussed in earlier articles (higher rates, higher taxes, carry trade unwind, wearing off of artificial stimulus/fed MBS purchases/tax credits, rising delinquencies, reversal of off balance sheet accounting/M2M rules, etc..)

As for buyers, if they are not frustrated by the slim pickings of quality property that is priced right then they are focusing on listings that have been on the market for 6+ months yet had not sold. The thinking here is to find sellers that missed the action because they were priced wrong and too high, but who now 'get it' and started to more aggressively lower their asking price. Perhaps those sellers are now tired of the selling process and ready to get it over with.

As for wall street bonuses, as I said in my October piece "Euphoria or Reality Over Upcoming Bonuses?":

What I don't hear are terms like: distribution of cash component vs stock options, deferred stock compensation, clawbacks, ROE shares deferred, toxic asset bonus fund (credit suisse in 2008), other government tax policy on future bonuses, etc..

In addition, you must keep in mind that this also could affect existing homeowners who counted on that cash bonus to maintain a certain lifestyle or high end property that was purchased near peak. Again, time will tell.

For now, be patient as I would expect inventory to rise the next few months as sellers (both new and re-listers) come back to the market hopefully at asking prices that are in line with where trades seem to be occurring. If I can make one more prediction, get ready for Q1 sales volume to show a surge of perhaps 100% when released in early April and compared to the very weak year earlier Q1 of 2009 - how will the media handle that one when it comes out???

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ARM Recasts Starting Already? Delinquencies Gathering Speed

A: Let's be clear on what the real issue is here with these option ARM's and other negative amortizing loan products taken out at the height of the credit boom. It's not so much the rate reset that is the concern right now, with LIBOR and other index's that rate's reset to much lower than they were when credit blew out. Rather, its the loan recast that should be the concern. Let's talk about this once again now that it seems to be making headlines for struggling borrowers across the nation. And let us not forget about the delinquencies in Prime, Jumbo, and Alt-A that seem to be gathering speed right now.

I wonder whether we really will be able to carry trade our way out of this mess given the artificial nature of what is driving asset classes across all markets right now! The search for yield while balancing risk is getting harder and harder. Between artificially low rates, a huge expiring debt monetization experiment, artificial stimulus plans stealing future growth, artificial incentives to homebuyers and builders, removal of mark-to-market rules, easing of off-balance sheet accounting rules, surging budget deficits and treasury issuance, etc.., just how solid is this foundation of growth built on? That has always been something I questioned.

The story today from CNBC is that "More Homeowners Struggling As Option ARMs Reset Higher":

Thousands of American homeowners are starting to see their monthly mortgage payments skyrocket, dealing a fresh blow to the already shaky housing recovery.

The widely feared reset of thousands of option adjustable-rate mortgages-where both interest and principal payments rise sharply-is already leaving many homeowners struggling to keep a roof over their head. Terms of the loan usually allowed the borrower to make low monthly payments initially-sometimes by just paying interest only.

But as the terms of those mortgages now readjust, homeowners are facing much higher mortgage payments at a time when the value of their house has plummeted and many are out of work. In some cases, homeowners who chose a very low starting interest rate have actually seen the overall amount of their mortgage increase-known as negative amoritization-putting them even deeper in debt.

Loan recasts are one of them. As I talked about almost a year ago in my "You Worry About ARM Resets, I'm Worried About Recasts!" piece:

While LIBOR and other indexes that are tied to Option ARM resets have come down greatly, its NOT the reset I worry about; its the RECAST! LOAN RECAST - when your loan is re-calculated with the new principal amount, to fully amortize within the previously agreed upon term; a.k.a, re-amortization of outstanding principal at the fully indexed rate. When the loan is recast, the payment required to fully amortize the loan over the remaining term becomes the new minimum payment, and the payment cap no longer applies.

It's the NEW PRINCIPAL AMOUNT that is the worry here, because of all the borrowers out there choosing the negative amortizing monthly payment option that causes the original loan amount to rise over time! There are two main reasons why your Adjustable Rate Mortgage will re-cast:

1) the loan reaches it's balance cap
2) the first scheduled re-cast date, usually 5 years from origination

Think of all the borrowers, with Option Arms/NegAm/Cosi/Cofi/Pick-A-Pay loans, that chose to pay the bare minimum monthly payment in order to buy the house that otherwise they couldn't afford, and saw their original principal rise over time; and now the recast is near! You worry about the loan resets, I'm worried about the loan recasts!

According to a Sept 2009 report from Bloomberg,

"...About $134 billion of securitized “option” adjustable-rate mortgages will reset to higher payments over the next two years, worsening the performance of bonds backed by the debt, according to Fitch Ratings. Payment resets occur after five years or when the debt grows to a preset amount, typically 110 percent to 125 percent of the original principal. Recast payments are on average 63 percent higher than homeowners’ initial minimums, and can be more than double, Fitch said."

Just because you don't hear about much anymore, doesn't mean it isn't still lingering there!

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The Improvement Was Progressive in Nature

A: An important discussion to recognize the progressive nature in which bids for Manhattan real estate has improved since the March lows. Putting aside the fact that every buyer values property features differently, we must also understand that this market does not operate in a vacuum. For some, rising interest rates over the past few weeks causes hesitation. For others, the loss of a few missed opportunities causes more aggressive bidding the next time something pops up. Its important to note just how complicated and how many factors play a role in how any one buyer decides to bid for any one property - and that buyers can and do sometimes get interested in the same place. Just because you feel a certain way, doesn't mean the rest of the buyers out there feel that way too!

To secure my bachelors of science degree in Psychology at Union College, I did my thesis on the False Consensus Effect - which is the tendency for people to project their way of thinking onto other people. I came up with my own experiment, got the money from PSY department to run it, and found that students participating indeed exercised a noticeable degree of false consensus when estimating how others think about their opinions for a series of situations. I find this false force to exist quite often when it comes to one's perception of the strength or weakness of our real estate market. If a broker has a slow few months, they tend to think the market as a whole is slow. If a buyer thinks higher rates and higher taxes brings their affordability down 5%, they tend to overestimate how every buyer thinks this way too. Its an interesting concept that I wanted to mention to begin this discussion, but now lets get onto the point.

At the height of fear, trades seemed to be occurring down from peak as follows based on price point - as discussed in my March 9th, 2009 piece "Understanding 'Liquidity', or Lack Thereof For Manhattan":

HIGH END ($5M+) - down aprox 25% - 40% from 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

The above marks the limited trades that took place in a 1-2 month window at the height of fear. It didn't last long at all and only about 450-550 contracts were being signed a month during those fear trade months! That is well below our average and indicative of the plunge in sales volume at that time! One can argue that only 900-1,100 trades across this entire marketplace really took place at the height of fear - and who knows how many of those deals didn't go through because of inability to secure financing, buyer walk aways, and co-op board rejections. That's not many at all!

The reflation was slow to start and progressive in nature. It did not all occur at one point in time. Rather, it started in the lower end around May/June and trickled to the higher end over time. It was progressive in nature meaning the improvement in bids occurred as time went on, to where we are today!

Now, not to say that there is a 1:1 relationship between this real estate market and equity markets, but lets use the progressive rise in equities as an analogy --> as the S&P went from 676 in March TO 834 in April TO 900 in May TO 1,000 in August TO 1,065 in September TO 1,100 in November AND TO 1,135 today, the rise in confidence and equity prices was progressive taking us to where we are right now! It took ten months and a few minor downtrends in between to get to where are now! Some call it a bullshit move, an artificial move, a 'sucking in' process, a rebuilding of 'hope' process that will later destroy, whatever...it doesn't matter! It happened and its in the books.

That is how the improvement in bids since the March lows occurred in this market too. As I said, every property is unique and every buyer values views, light, building amenities, renovations, monthly expenses, location, layout, and other unique property features differently! So one product may very well trade slightly different than another product even though they are both full service prewar Classic 6s in the West 80s! I don't need to justify why one product trades a bit higher or lower than another with a specific market reason. Its the nature of real estate markets and this market does not operate in a vacuum. And I certainly don't need to justify why one broker may see a different market than what I am seeing. The key is to get as much information from as wide a pool of sources as possible to see whether what I am seeing is consistent with what others are seeing on a mass scale. Outside of that of course I won't always pinpoint the market perfectly!

So in my opinion how have bids improved and where do I see trades happening right now? To keep it consistent so you can imagine the improvement from the March lows, it would be something like this:

HIGH END ($5M+) - down aprox 20% - 30% from peak
HIGH/MIDDLE ($2M - $5M) - down aprox 20% - 27% from peak
MID END ($1M - $2M) - down aprox 18% to 25% from peak
LOWER END (Under $1M) - down aprox 13% - 20% from peak

I'm not saying deals are happening at peak levels and besides it takes two to tango so the seller needs to be on board with where bids are before any trade takes place! Clearly a seller is much less motivated to hit a low ball bid today than they were in March of 2009. Instead, what I am saying is that contracts being signed right now show a discount from peak that is not nearly as fierce as it was ten months ago - and that improvement was progressive with time. Properties with higher quality features and that are priced right are trading faster and seeing solid interest. Properties with cookie cutter features that are priced high are still taking time to trade or procure aggressive bids.

With that said, you can add in two clear wild cards that really differentiate today's market from the environment last March:

a) Much Lower Inventory - Total active inventory is down from about 11,100 units in March to about 7,111 units today! Yes, a 36% decline is a noticeable one and leads to emotional decisions by buyers that are frustrated with options available to them right now. Who knows, maybe a buyer missed multiple perfect properties along the way and when a desired product is found today, they are much more willing to get aggressive to go get it than they were back in March.

b) Confidence Shift from Fear to Reflation - Never discount the emotional element that affects both buyers and sellers when it comes to buying and selling real estate. The difference between the world ten months ago and the world today is significant. It doesn't matter about future headwinds (rates, taxes, carry trade unwind, less cash bonuses, stock selloff, etc.), whether you believe in it or not, and whether you think the rally is artificial in nature! Humans are irrational creatures! The markets certainly are NOT rational! Markets are not efficient, sentiment does matter, history usually repeats itself, and we tend to operate with a herd like mentality!

I really enjoyed Barry Ritholtz's piece on dissing the Chicago School of Economics; which assumes rational expectations and an efficient markets theory.

This market is a fast moving animal and many forces are at work, as proven by the last 18-24 months. In the meantime, as long as there is cash and improving confidence out there this market will continue to see demand; i.e. trades. We can always question how higher taxes, higher rates, less cash for bonuses, rising inventory and tighter lending may ultimately stifle this recovery. As it changes, I'll report on it the best I can and without bias - that's all I can do.

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Manhattan Q4: Sales Up 8.4% From Prior Year

A: A quick update for you guys on the number of sales with Q4 reports out a few days ago. The chart below should clearly show you the adjustment we had and the recent surge in contracts signed that has pending sales awaiting closing at healthy levels. I would expect the next quarter to continue to see closings above the 2,000 mark as the pipeline deals clear; and represent a HUGE percentage increase over Q1-2009 sales volume when its released early April.

Here are Manhattan Total Sales broken down by quarter for Co-ops + Condos:

*Data courtesy of MillerSamuel.com/Data

MillerSamuel's Q4 Report adds:

There were 2,473 sales in the current quarter, up 8.4% from the 2,282 sales in the prior year quarter and up 10.9% from the prior quarter. This level of activity was more than twice the 1,195 sales seen in the first quarter of 2009, which had been lowest level of sales in nearly 15 years. The return to more normal historical levels of sales activity was also reflected in the decline in inventory levels.

"With many deals still in the pipeline, we might be able to beat Q4 2008's number when that data is released January 2nd, 2010."

The surge in activity continued into year end, although not quite the pace we saw in June-Early Aug, so expect another quarter or so of solid closing data when Q1 sales are released in early April. Currently, I have pending sales around the 4,684 units level.

Cheers all!

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Quick Pre-Holiday Market Check

A: I wanted to wish everyone a very Happy Holidays and a safe and enjoyable upcoming New Years! Its been another great year for UrbanDigs and 2010 looks to be even more exciting. I can't wait to share with you guys what I spent so much time working on and years trying to secure the right data source to build the tools I think this market so desperately needs! For now, here is a quick check into the pre-holiday real estate market.

The market is still more active than normal for this time of year. What amazes me is the traffic levels and demand that seems to be out there for higher price points. I simply cannot deny it and will continue to try to keep it real; whether it be bearish or bullish for the very short term. In the end, pricing correctly is the most important thing a seller can do right now to take advantage of a healthy buyer pool in a much stabilized marketplace. If anything, I am finding a lack of properly priced quality products in the marketplace today.

Since following the market on a short term basis is so in demand, I have to describe things in relative terms. What I mean is, bids seem to be coming in about 5-10% higher than they did 8-9 months ago, but still 15-25% lower than peak levels - depending on price point. The improvement in bids was documented here many months ago, has sustained itself up to todays marketplace, and is a result of a reflation mentality from the fed's liquidity facilities, guarantees, and zero interest rate policy. Credit is much improved and on fire lately, as the search for yield continues! Stocks are a proxy for everything as bids improved in asset classes across the board.

You know my thoughts on that gravy train ride - at some point it will end and a carry trade unwind will occur. When? Who knows? How fierce? Who knows? Just keep your eyes on it.

As for our market, I can see a few general trends:

1) Listings Removed - I see about 2,146 listings taken off the market in the past 30 days or so. The majority of which were removed in the past 3 weeks as we entered December. This is a seasonal pattern and follows a trend where fewer sellers were removing listings from the marketplace likely as a result of the improvement in bids. I have listings lingering off market at around 11,283 or so - the new site will offer a breakdown of this metric so we can try to pinpoint the shadow inventory trends that encompasses existing inventory removed and not just new development units that are yet to hit the marketplace.

2) Contracts Signed - Healthy. I have 1,089 contracts signed in the past 30 days or so; very solid given this time of year. Contracts signed surged from 550/mth in February & March to about 1,100-1,200/mth in June-August or so as pent up demand from the freeze up period swamped in with lower prices - as discussed in mid-July.

Now, there are a few listings where the broker keeps adjusting the status from CONTRACT SIGNED to PERM OFF MARKET back to CONTRACT SIGNED back to PERM OFF MARKET, etc., over and over and over again. So, we are in the process of accounting for these types of errors in the backend so that trends and data we release to you is as accurate and bug free as possible. Trust me, it's a very tedious process that has taken us many months to get to where we are at now. I'm about 95% confident right now in the data we have and should be closer to 97-98% confident in another few weeks before launch. We will explain everything once we launch so you know up front how we count each datapoint and what flaws might exist due to source data problems.

3) Active Inventory - We have active inventory at 7,787 units as of right now. This represents a 10.2% decline in the past 3 months and a 25.8% decline in the past 6 months.

4) Pending Sales - We have pending sales data at about 4,938 units. These are listings in contract that are awaiting closing. Relatively speaking, pending sales went from 7,500 units or so in early-mid 2008 (a function of the post-peak market), to about 3,250 units in early 2009 (a function of the freeze-up period and buyer-seller disconnect after Lehman), to about 4,938 today. We have flatlined around this level for the past 4-5 months. This means pent up demand surge came and went after the adjustment and the market has stabilized to more normal levels the past few months. Although I would add that the market to me still seems a bit stronger than usual for this time of year, since after Labor Day.

All in all, I would expect minimal activity for the next 2-3 weeks for holidays. The market tends to pick up in mid-January and listings start to come back on around the end of January and into February for the active season. The data will show it, so we will track it!

Happy Holidays all!!

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Q & A with Bob Knakal

A: I had the pleasure of meeting Mr. Bob Knakal a few weeks ago for an after-work chat to discuss everything markets. It was time very well spent. Mr. Knakal is chairman and founding partner of Massey Knakal Realty Services and publisher of the relatively new StreetWise blog where he discusses thoughts on the macro economy & New York City Investment Markets. I find his content to be unbiased, real time, educational and easy to read. I asked him to delve into some questions that UrbanDigs readers might be interested in, and he quickly agreed. Enjoy!

Question: Where are we in this residential & commercial cycle? What inning might we be in?

Answer: I believe the residential market is further along in the cycle than the commercial market. While it is difficult to predict precisely where the residential market is, I believe that we could be close to approaching a bottom. The tremendous and unprecedented government intervention that we have witnessed has artificially propped up the market in a number of ways. Therefore, I don’t believe that we are presently at a natural bottom and there may be a slight double dip. The first time home buyers credit, artificially low interest rates and the fact that the government (between Fannie Mae, Freddie Mac and FHA) guarantees 92% of all home loans in the country. This is an unsustainable level of support. That being said, I believe that the residential market is somewhere in the 7th or 8th inning and that we could see an upswing in the market sometime in 2010.

With respect to the commercial market, we have seen the volume of sales start to increase from its low point, however, value continues to slide. This slide is based upon the fact that unemployment is continuing to rise and we must always remain cognizant of the fact that there is nothing that more profoundly affects the fundamentals of real estate than employment. As most economists expect unemployment to peak in the first half of 2010, it is very likely that at that peak we will see the weakest status of our fundamentals and, therefore, a low point in value. After hitting this low point, we expect value will bounce along that bottom for an extended period of time until a determination is made as to whether all of the capital on the sidelines will rush into prop the market up or the deleveraging process will be so debilitating that it will keep value at it’s low point.

Question: What are the biggest 3 bearish risks to Manhattan real estate going forward?

Answer: The first bearish risk for the marketplace has to be taxes. We have seen, recently, a substantial increase in real estate tax rates which are further compounded by increasing property assessments. This is a trend that we don’t expect to see reversed any time soon as the city deals with its fiscal problems. We expect increased taxes, not only on the real estate front but, with respect to state and local income taxes and other taxes and fees. These are a significant downside risk to the marketplace.

The second risk is based upon the extraordinarily liberal, if not militant, positions on regulation and oversight of our markets by the New York City Council and our elected officials on Albany. Some of the positions they have taken recently are extremely harmful to the marketplace from a number of perspectives. The pending changes to the residential rent regulation system will, if passed by the Senate, cut jobs and reduce tax collections. Fortunately, the commercial rent control bill seems to be on the back burner for the time being although that would have also cut a significant number of jobs and reduce tax collections.

Particularly distressing is the position that the City Council took relative to Related’s Knightsbridge Armory development in the Bronx. There position was one of not only telling developers what they could build and how they can build it, but, they attempted to place restrictions on the tenants in the property requiring the tenants to pay its employees wages in excess of the minimum wage. This would knock out many of the national big box retailers who would be natural prospects for a development of this nature. This proposal, and its restrictions, makes absolutely no sense for the city nor to Related and the transaction is now stalled leaving a dilapidated eyesore in the middle of the Bronx. This property has been abandoned for over 10 years and will remain so indefinitely. Rather than having economic development, job creation and increased tax collections we are left with stagnation. We have witnessed a project that would have created 1200 construction jobs and 1100 permanent retail jobs go down the drain due to irresponsible policy. The result is that today there are no jobs and no wages being paid at that site.

The third downside risk to the marketplace is that our infrastructure continues to age. Stimulative dollars could be spent upgrading the various infrastructure systems of the city. Particularly if, as the Bloomberg PlanNYC projects, one million additional residents move to the city over the next 20 years, our infrastructure systems need to keep up with the demand that will be created.

Question: What are the biggest 3 bullish factors for Manhattan real estate going forward?

Answer: Perhaps the most pronounced bullish factor is the fact that we went into this down cycle with far less speculative construction than we did going into the recession of the early 90’s. Supply of available property is very low and the amount of new construction is not nearly what it would need to be to meet the demand that is projected for the future. This dynamic alone could lead to an extremely sharp spike in value when the market is in full and tangible recovery mode.

Secondly, New York City seems to be maintaining its domestic and global standing as the financial capital of the world. During this global economic recession, we have seen significant problems emerge in London and Paris and we have seen emerging markets like Dubai show their vulnerabilities. The fact that New York is still the number one destination for investment capital from around the globe is extremely positive and will serve the city well.

The third thing to keep in mind, which is a more long-term benefit for our marketplace, is that the city is literally running out of developable land. There are very few large land parcels that even exist, let alone available to be developed. At some point, particularly in Manhattan, we will see a dynamic similar to what Tokyo has experienced where values will spike considerably simply based on the fact that supply constraint will be very palpable.

Question: Do you see a second wave to this credit crisis, ultimately affecting Wall Street and our markets, or did the fed save the day?

Answer: Well, I believe the Fed’s policies stopped us from entering a catastrophic period that we all feared. If you recall, one year ago, everyone was running around putting money into different banks and were trying to figure out which banks would be solvent and which ones wouldn’t be. There were some major banks that failed and it was really unclear as to whether the system could recover. Policies that were implemented brought us off of the edge of the cliff but we still have a significant way to go before we can have a tangible recovery. Unprecedented government intervention has created a scenario where banks do not have to face the losses that are, so clearly, embedded in their balance sheets. The changes to mark-to-market accounting rules, the fact that bank regulators have been allowing banks to keep loans on their books at par even thought the collateral may be worth half of that, and the modifications to the REMIC guidelines have created an environment in which balance sheet losses can simply be ignored. It is very clear that we have to go through a massive deleveraging process to create stability in our marketplace and until that occurs there is still some downside risk embedded in our marketplace.

Question: Do you see continued concessions by landlords and owners to fill vacancies or have we seen the peak of the deals already being offered?

Answer: We have seen periods of significant concessions on behalf of both residential owners and commercial owners. In the residential sector, we have seen owners offering one or two months of free rent as well as owners paying brokers one month rent as commissions as well. We have seen effective rents down 20-25% causing significant downward pressure on values. In the commercial sector, we have seen inflated free rent periods and work letters for tenants bringing office rents down anywhere from 30-40% depending on the report that you read. I don’t believe we will see concessions grow and, as history tells us, we will see these concessions start to dissipate before we see increases in rent levels.

Question: When do you envision higher interest rates being a significant drag on housing investment in Manhattan? With rates close to all time lows today, is this even a risk worth discussing now?

Answer: Higher interest rates are absolutely a risk but not necessarily in the short-term. All signals coming from the Fed are that they are going to keep interest rates near zero for the foreseeable future. If there was any inkling that rates might be raised, the financial problems in Dubai have cast a spotlight on credit problems that may exist both worldwide and at home. There are other countries that have significant debt problems, such as Greece, where credit ratings of sovereign states are in question. We believe that we will see inflation based upon the massive increases that we have seen in the money supply and that, with this inflation, the Fed will have no choice but to tighten monetary policy. As they tighten, they will increase the Federal funds rate which will put pressure on the spreads that the banking industry is currently enjoying. The Fed’s monetary policy has allowed for a recapitalization of the banking industry and banks have become comfortable with their massive spreads. So the question is: When the Fed starts to tighten monetary policy, how much of that rate increase will the banks absorb, in the form of compressed spreads, before they start to pass increases along to the consumer in form of higher mortgage rates. Most of the bankers I have spoken to have indicated that they would absorb 50-75 basis points of increase but, above that, would start to pass along the increased rates to the consumer. As interest rates increase, it places downward pressure on value.

Question: Please discuss your thoughts on the recent tax hike of 10.3% for NYC co-op and condo owners and the affect it might have on affordability for future sales?

Answer: I am generally opposed to tax increases and believe that the government should exhibit more restraint on the spending side of the equation. However, given that condos, and most particularly coops, are typically taxed at a much lower taxes per square foot than other building classes (due to the low target assessments), increasing tax rates on that type of property is serving to equalize the tax burden and is probably an appropriate move for the city.

Question: Is inflation a threat in your mind, and if so, is real estate a good hedge?

Answer: Inflation is definitely a threat. As I mentioned above, the increase in the money supply over the past nine months has doubled the country’s money supply and the increase is larger than the aggregate increase over the prior 50 years. This has to lead to above-trend inflation and hard assets are the best hedge against inflation. Commercial real estate is a great hard asset. The only caveat is that you would want to buy it before the inflation kicks in and lock in the low interest rates associated with the pre-inflationary period. Owners who lock in fixed-rate debt at today’s rates for the long-term will enjoy significant benefits of owning commercial real estate. Commercial properties are also a better hedge against inflation than residential properties as it is possible to pass along the increase in operating costs to commercial tenants.

A big THANK YOU to Mr. Knakal for taking the time to answer these questions for our readers!! Great stuff!

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Fed Update: "Low Funds Rate For Extended Period"

A: Quick check into the fed meeting and statement today.

As expected the Fed left rates unchanged and continues a zero interest rate policy. Actually rates are not zero, but rather hovering between 0.11% - 0.13% or so. Close enough right.

Here is the full Fed Statement.

In my opinion there are a few main things going on here that people should be aware of - Ill point out in bold and then include the fed wording in quotes:

A) Gradual Wind-down of Emergency Liquidity Programs - My thoughts on exit strategy were discussed here back in August. "First they will slowly remove emergency credit facilities", was my starting point.

In the fed's words:

"In light of ongoing improvements in the functioning of financial markets, the Committee and the Board of Governors anticipate that most of the Federal Reserve’s special liquidity facilities will expire on February 1, 2010, consistent with the Federal Reserve’s announcement of June 25, 2009. These facilities include the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility. The Federal Reserve will also be working with its central bank counterparties to close its temporary liquidity swap arrangements by February 1. The Federal Reserve expects that amounts provided under the Term Auction Facility will continue to be scaled back in early 2010. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30, 2010, for loans backed by new-issue commercial mortgage-backed securities and March 31, 2010, for loans backed by all other types of collateral."

B) Engineered Bank Recapitalization Environment Will Continue - Make no mistake about it, the fed has successfully engineered an environment suitable for the banks to recapitalize themselves. We can debate the merits of their policy choices in another discussion. The point was to recapitalize the banks, period - and we are in the process of doing this.

Yes unemployment is high and rising, yes we faced a severe recession, but the real damage was done to the banking system and that is where the fed is trying to target their fixes. Without healthy banks even when the economy and unemployment start to recover, lending will be subdued at best. Many think lending will be subdued anyway as accounting rule changes and off balance sheet rule changes will drag the writedown process out for years; i.e. zombie banks. I probably put myself in that camp. We still do not know how far off the marks are for CMBS, Whole Loans, P/E lbo's, etc.., or where these mis-marked assets may be hiding off balance sheet.

Everything and anything was done to help the banks. Now the street is riding the dollar carry gravy train looking for yield!

C) Lending Rates Are Super Low Because The Fed Wants Them That Way - Duh, right? Lending rates are likely 50-75bps lower than they probably would be due to a massive debt monetization experiment in which the fed is buying agency debt and agency mortgage backed securities. The total purchases are set to reach around $1.425 trillion! Umm, I don't even know what that is anymore. Given that close to $2 trillion in losses in the shadow banking system and who knows how many future anticipated losses are sitting on the books of the financials now that every rule was changed to benefit banks, the number is not as inflationary as some may think. In short, the money printing is not entering the economy!

Rather, the banks continue to hoard just under $1.1 Trillion in Excess Reserves as seen in the chart below (via the St. Louis fed).

Why would they do this? Two main reasons that I see:

1) Banks should not and are not lending to consumers and businesses that are experiencing declining credit quality in a rising unemployment environment where everyone seems to be spending less, and...

2) Money is being hoarded to help absorb future loan losses that were not taken and rebuild capital ratios

If you see other reasons why the banks are hoarding, please speak up! These are the main reasons I think banks are not increasing lending, and rightfully so. Its the one thing banks got right in this whole mess.

So, rates are low because the fed wants them that way. In the fed's own words:

"To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt."

1. First they will slowly remove emergency credit facilities - that is clear
2. Second, they will be forced to raise rates - timing is iffy, and markets may force their hand
3. Third, they can sell securities to primary dealers via POMO at the NY Fed, thereby draining liquidity from excess reserves - likely way out there, maybe 2011-2012.
4. And finally, as a final and more aggressive measure, we could see capital or reserve requirements tightened on banks to hold back aggressive lending that may cause inflationary pressures and money velocity to surge. - at some point, yes.

These are my thoughts on the fed, what the fed is doing, the environment they are engineering, and what likely steps they have ahead of them over the next 2-4 years. Since they don't want to rattle markets or do anything counterproductive to their bank recap goals, these steps will likely be implemented slowly and in stages.

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The future's so bright ... don't break out the shades just yet

Apparently, the NYC economy is better off than many would have otherwise expected. A new IBO (Independent Budget Office) report provides a few juicy tidbits:

2009 profits are expected to be $59bn for 2009, versus the record $42.6bn in losses for 2008 and $11.3bn losses in 2007 (not too shabby a turnaround)

Higher expected tax revenues of $35.5bn ($650m more than last year) based on Wall Street Profits, in the form of personal income tax collections from high bonuses ...clearly they're expecting a high cash component of given bonuses (Noah's post on the bonus discussion)

Fewer than expected job losses of 157,200 versus the predicted 254,500

A resumption of peak employment levels by Q1 of 2013 (after bottoming out in Q3 of 2010)

Looking at demographic trends in the city, we know that:

- Since 2000, NY has experienced the greatest national migration loss of 1.5million people; this has been offset by a large influx of foreigners which has lead to a mild overall population increase
- 85% of the above loss has come from the NYC region, while 70% has been from the city, itself
- The annual peak was at 250,000 people in 2005 and the low was 126,000 last year (reflecting a national mobility decrease)
- Interestingly, the income of households moving out of the state was 13% greater than those coming into the state

So ... what say you, UD readers? What's your outlook for the NYC economy and how do you weigh all of these factors in terms of landing on a macro-economic perspective on the health of the Big Apple?

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Double Double Toil and Trouble: Conjuring Up Spells to Get to the Closing Table

We all know that the HVCC (Home Valuation Code of Conduct) has changed how appraisers are engaged, leading to the hiring of professionals who are not as familiar with the Manhattan market. More often than not, this change has resulted in lowered (you might say bewitched) appraisal values, for the most part, putting both buyer and seller in an interesting predicament.

We've come across several such situations where sellers believe that the buyers must come up in price, and that they have no choice in the matter as if entranced. This is simply not true, especially not when 98% of loans extended are mortgage-contigent. We are living in different times, my friends.

So what are the choices that both parties have if the appraised value comes in below the contract signed price?

Buyers:

1. Come up in price by that difference between the appraised and contract numbers, that is, if you want the property badly enough or if there are other bidders breathing down your neck
2. Pay for PMI to lower the 20% downpayment threshold, resulting in a one-time lump sum payment and higher monthly premiums. Here, try to negotiate with the seller for a concession towards that lump sum.
3. Renegotiate the contract price to the appraised value
4. Walk away altogether by getting a declination letter from your bank. This document basically states that the bank is not willing to extend you financing based on the previously-agreed-upon price and loan to value, making the contract null and void.

Sellers:

1. You can reduce the price of your property to the appraised value; this is where you need to manage your expectations throughout the process. Just because you have a contract signed close to ask, doesn't mean it will close for that much.
2. Reimburse the PMI lump sum via a concession at closing ... at least you're meeting the buyer part-way.
3. Let the buyer go, and cast a spell for an all cash buyer to come your way before the next full moon. Be very careful here; unless you happen to be in the lucky position where you have other buyers who have not yet left the table despite the contract being signed, you would be starting the process all over again. Though all-cash buyers do exist, you would need some pretty strong bat whiskers and mummified toenails to create that magic upon request.

As always, we'd love to hear from you on both sides of the transaction. What have you seen and, perhaps more importantly, which choice would you make?

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'Carry' On!: All In The Search For Yield

A: I realize this is not a direct discussion of Manhattan real estate, but then again, when the ABX's started to plunge in the fall of 2007 that was also a topic I felt worth discussing as a sign that maybe a problem could be brewing in the secondary mortgage markets that could possibly signal a credit event and a stress to the banking system; a ripple effect that could and did ultimately hit out our markets. We have to continue to think outside the box and talk about the stuff that is not in the rear view mirror, but that may lie ahead of us and impact our markets. This is not a fear tactic, its a discussion of one possibly big unintended consequence of policy actions that were taken to stem the debt-deflationary episode we just went through to avoid a second depression. The latest warning comes from China's chief banking regulator. Meanwhile, Money Market Mutual Fund Assets continued their decline to almost $500Bln YTD.

I discussed the extreme positive carry that trade that is on a few weeks ago:

"With the fed guaranteeing everything and engineering such a low interest rate environment (basically to recapitalize our banks), almost all assets got a strong bid; yes, the crappy ones too. AN EXTREME POSITIVE CARRY TRADE IS ON!!

China's chief banking regulator on Sunday sharply criticized loose U.S. monetary policy, including the weak U.S. dollar, saying the situation is creating massive speculation in global asset markets.

The U.S. Federal Reserve's promise to keep U.S. interest rates at extraordinarily low levels for an extended period "has already led to a massive U.S. dollar carry trade and massive speculation," Liu Mingkang said at the International Finance Forum in Beijing, which began just hours before U.S. President Barack Obama was scheduled to land in China on his first ever visit.

Liu said that the weak U.S. dollar and low U.S. interest rates are creating "unavoidable risks for the recovery of the global economy, especially emerging economies" and that the situation is "seriously impacting global asset prices and encouraging speculation in stock and property markets." In such a trade, investors sell currencies with low interest rates to buy higher-yielding units - a common theme in the foreign exchange markets that has already put the dollar under pressure in recent months.

The only reason credit is flowing in the short end, in libor, in agencies, in everything for that matter is because of the gov't guarantee that nothing will fail. Liquidity started with the fed and was multiplied by the street and global investors. Fed policy, post Lehman, is clearly that no large firm will be allowed to fail and as a result, excessive risk is being taken as investors are being forced to the outside of the curve to get return. It is no different than the last time. Money market fund assets are dropping like a stone as investors take on risk such as high yield junk bonds, stocks...basically everything all in the search for yield!

Here is a chart courtesy of my old trading buddy Anthony over at Momentum Trading Partners, showing us the YTD decline in money market fund assets as dollars chase yield:

*Click For Larger Image

Now that is money looking for return! Another clear of example of this is the disconnect between plunging commercial real estate prices and rising defaults in the commercial sector all while bids for CMBS surge. All asset classes have been affected.

Hard to time the end of this game or to predict the spark that may light the fire. Maybe its China? Maybe something else. Who knows - for now its ride the carry gravy train for as long as possible. One thing I learned about speculative episodes is that it they usually last far longer than people think and well after the alarm bells first start to go off. The unwind then occurs when the story is too dated to make headlines.

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Rent v Buy: The Spillover Debate

I am in St. Thomas right now and have been trying to find a way to weave the thoughts I’ve had on the island with some smart insights for UrbanDigs readers. What, oh what, do St. Thomas as NYC have in common … To generate some good blog fodder, I attended (for the first time ever) a timeshare presentation while bracing myself for whatever heavy sales pitch would follow.

… and what was the main thrust of the pitch? Rent vs. buy! (In this case, it was the idea that if you’re normally vacationing for 2 weeks/year over the course of 20 years, you’re paying $100k to rent your vacation, while you could be spending a similar amount to actually own something.)

Our previous post, A Kiss is Just a Kiss, An Ask is Just an Ask, generated so much discussion in the rent versus buy category that I saw this presentation as a sign to formally continue it.

So, let’s recap a few of the factors that are good, standard ingredients in a healthy rent/buy debate recipe, shall we?

• ½ cup: The rental price versus mortgage payments + carrying costs
• 1/3 cup: Tax and other government-subsidized benefits
• 2 Tablespoons: The above comparison with different down-payment scenarios
• ½ cup: The opportunity cost of that down-payment (careful of 20/20 hindsight)
• 1 Teaspoon: Transaction costs (and their amortization over time)
• A dash: The cost of capital, itself
• A pinch: Leftover liquidity
• 1 cup: Expectations on rising vs. falling real estate values over time
• 1 Tablespoon: the emotional benefits of owning

These are our standard, go-to, ingredients.

What I still can’t get my head around is where the heat comes from in these debates. It could just be that UD readers are passionate people who enjoy a meaty back and forth (though the heat is by no means limited to the UD playground). It seems to me, though, that people’s positions are relatively static over multi-year periods. An avid renter is not going to be convinced into buying over the normal course of the next year. Further, an outright buyer won’t be debated out of buying, regardless of what the numbers say.

I’m not finding similar debates on leasing vs buying cars, purchasing timeshares or [insert your preferred debate of choice here] I would personally love to hear from you three things:

1. Do we have all of the ingredients covered, above? Anything missing? The lack of availability of cheap and exotic loan products perhaps?
2. Where do you feel the heat comes from? What is it about the home purchase/rent debate that pulls those emotional strings?
3. Whatever your position in the debate, is there anything the “other” side could say that would sway you?

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Madoff Unit Reduced 10%

A: At least its heading in the right direction! Another 10%-15% reduction will bring it closer to where it probably should have started out, around 7.495M - $7.95M or so. I still have my bets on between $6M - $6.5M for a final sale price though. If there really is no board review as I have heard on the street, maybe a bit more. Cmon New Yorkers, the Madoff victims need some help here! Call the "foreigners", talk about the "weak dollar", "buy now or be priced out forever", our market is on an "island and limited in supply"; will no broker phrase help this thing sell for near the new ask of $8,900,000.00???

Via Streeteasy.com:

Where do you say it trades???

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Another Quick Check Into Manhattan Real Estate

A: Just wanted to provide some recent thoughts on the marketplace as seen through this broker/blogger's eyes.

The Real Deal reports that "buyer are back to more rational behaviors":

A year after the financial crisis, Manhattan real estate brokers report that the market is finally returning to normal. But they don't mean the lightning-fast sales and skyrocketing prices of the recent real estate boom. They're talking about a more moderate, predictable real estate market, the likes of which hasn't been seen in Manhattan for years.

"The last three years have been very interesting," said Jill Bane, an associate at Leslie J. Garfield & Co. Before the market cratered as a result of the subprime crisis, "prices were very high and there always seemed to be several competing bids," she said.

Now, however, "a sense of normalcy has returned to the market," said Bane. Bane represented a townhouse at 17 Bank Street, on the market for $10.5 million, that recently went into contract. "People are buying; they are just not as irrational as the prior two to three seasons."

In the wake of the financial crisis, the last few quarters have been characterized by unpredictable swings in activity. The fall of 2008 saw the market at a virtual standstill; spring began to thaw, and summer -- normally one of the slowest seasons of the year -- brought an unusual frenzy of sales.

By contrast, the level of activity this fall seems to be relatively normal, settling back into its predictable seasonal pattern. Brokers, upbeat as always, say prices are at or close to their lowest point.

I still believe that we have 1 or 2 more quarters of positive reports ahead of us, as deals in the pipeline close. These reports will be compared to beaten down reports in the same period one year earlier and likely provide support for broker statements that the market has indeed bottomed and is on the path to recovery.

My opinion on that topic is a bit different. Fundamentally, we still have a weak labor market and are yet to experience any of the unintended consequences from actions taken to stem the crisis we just went through. Higher rates is likely one unintended consequence. Higher taxes or change to the tax code is likely another unintended consequence. Restrictions/deferred stock on bonus pay and regulation on wall street are a few others. However, I do NOT see a jolt to the market like we had when Lehman failed. Rather, there are things that can play out that constrain our market from seeing longer term sustainable price appreciation.

What made me significantly less bearish in June than I was in late 2007 is the simple fact that the adjustment has occurred in a fast & furious way. Lehman failed and boom, the market froze and the adjustment took place. That was healthy. So healthy in fact that about 8 months later we started to see sales volume typical of the peak year in 2007! The main reason was lower prices, continued low lending rates and higher confidence in the asset class as a reflation trade mentality sunk in to buyers of Manhattan property.

As this trend continued and became clear sell side optimism started to outpace the improvement in bids - discussed in the 'It Takes Two to Tango' piece in early August. That is when sales volume started to slow again! It takes two to tango and brokers hate when buyers' bids stop improving yet sellers optimistic expectations keep on rising!!

As a seller you get access to way more information then any one buyer does. Sellers know traffic levels and where interest is for their property; assuming they require real time reports from their hired agents. Sellers also know where the bids are coming in! After a while both the broker & seller should get an idea on where a deal is going to happen at - and sometimes a solid early bid will have been overlooked and regretfully dismissed!

Its not a surprise that when brokers discuss the increase in activity over the course of 4-5 months that maybe, just maybe, sellers are going to get a bit too optimistic on a stronger future bid to come in. This is where I see the market today. A slight healthy improvement in our marketplace as Armageddon was priced out from deals signed during the fear trade months of Feb-April - buyers react one way, sellers react another and here we are.

Since I am only one man and Manhattan properties vary so much, I can only estimate the improvement in bids lately; it would look something like this:

IMPROVEMENT IN TRADES FROM EARLY 2009 (by price point)

HIGH END ($5M+) - bids improved from down 25%-40% from peak to down 25%-32% from peak
HIGH/MIDDLE ($2M - $5M) - bids improved from down 28%-33% from peak to down 23%-28% from peak
MID END ($1M - $2M) - bids improved from down 20%-30% from peak to down 18%-23% from peak
LOWER END (Under $1M) - bids improved from down 17%-25% from peak to down 13%-18% from peak

Something along those lines and most of the action has been in the lower end. I can't deny the improvement in bids just like sellers shouldn't deny that there is a limit to this improvement. It's impossible for me to see the entire market and since the contract price is kept a secret until closing to protect the parties involved in the transaction, I have to estimate based on my experience in the field and talks with colleagues that I trust.

Every property is different and those with special features such as park/river views, private outdoor space, wood burning fireplace, or an exquisite renovation will retain their value better than properties without them. Dark apartments with little or no view and properties that require an extensive gut renovation are still hard sells. This is the most real time update I can provide; sorry its not more specific but you can't get too specific in a market like this where products have so many varying features attached to them! I don't see much in the way of major changes unless the tradable markets have a surprise for us down the road!

If you have any observations on where bids are coming in, feel free to share your stories!

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A Rising Tide or Just a Ripple?

It’s always nice to experience so much of what we’ve talked about. A few weeks ago, Christine talked about a shift in the lower end of the market and seeing significant signs of pick-up in activity. Considering the relatively limited inventory of <$400k properties, it’s not surprising that first time home-buyers may be using this time to swoop into the market and take advantage of historically low interest rates. The question is: is the shift spreading upwards to higher price-points or is this just a last hurrah before the expected anemic holiday months arrive?

Though far from arguing that this is representative of the market as a whole, here is one recent on-the-ground example to chew on:

- The property: A $750k 1-bedroom in West Chelsea, on the market for a mere three weeks from listing to a signed contract.
- Three open houses were held: 14, 2 and 6 visitors, respectively, with an overlay of 5-8 showings per week excluding open house traffic.
- Five offers altogether (one direct, four co-brokes); interestingly, yet as expected, all offers were generated from the first week of showings and inquiries. Further, three of the five offers came from investors, with only two representing first time home buyers.
- The kicker: the final price (upon closing) will have been less than 3% away from ask. And no, this particular property did not represent a distressed situation, nor is the buyer flush with cash.

So here are a few take-aways:

For do-it-yourself sellers: a vast majority of activity comes from customers engaging buyer’s brokers. In this case, 80% of the offers came from this sub-segment (lower than the 85%-90% we normally see). If you are listing the property yourself and not getting the traffic you’d like, visit the open houses of comparable properties in your area and gauge their activity. If they’re hopping and you’re not, consider at least welcoming buyers with representation (i.e. paying their broker’s fee). For that matter, consider open listing with 1-2 firms to get that additional exposure that could well make the difference. If that doesn’t yield material results after a couple of weeks, officially list your property to get on the brokerage radar screen. [This is what happened with a $1.5mm seller whom we were advising; the disparity between his open house traffic and that of broker-represented comparables he toured was so great that it served as the tipping point to finally list.]

For all sellers: it’s worth repeating that the first two to three weeks of a property’s life on the market are the most critical (here’s an UrbanDigs oldie but goodie as a reminder). Don’t squander it: maximize open house success and test different times on both weekends and weekday evenings. Lastly, be flexible with when your apartment can be shown (i.e. last-minute and evening requests); in this market, every show counts. Your highest & best offer usually comes in those first 2-3 weeks!

For buyers: it’s understandable that you want to test the price elasticity of the property you like by starting out low in negotiations. That said, try to determine the maximum price you’d be willing to pay on the property BEFORE fully engaging (though clearly after having done your due diligence). This will not only help you avoid getting sucked into the emotional trap of bidding the property up just to stay in the game, but will allow you to confidently present your last and final offer, knowing that it’s just that: your last and final (preferably with an expiration date).

We’d love to hear from you. Do you see activity (and more importantly, conversions) oozing up into higher price-points or are examples such as the one above exceptions rather than the rule?

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Stiglitz: US Paying For Not Nationalizing Banks

A: Well, I would think part right. But the core of the argument is that banks have not been lending and taking enough risk in the US consumer. With such excess and buildup of debt over the past decade, Im not sure increased lending and risk is what you want for a US consumer that is in the process of repairing their balance sheet and struggling with a rising unemployment environment. Seems counter productive to me. Time is what we need. Debt restructuring is what we need. Reorganization is what we need. And over time the write downs must be taken and the balance sheet repaired. Over the course of the process, everybody cutbacks. Hence the deflationary pressures. Fighting the natural order of things will only artificially heal things and likely lead to another crisis down the road. In the end, we'll have to finish the repair.

Bloomberg reports that "Stiglitz Says U.S. Is Paying for Failure to Nationalize Banks":

“If we had done the right thing, we would be able to have more influence over the banks,” Stiglitz told reporters at an economic conference in Shanghai Oct 31. “They would be lending and the economy would be stronger.”

Did you know the Personal Bankruptcy Filings are up 41% compared to Sept 2008? Calculated Risk shows us the steady surge in filings since 2006 (click chart for larger picture).

Now we see CIT Group finally filing for bankruptcy. Its the right thing. As painful as it may be for small businesses across the country, its what needs to be done. The US Treasury never should have injected funds for CIT preferred equity and warrants to begin with; and they would have saved about $2.3Bln from the TARP pool. Now the "government investment is likely to be wiped out, said people familiar with the matter." In the end, the same outcome prevailed.

Stiglitz continues:

“The big risk we face now is that banks are going to overcorrect and not take enough risk,” Geithner said. “We need them to take a chance again on the American economy. That’s going to be important to recovery.”

Our fractional reserve system of multiplying money is not working the way it was designed to because of the flaws embedded in the system itself.

Stiglitz then gets the chord right:

“We have this very strange situation today in America where we have given banks hundreds of billions of dollars and the president has to beg the banks to lend and they refuse,” Stiglitz said. “What we did was the wrong thing. It has weakened the economy and has increased our deficit, making it more difficult for the future.”

Banks simply need to take the write-downs, restructure the debts, reorganize the business models, and come out stronger at the end of the day. If that means bankruptcy or nationalization, so be it. Mike Mayo was back at it again Friday reporting on Citigroup facing another $10Bln writedown ahead on tax deferred assets.

The risk of not doing this is a lost decade with subpar lending even when the US consumer sees a stabilizing or better yet, a growing labor market. Thats the thing, at some point the labor market will stabilize and start to grow again; but how strong will the foundation be and how healthy will the banks be at that time? Accounting gimmickry and 'extend & pretend' can only take you so far! In the end, it all will come out. Bary Ritholtz also chimed in:

"One of the major complaints I have had about the bailouts and faux regulatory reform has been that it spurned the proven solution — the Swedish model — and instead embraced the worst example on the planet: The Japanese model. The refusal to force insolvent banking entities into bankruptcy is a large part of the reason, but its not the only one."

My main point is, it was prudent for banks to slow lending to a US consumer that was already heavily in debt with housing prices looking for a bottom, in a rising unemployment environment. Arguing for more lending in this type of environment would have kicked the can down the road for another day. A contraction in lending is, while not the American way, one of the healthier things the banks could do given the environment we are both in now, and just went through.

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Fed Treasury Purchases Over / Carry Trade On

A: The fed's debt monetization experiment was a two pronged monster: buying tons of agency debt + $300bln of treasury securities. So far the huge supply of treasury auctions is not affecting the market at all. In fact, bid to cover ratios for the most recent 5-yr auction was 2.63 compared to the average of 2.35 for the prior 4 auctions. With $123Bln in auctions this week so far, more than $370Bln in bids were submitted; big time oversubscribed. Now the fed is no longer buying treasury securities, but will continue to buy agency debt albeit at a slower pace heading into the first half of 2010. One aspect of the quantitative easing program is now done with, for now. In the meantime, a big time positive carry trade continues as the fed stands behind everything.

Don't be surprised to see the fed revive the treasury purchase program in 2010 or later should the bond market have a disruption or future auctions don't go as well as they have been recently.

Via Bloomberg, "Fed Ends Treasury Buys That Capped Rates, Stabilized Housing":

The Federal Reserve completed its $300 billion Treasury purchase program today amid signs the seven-month buying spree helped stabilize the housing market and limited increases in borrowing costs.

Yields on the benchmark 10-year note, which help determine rates on everything from mortgages to corporate bonds, never rose above 4 percent after the central bank began acquiring the debt.

The purchases were the first of U.S. Treasuries by the central bank to keep borrowing costs low since the 1960s. The Fed joined its counterparts in the U.K. and Japan in extraordinary debt-buying programs, broadening efforts to unlock credit and end the worst recession since the 1930s after cutting the benchmark U.S. interest rate to a range of zero to 0.25 percent.

“The Fed also happens to be exiting the Treasury market at a good time,” Goncalves added. “Other markets, such as equities, which performed well due to the expansion of the Fed’s balance sheet are retreating and that will provide a backstop for the Treasury market.”

Fed purchases have helped buttress demand as the U.S. sells record amounts of debt to finance a budget deficit that exceeds $1 trillion for the first time. Total sales of Treasuries will increase to $2.38 trillion in the fiscal year that began Oct. 1, from $1.81 trillion in the prior 12 months, primary dealer Goldman Sachs Group Inc. said in a report on Oct. 20.

The credit crisis seems to be over. Almost every indicator there is that would show a distress in creditville if there were one, is looking good. Credit the fed's intense emergency programs, rate cuts and liquidity facilities for that. Armageddon certainly seems to be completely off the table. I wonder where the next hiccup might come from? It may not be from credit. We are entering what may be the next phase of this cycle and the markets could react next to the massive government spending/deficits that have taken place to stem the worst recession since the 30s.

With the fed guaranteeing everything and engineering such a low interest rate environment (basically to recapitalize our banks), almost all assets got a strong bid; yes, the crappy ones too. AN EXTREMELY POSITIVE CARRY TRADE IS ON!! Stocks have been a proxy for everything. Remember I discussed how even with all the commercial real estate fears, the "CMBS AAAs, series 1, can't rally much more because the bids are close to par right now - around 93/94". There was a recent stumble in CMBS AAAs, Series 5 in the past week or so but I wonder how much of that was a result of the Stuy-town ruling against Tishman-Speyer.

What happens when the fed is no longer there as a backstop? What happens to the carry trade? Things that make you go hmmmmmmmmmm. I'll get into this topic in more detail later. No good party lasts forever.

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Once a puzzle, always a puzzle: Reading Housing Data

We couldn't help but take note of today's article in the Real Deal that notes the downside of giving too much credence to national housing data.

"With the glut of housing data and statistics available, it's difficult to know which figures give the most accurate representation of home sales and prices. In Manhattan, the disparity between national housing figures, such as average home price and sales, and city numbers can be particularly noticeable. Rather than one national market, there are, in reality, many mini-markets to evaluate, according to broker Douglas Heddings, president of the Manhattan-based Heddings Property Group at Charles Rutenberg Realty. Heddings told Fox Business News that it's unwise for both homebuyers and mortgage lenders to rely on monthly national data to determine housing trends. The data "can be incredibly confusing to the buying and selling public," Heddings said."

Let's take a peek at the various aspects of reading data, and ways to avoid the pitfalls in trying to digest it.

Seasonality: It's not news that real estate is highly seasonal. This means buyers buy in the spring and fall, renters lease in the summer and most activity is dead in peak winter months, each and every year for the most part. To adequately analyze housing data, you need to compare numbers to those of the same "season" last year. This is why month to month comparisons fail to see the big picture. Rather than waiting a whole year to compare data as it is generated, researchers "seasonally adjust" data to make it more useful and relevant, smoothing it out over the course of the year. Pay attention to the numbers quoted: seasonally adjusted data is reported as "SA", and not seasonally adjusted data is reported as "NSA". The trick is knowing which is which and how to read it. In a period of high seasonal volume, the adjusted numbers will be lower than the not adjusted, and vice versa, precisely due to this smoothing out process. Reading that SA housing starts are up by 20%, for example, doesn't mean that starts themselves are up by that much; rather that they beat the expectations of the smoothed out numbers we would have seen had we ignored seasonal influences. Understsand the nature of the numbers you are reading, SA or NSA, and read analyses through those respective lens.

Margin of error: New home sales data comes out monthly, only to be revised up or down a some time later (same goes for unemployment figures, jobless claims, home prices, etc.). Needless to say, when the margin of error % is greater than the actual reported change in sales, the released figure becomes meaningless. Since the markets are forward looking, few people actually look back to see the revised numbers, relying purely on the first-reported estimates. Compare the margin of error with the degree of change being reported to gauge how meaningful the data really is, and don't neglect revisions.

Trend numbers are so last year: Trend numbers imply a linearity of sorts. One could look at prices in February versus May, for example, draw a straight line and conclude the degree of movement (falsely assuming the data reflects the same 1-bed that sold for in February for $600k is now selling for $550k). What such trends neglect is the actual shift in inventory from month to month or quarter to quarter. The key question is: Is there a seasonal difference in actual market inventory, what does it look like and how significant is it? Observe the changing inventory of what you are comparing as a backdrop against which to analyze the data.

Beware of sequential reporting: Take month-on-month and quarter-on-quarter data analysis with a grain of salt, as it neglects the very seasonality we've been discussing. Of course Q2 will be busier than Q1, for example; this happens every year. This is why researchers primarily use seasonally adjusted numbers versus not seasonally adjusted data. Year on year comparisons (y-o-y) provide a more accurate perspective on market activity. Do not make decisions or enter negotiations relying solely on quarter-on-quarter data.

Year on year imperfections: While Y-o-Y data is the gold standard, even it is imperfect. Great examples can be found on the Lower East Side and Midtown East, where a plethora of new condo developments have significantly skewed year-on-year sales numbers upwards based on luxury inventory which previously did not exist. Neighborhoods have evolved significantly over the last few years and will continue to change over time. Analyze year on year data with an understanding of neighborhood-specific developments.

To tidy up all of these points and wrap'em with a ribbon, not so long ago, we came across a WSJ article mentioning that NYC housing prices were flat, only to add in a small caption that the NY data did not include co-ops and condos. Reader beware. Don't take headlines at face value, particularly national headlines. While there are nation-wide, macro dynamics at work, real estate has and always will be a local game, with all the pros and cons that come with that.

So, while Noah and company at UrbanDigs will still provide real time analysis on changing trends in the Manhattan residential marketplace ("Expect Significant Quarter-to-Quarter Improvements"), their will always be a caution tag attached.

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Discounted Sublease Rates Pressuring Landlords

A: This is part of the deflationary pressures that I discuss here often, all part of the healing process. Its painful, but it's healthy and corrective.

Half off sales, foreclosure sales, Bulk REO deals all lead to new owners with a more efficient operating environment with less debt overhang with which to manage the properties. This allows the investor/purchaser to offer lower rates to consumers; assuming an income producing property of course. This in turn pressures existing inventory. The deflationary cycle is a cycle like any other, feeding on itself until the excess is purged.

Add in the sublease element and the companies that are tied in to longer term leases but are no longer using the space, and you get one more pressure. The chart below for 2009 Manhattan Office Market Vacancies is from OptimalSpaces.com.

The NY Times reports, "Bargains Abound in New York’s Sublease Market":

Financial companies are trying to sublet space that they are no longer using in some of the most desirable office buildings in Midtown Manhattan, and the rents they are asking are heavily discounted compared with what landlords are seeking for similar space across the street — or even in the same buildings.

Many large financial companies dumped hundreds of thousands of square feet on the sublet market, with much of that space in prime Midtown locales near Grand Central Terminal, Rockefeller Center and the Plaza Hotel. Now, the sublet space that is still on the market is being offered at rents much lower than rents for space that can be leased directly from landlords in the same submarkets.

“This is going to have an impact on the rest of the market” for office space in New York, said Joseph Harbert, the chief operating officer of the New York metropolitan region for Cushman & Wakefield, a provider of commercial real estate services. “If I am a tenant, and I can get sublet space on Park Avenue at a discount, why would I go elsewhere and pay more?”

He said that the gap between the asking rents for direct space and sublet space in the most desirable Midtown office buildings — what brokers generally refer to as Class A space — was the largest he could remember.

On average, the owners of Class A buildings in Midtown Manhattan are now asking $72.03 a square foot, compared with $55.68 for comparable sublet space, according to Cushman & Wakefield. So tenants willing to sublet can get a 22.7 percent discount in Midtown. The discount was 12.6 percent a year ago.

Enter Robert Knakal, Chairman & Founding Partner of Massey Knakal, who writes on NYC's investment markets in his StreetWise blog:

"Sublease space is very indicative of what the real market is, because the sub lessor is willing to get whatever the market will currently bear. They do not have artificial constraints on what the lender is requiring or what the debt service payments require rent levels to be. The key area is the term of the sublease. In order for the sublet rent to have integrity as an indicator though, the sublease term has to be substantial enough to be a truer indicator of the market. A minimum of five years and ideally as close to ten years as possible would help gain credibility as a true indicator of the market. Clearly short term sublets for 3 years or less are not indicative of what market rents are."

One thing is certain, the phenomenon is a deflationary one.

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Co-ops Should Ease Up A Bit & Shore Up Balance Sheets

A: Before you mis-interpret the headline, please read on. Did you ever wonder what percentage of buildings out there may be financially mismanaged? I am of the belief that when things get euphoric, regulation of some kind should tighten to constrain risk taking and speculation. On the flip side, when things get too slow or facing a fierce downturn regulation of some kind could loosen a bit and encourage a more stable marketplace. All within limits and never incentivizing too much risk taking or buying something you can't afford. This is not the kind of market that co-ops should be tightening up in; yet today I am both hearing and seeing more talk of board turndowns without a reason provided. Lets assume for a moment that the main purpose of a co-op board is to efficiently and properly manage their building and to maximize value for the shareholders of the corporation. Lets also assume that the value of the shares owned in this corporation goes into a multi-year recession; and are worth less than it was at peak, trending lower, and seeking stabilization. Sounds like what we just went through. What is a co-op board to do? Well, one quick way is to use your powers to loosen up policy a bit without sacrificing future shareholder value? In a phrase, expand the target audience that is both willing & able to buy into your corporation!

Its funny, without naming building addresses I can tell you that I just experienced my 2nd board turndown in a co-op that was low on cash in reserves and set to make a huge chunk of change via a flip tax from an original shareholder from the 70s. I can also tell you the buyers were more than qualified to purchase this unit and secured a loan commitment. No reason provided. Make much sense? Not at all. I know that the building reserve fund would have surged 55% if they approved the deal. Yet it was not to be. Now future buyers in the building may adjust their bids or walk away after discovering a large building with such low reserves - how is that for maximizing shareholder value.

Some reasons I am hearing for recent board rejections include:

a) price being too low
b) buyers debt/income ratio being over 25%
c) aggressive accounting on tax returns shows a much lower Adjusted Gross Income
d) inconsistencies in the board package & financial statements provided
e) lack of liquid assets after closing
f) uncertain employment situation
g) inter-building conflicts

Co-op boards will always be protective of their shareholders and their building; as they should be. But often in crazy times the line gets crossed and decisions come down that makes even the most experienced brokers or managing agents scratch their heads. Co-ops that have a history of being tight & nitpicky should consider loosening up a bit; especially if the building just finished multiple assessments for major capital improvements and is facing a depleted reserve fund.

You see, I find that many buyer's generally want it all and who can blame them. They want low monthly expenses, but they want every amenity possible. They want the building to operate at a profit, but they don't want any flip tax. They want recent capital improvements but no assessments. You can't have it both ways and in the end every building must be managed properly to handle the work that needs to be done down the road. Every building will have leaks, need a roof repair, need a boiler, need a replacement of elevator relay switches, local law 10/11 facade inspection and pointing, and have to upgrade their hallways, elevators, lobby, etc.. at some point in time. No building is exempt from the effects of time so they should financially prepare for it today - call it the building's retirement account.

Start basic. This is the time where co-ops can loosen up a bit on house rules within reason. If the building has a high owner/occupancy rate because of a very strict subletting policy, perhaps the time has come to loosen that rule a bit and widen the target audience interested in your products. Add a fee for the owner or other revenue generator that goes directly to the building reserve fund for a 2 & 2 subletting policy - keeping in mind that you can't let the owner/occ rate decline to a level that adversely affects the entire corporation. If the building does not allow pied-a-terres, maybe now is the time to overturn that rule and reach out to a slightly wider audience? Other areas to loosen include allowing guarantors, co-purchaser's, or parents buying for their children; all within reason and board pre-determined guidelines.

Maybe the building has a loan tied to a very high interest rate? Perhaps a simple refinance at a lower rate and take out a bit more equity to the point where the interest payments are still the same, or only slightly lower - then deposit that extra money into reserves for future capital improvements limiting the need for more aggressive assessments? Buyers love reserve funds! Minimizing red flags may maximize transaction volume; especially for building's that utilize a flip tax as a revenue generator,

Shore up your balance sheet, add more revenue generating services to your business, expand your target audience, and increase demand to your product. Increased shareholder value + increased confidence in the product being purchased = stock goes up. At least in theory. Building's whose reliance for revenue is on flip tax only may see problems if the market goes into another freeze or sales volume dries up because of a lack of transactions in the building. Co-ops should try to spread out their revenue streams rather than rely only one main source! The goal is to minimize consistent rises in monthly maintenance that will constrain affordability for future sellers in the open market.

You can't change the market or the markets way of valuing your product due to general confidence, macro factors, and affordability. But you can enhance demand and increase the size of the buyer pool that views your building/unit as 'meeting their needs'! And that can go far in cushioning this downturn. Call it 'maximizing shareholder value'.

Where you don't ease up is financial qualifications for prospective purchasers. However, you can certainly loosen up on the "% DOWN" requirement if your building has enacted more stringent policy over the course of the past boom. I mean, do you really need to require 40%+ down right now to protect shareholder's interest against the likelihood of default? No, you don't. Rather that policy was intended to target a different end result; targeting a certain kind of buyer to 'join the club'. Lower it and ask the buyer to put 12 months of maintenance in escrow if they are borderline to meet pre-determined financial guidelines.

If your building has a 40% or more requirement for down payments and you are noticing a big dry up in prospective buyers given the nature of this slowdown, what will happen if you lower that restriction to 35% or 30% down? Does this really put the co-op at serious risk in regards to a buyer that can't afford the property? The key is maintaining tight requirements for employment situation, salary, debt/income ratio and liquid assets leftover after closing. By tweaking the percent down rule slightly, I don't think you risk a whole lot but your rewards could be a wider buyer pool that can now afford to purchase a unit in the building & pass your board! Today, I find banks to be more lenient than co-op boards; even with the tightening of underwriting standards.

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Residential Construction Expected to Plummet 81%

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

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

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

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

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

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

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

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

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

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Credit Suisse Pay Plan Altered

A: Good thing we covered this topic yesterday! People hear numbers like $140Bln and they immediately think of all the cold, hard cash that will pour into our markets - so bid up. What gets overlooked is the structure of these handouts and the fact that the cash portion is likely to shrink and be deferred. How does this affect the existing homeowner that is counting on a huge cash bonus to settle rising debts or continue to fund their lifestyle? There are two sides to the bonus coin: the affect on buyers and the affect on sellers.

According to the NY Times Dealbook, "Credit Suisse Alters Pay Plan for Top Executives":

Under the new plan, top executives will receive a proportionately higher base salary in cash. But the bonuses they receive on top of this will be deferred for a longer period and tied more closely to the bank’s performance and the performance of employees’ individual business units.

The bonuses will be split evenly between deferred stock and deferred cash. The stock portion of the bonuses will vest after four years — a year longer than has been the practice at Credit Suisse in the past — and will be adjusted according to the average share price and return on equity.

The cash aspect of the bonuses, which Credit Suisse says is new, will be deferred for three years and will be based on return on equity and the performance of business units.

The compensation changes cover salaries and bonuses for the firm’s 7,200 managing directors and directors worldwide. They take effect in January and apply to pay for 2009.

"What I don't hear are terms like: distribution of cash component vs stock options, deferred stock compensation, clawbacks, ROE shares deferred, toxic asset bonus fund (credit suisse in 2008), other government tax policy on future bonuses, etc.."

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Knakal: Resurgence of Institutional Capital

A: I need to plug Robert Knakal's Streetwise blog because the content has been a breath of fresh air for the past nine months or so. In his latest piece, he discusses the "resurgence" of institutional capital interested in buying distressed Manhattan property, to which their is limited supply (office, multi-family, mixed-use, etc..). With transactional volume down "60% from 2008 and 75% from 2007", average property values fell about 32% from peak levels. Sounds about right with office properties seeing the most pressure. But with sales volume down so sharply, why the limited supply?

There are three main pressures on commercial properties:

a) rising unemployment
b) declining rents
c) tight financing in the mid to high end

Strange to see inventory levels so tight given the plunge in sales volume. To hear Knakal describe it, "...discretionary sellers are seeing these pricing trends as a tangible reason not to place properties on the market at the present time". According to "Low Volume of Investment Sales Caused by Supply Constraint; Demand Still Strong":

The volume of investment sales recently has been extraordinarily weak whether you look at aggregate sales price or number of transactions. In fact, we are on pace to see sales volume hit the lowest level we have seen in the 26 years we have been tracking these statistics.

Average property value has fallen in New York by 32% from its peak levels. Multi-family properties have been performing best, having lost only 16% of value while office buildings with significant exposure to the marketplace have been the most negatively affected, seeing a reduction in value of about 70%.

These reduced values have peaked the interest from the buying community as investors are looking for core assets at greatly reduced prices. Conversely, discretionary sellers are seeing these pricing trends as a tangible reason not to place properties on the market at the present time. At the height of the market in the first half of 2007, we had, at one point, 836 exclusive listings. Today, we have just 513 and have been below 600 for the entire year.

We remain hopeful that the supply side of the equation will get better as distressed assets appear to be coming to the market in slightly better numbers than we have seen thus far in the cycle.

I too know of a few funds that were recently set up to take advantage of distress opportunities in that sector. Leads me to believe that a disconnect may exist in the most distressed commercial sectors as bids, while out there, just are not at levels that non pressured sellers would consider trading at - but then again, what the heck is non pressured sellers anyway. How do we quantify who needs to raise cash fast and close within a few months or else default? And how do you add in to that the human reaction to dealing with a financially stressed situation? Maybe a seller is in denial and ignores what in hindsight turns out to be a solid bid?

With declining rents, rising unemployment, and a tight financing market, the price has to be right; as the new owner will ultimately have a much better environment with which to operate the property. This is a highly deflationary phenomenon and tends to have a ripple effect on competing properties. This also may be one reason why bids have improved in the sense that Armageddon is now off the table, but not to a level that would jive with the current reflation trade mentality. The numbers still have to work!

For now, it's likely a good time to get into some distressed properties in office and mixed use marketplace if you have the cash and the numbers work! The chances of a natural overshoot to downside are high with such a fierce move; especially in office markets. For residential, the fear trades window was about 2-3 months (Feb, March, into early April) before the market saw a re-emergence of buyers and bids started to price out systemic risk. We found out later which months ultimately saw the sharpest deals.

Last check saw Manhattan office vacancy rates at 11.1%, a five year high, with rents falling 5.2% from the 2nd quarter and down 22% from the year ago period; via Bloomberg.

Calculated Risk adds some thoughts from NY Fed President William Dudley:

"First, the capitalization rate—the ratio of income to valuation—has climbed sharply. At the peak, capitalization rates for prime properties were in the range of 5 percent. That means that investors were willing to pay $20 for a $1 of income. Today, the capitalization rate appears to have risen to about 8 percent. That means that the same dollar of income is now capitalized as worth only $12.50. In other words, if income were stable, the value of the properties would have fallen by 37.5 percent. Second, the income generated by commercial real estate has generally been falling."

Net effective rents are more clearly showing the furious adjustment; these are rents after deductions and landlord concessions are factored in. Crain's reports net effective rents for commercial sector "hit levels that are 45% below their pre-recession peaks".

While I just renewed my residential lease 2 weeks ago, I'll share the outcome:

I rent a 891 sft, JR4, with 1 bathroom in full service upper east side building. E 80s location, west of 3rd avenue. My starting rent in 2006 was $2,900. It was raised to $3,100 in 2007 and raised again to $3,300 in 2008 (they asked for $3,450, but only offered $3,300) as there was no inventory in building even though markets seemed to be trending down this time last year already.

Landlord offered me $3,150 + 1 month free rent for a 13 month lease renewal. I asked for $2,900 plus the same concession. They came to $3,000/mth + 1 month free on a 13 month lease. I took it. So, that brings the net effective rent to about $2,750/month, or a 17% reduction from last year's levels.

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Manhattan Rents Fall / Office Vacancies Rise

A: Just passing along the latest. This is all not new and the process is a healthy one. I wouldn't be surprised if stabilization shows up in one of the next two quarterly reports.

Bloomberg reports, "Manhattan Rents Fall More Than 8% on Unemployment":

Manhattan apartment rents fell as much as 8.9 percent in the third quarter from a year earlier as rising unemployment cut demand, Citi-Habitats Inc. said.

Average rents declined for all apartment sizes as landlords offered concessions to tenants, the New York-based property broker said in a report issued today.

“The only way you can create demand is to make the market and the way you make the market is adjust the prices accordingly,” Gary Malin, president of Citi-Habitats, said in an interview.

Rents for studio apartments fell 8.2 percent to an average of $1,760. One-bedroom units dropped 8.8 percent $2,423. The cost of renting two-bedroom apartments declined 8.9 percent to $3,381 and three-bedrooms fell 7.9 percent to $4,591.

The rates reflect some, but not all, of the concessions offered by landlords, including a month of free rent, Malin said.

Wow, check out the vacancy rate of the Upper East Side jumping to 2.49%! Bloomberg then gets into how "Manhattan Office Vacancies Reach Five-Year High":

Manhattan’s third-quarter office vacancy rate hit a five-year high as unemployment rose and companies gave up space in the recession.

The rate rose to 11.1 percent, the highest since the third quarter of 2004, New York-based broker Cushman & Wakefield Inc. said in a statement today. Rents fell 5.2 percent from the second quarter to $57.08 a square foot and were down 22 percent from a year earlier.

Sublease space declined to 11.1 million square feet from 11.4 million at mid-year, the first drop since the end of 2007, Cushman said.

“This is probably an indicator that you’re starting to see a market starting to bottom out,” said Joseph Harbert, chief operating officer for Cushman’s New York metropolitan region. “I would look at that as a harbinger of what’s to come. We’ve got a ways to go.”

The consumer is still repairing their balance sheets and dealing with a tough labor market. The Fed is continuing to engineer a bank recapitalization environment even as some asset values feel like they are getting a bit frothy. The idea is to cushion the deflationary blow, cushion the hit to the economy and allow banks to re-organize themselves and try to earn their way back to health. Do we really want banks to go crazy lending to consumers in a deteriorating credit and rising unemployment environment? No, we dont. The system needs to purge itself of the excess that came with credit binge over many many years. In the meantime, each half off sale that we hear about (i.e. California Hotel Foreclosures Triple in first 9 months of 2009) will result in its own deflationary whiplash as the new owner has a much more efficient operating environment with way less debt in which to run the existing business.

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Lower End Market Shift: Call It Broker Babble If You'd Like

Toes Here! Just want to pass on what I am both seeing & hearing out there. I know you're all going to pounce on me if you aren't actively in the market right now, but so be it! This post mainly has to do with sub $1M properties that are PRICED WELL, i.e. below the most comparable active competition.

I have sensed a market shift in the last four-six weeks. One of my sales listings had a bidding war in the first 9 days on the market where there were three bidders very close to the asking price, one all cash. A fourth buyer came in 15% lower than ask and was flabbergasted that his offer was so much lower than others.

A buyer of mine offered full asking price on a $299K apartment only to be beaten out by someone putting more than 30% down (building only requires 20% down). The lower end market has been very active as of late.

Another buyer of mine offered full asking price (just reduced to $515K from $538K a month ago) on an apartment, but was two days late - a contract was going out and his offer wasn't high enough to disrupt the current deal.

I wanted to make sure this wasn't just something I was seeing in my own business, so I took a survey. Here was my question to my fellow brokers:

"Hi y'all,

I have 2 separate buyers who lost bidding wars this week ($299K and $515K downtown).
One listing where we had a bidding war (UES, $525K) between three great buyers.
And I have noticed a few brokers/sales offices RAISING prices on a few apartments. (Don't they know that everyone is on streeteasy & knows that they raised the price!?)

Is this happening everywhere? Do I need to tell my buyers that literally in the last few weeks this market has just shifted? I'm worried that they will think I am giving them "broker babble" or they'll think I am being "pushy broker girl." So I would like to get some more anecdotal evidence before I start making assumptions about the market based on my own business.
Thanks so much for your feedback! Christine"

1. Sales offices will do that especially if they've had listings on since 2007- they just assume that the apt has appreciated, but in reality, they will cut a good deal, especially if they wish to sell the last few remaining units- not the case for all sponsors, but for some.

2. For buyers, I would use inventory facts. Inventory is decreasing so there's less choice. Since there are a lot more serious buyers out there, the "freefall" in prices is over and realistic offers will need to be made, sometimes very close or at or even above ask price.

3. We discussed this in our meeting this week as well and I have been involved w/ one bidding war this past month. It is still a shaky market in my opinion and only the best priced apt is priced a bit lower are getting the bidding wars. That said you can only present the situation to the buyer and have them decide on best and final offers - that would save u criticism in future about your advice should the market take a tumble.

4. Christine, I assist 2 VPs, and I’ve been seeing it happen on deals for both of them. We’re seeing it on deals from the 600k range all the way up to $5mil on Park Avenue. I know what you mean about being accused of broker-spin, but it really is happening (on well-priced and otherwise awesome apartments). Even just had a bidding war on a $5,000 rental

5. Working with a studio buyer under 500k currently and it is shocking what is going on. Every good property has at least one offer on it. Just lost out on a bidding war for a property that was on the market since July and now all of a sudden got 3 offers on it. She lost out on another a couple of weeks ago. It's hard for first time buyers to deal with it.

6. Christine - I also get a sense that the lower end of the market is shifting since mid August and prices are tightening up in the $450,000 and below range. I too have seen a few price increases.

7. Hey pushy broker girl. I had 4 offers over ask on a townhouse in Bklyn last month. So it is happening when props are priced right.

8. I had 3 bidding wars in May/June. Each apartment went for below the asking price, but they were priced right for what they were in this market. I think its nuts to raise prices in this market.

There you have it! The buyers are out there and when something is priced right, apartments are selling and there are even bidding wars.

Toes says: Don't be surprised if you have to pay asking price or very close to asking price for an apartment. Whether its a real shift or just a temporary bubble, I don't know, but studios and one bedroom apartment in particular are selling if they're priced right.

Toes says: If you've been active in the market and are ready to pounce on something, be prepared with your financial statement filled out and ready to go, your Manhattan real estate attorney in your back pocket & a recent mortgage pre-qual letter. The most prepared birds get the worm:)

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Manhattan Q3: Sales Surge 46% From Q2, Prices Fall

A: Not news for UD readers, but will certainly cover the main street media headlines today. Here is your Q3 data.

I must say I am a little surprised they focused on continuing pressure in price levels in the headline, rather than the surge in activity from the prior quarter. Good to see the headlines keeping it real!

Via Bloomberg's, "Manhattan Apartment Prices Decline for Second Straight Quarter":

Manhattan apartment prices fell for a second consecutive quarter, helping drive the biggest gain in sales in more than 13 years as buyers seized on discounts. The number of sales jumped 46 percent from the second quarter, the biggest third quarter increase since 1996.

The median price slid 8.4 percent to $850,000 in the third quarter from a year earlier, New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said today. Values fell for cooperatives and condominiums of every size and price as New York City’s unemployment rate jumped to 10.3 percent in August.

Studio apartment prices fell 6 percent from a year earlier to a median of $399,000, Miller Samuel said. One-bedrooms dropped 11 percent to $645,000; two-bedrooms fell 23 percent to $1.18 million and three-bedrooms dropped 41 percent to $2.25 million.

Four bedroom apartments plunged 49 percent to a median of $5.18 million, reflecting, in part, a decline in luxury sales, Miller said. Those sales declined 16 percent. The luxury segment is defined as the top ten percent of co-op and condo sales.

The above graph makes it clear to see the decline in sales in each quarter since the peak in 2007. With many deals still in the pipeline, we might be able to beat Q4 2008's number when that data is released January 2nd, 2010. Our active season was delayed as deals started to pick up in May with prices correcting to a new, lower level. It was this adjustment in prices that re-sparked interest in Manhattan residential property. As months went on and a reflation mentality took hold for all markets, activity surged. This is what today's report shows.

The biggest concern right now is if sellers get too euphoric with the improvement in bids since fear engulfed the markets earlier in the year. I am starting to see this happen over the last few weeks. For the period of May-Aug or so, many sellers came to the realization that bids for their property were coming in at this new, lower level. It took some time but the message got through and many deals were finally signed into contract. It wasn't because bids all of a sudden spiked higher, rather, sellers over time got more realistic about what the market was telling them their place was worth. After 4-5 months of this type of activity, I am getting the feeling that sellers are starting to take it a bit too far.

In early August I wrote about this future concern in, "It Takes Two To Tango: Are Buyers On Board?", which garnered a nice reaction in comments:

"I don't see a sustainable uptrend in bids just because stocks say so, as buyers don't seem to be fully on board the gravy train. But this fierce equity rally may just be enough to alter the psychology of sellers and slow this market down a bit. Unless buyers change too we will see a disconnect again leaving brokers and those same buyers wondering what the heck is going on."

Sellers expect bids to continue to improve and to price in future profit potential that hasn't happened yet. As a result, they are a bit less motivated to move property until they get their number. This is a dangerous emotional element for any seller considering the foundation that this so called reflation rally is built on. It can change on a dime at any time! Sellers need to ignore the equity rally and continue to price their properties where deals are happening - at this new, lower level. If they don't, sales volume will dry up pretty quickly and a reversal of inventory trends can put a bit more competition on each listing. Take advantage of the action and understand where the bids are!

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Get Ready! Here It Comes...

A: Its starting early and I suspect it will only get louder as we get to week end. With Manhattan's Q3 Residential Real Estate report slated to come out in a few days, expect a surge in activity to be reported. Quarterly reports are a peak into the rear view mirror for the past few months; so lets do a little backward looking. As usual, due to the lagging nature of these reports headlines may mis-represent what seems to be going on out there now. If you want to see whats in front of you, don't look in the rear view mirror.

Expect both contracts signed activity and actual sales to surge on a quarter-to-quarter basis. The preferred analysis will be y-o-y and that will probably show a level sales comparison with lower prices from the year ago quarter.

In Q3 2008 we had 2,654 sales. Its quite possible that we get close to that level in this upcoming report (closed sales) and actually beat next quarters level of around 2,300 when Q4 is ultimately reported. After all, many contracts were signed over the past 3-5 months and now we are just waiting for them to close; a 2-3 month process. In terms of sales volume, the quarters that defined the downturn for the Manhattan residential market were Q4-2008 through Q2-2009 - so we got some favorable comparable reports in our future for y-o-y analysis. Take a look...

*data courtesy of MillerSamuel.com

The one area we won't see improvements is in price levels. The NY Times discusses in "At Long Last, a Leveling Out? ":

A review of closing data shows that median and average prices on co-ops and condos have continued to drift lower in the third quarter. Sales volume has picked up from the moribund levels earlier in the year, but remains about 29 percent below the levels of a year ago.

Because of the long lag time between contract signings and closings in New York, many brokers are hoping to see stepped-up activity reported in the fourth quarter, normally a sluggish period. They are also looking forward to a surge in sales based on a forecast of significant bonuses, at least among the Wall Street firms that survived the downturn.

Its true that you can't deny the pricing out of fear this market experienced via the improvement in bids for Manhattan property. But to cherry pick price action and ignore the entire correction by looking at the improvement in bids recently is to miss out on the adjustment this market has made. Stabilization is quite different than a new sustainable rise in prices built on improving fundamentals. What we had is a stabilization of prices after an enormous shock that saw bids for Manhattan property adjust to a new, lower level. It took a few bumps to find that new, lower level, but then again that is usually how markets work. This is where we are now and this is where I think we will stay for a while.

The Q3 report will probably show this muddling around of prices on a quarter to quarter basis. No market was immune from the deflationary forces of the greatest round of debt deflation since the 30s. Anyone expecting a prediction from me going forward, I'm sorry to disappoint. The correction I was expecting happened, and other than muddling around for a while I don't see any big moves in either direction until some outside force acts upon us. This could be a number of things:

a) another shock to the credit markets - so far, the exact opposite has happened and credit has improved significantly
b) a sharp rise in rates - who knows how mortgage markets may react to the winding down of fed quantitative easing policies, continued supply of treasury auctions or perceived inflationary pressures in the years to come
c) another fierce equity selloff - tied to 'a' above, who knows when stocks will decide to fall given all known information being fully priced in - right now the path of least resistance is clearly up.

In the meantime, individual distress will be where the best values are and I'm sure consumer deleveraging will continue for years as homeowners in trouble will do everything they can before being forced to sell their primary residence. The banking system continues its recapitalization with plenty of outside help and bad debts need to ultimately be written down. At the same time consumers are repairing their own balance sheets via higher savings, less spending, and paying down of excess debts. When we reach the end of this cycle we can start to talk about sustainable credit expansion without emergency fed facilities for an economy that sees job creation and consumers with rising credit quality - that is when loans will start to accelerate and the money multiplier effect kick in again. For now, the patient is still receiving a steady IV drip to nurse itself back to health.

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Looking At Todays Manhattan Marketplace

A: I always enjoy reading my friend and fellow colleague Doug Heddings stuff over at TrueGotham.com, especially when its strictly about what he sees in the marketplace at any given time. His latest discussion delves into the realistic pricing adjustment that he says sellers have made either in listing price or in negotiated price for a deal. This varies depending on price point and right now the lower end (studios, 1BRs), especially under 1M, is very active. This is mostly a function of lower prices, higher buy side confidence and more liquidity in the mortgage markets. I see similar things that Doug reports on out there, but I also see a good amount of listings that are still ridiculously overpriced with no relation to past comparable sales. What buyers need to understand is that there will always be a subset of sellers that will test the market and have no financial or time pressure to sell. After all, its not your apartment to sell.

Doug discusses his feelings that "Sellers More Realistic Than Buyers in Today's Manhattan Real Estate Market":

Before you get all crazy on me, here me out. I'm not AT ALL suggesting that it is a seller's market...because it's not. That said, it also is NOT the buyer's market that many believe it to be.

Anecdotal evidence is showing that aggressively well priced properties are receiving multiple bids which may indicate that we are nearing the "bottom." Most sellers and their agents have already adjusted asking prices to reflect recent depreciation. Of course some are still delusional but it seems to me that asking prices are down almost the same 10-40% from peak levels. Buyers bidding another 20% below these already adjusted prices are experiencing overwhelming frustration at the inability to negotiate with sellers.

So despite the fact that we have witnessed one of the most rapid price declines in housing market history, buyers must take into consideration that many sellers have finally accepted this fact and adjusted prices accordingly.

I have certainly seen this market as quite active for about 4-5 months now. The market will always do what it wants to regardless of what you, me, or any one individual thinks or says. The fact is this market is reacting with the same reflation trade mentality that is encompassing the credit markets and the equity markets. It seems assets across the board have got a bid under them - even in the CMBS world where AAA Series 1 bids are in the low-mid 90s where it doesn't seem it could rally much further. Any talk about commercial real estate being the next shoe to drop certainly is not being reflected in dropped bids for commercial mortgage backed securities. Back to the market.

Looking at today's Manhattan marketplace it seems to be a classic case of a natural market rebound after an overshoot to the downside. In a few months you will have the analytics to see this in the data as it happens - so stay tuned as Im working hard on this now for you guys!

What buyers need to know is where this market seems to be trading right now. That is why Doug says, "It has never been more important than it is today to analyze an apartment's price and how it compares to peak pricing levels as well as recent sales and contract signings.". Well, where are contracts being signed? Where are the bids coming in? This is what brokers need to educate their clients on and in my opinion is where the true meat of the buy side consulting kicks in. If you are going to spend hundreds of thousands or millions of dollars on a property, its kind of important to have a credible guide advising you where this market seems to be trading today. Otherwise you will be navigating a very fast moving marketplace blind and bidding at a level conducive to 'getting a deal done'. If I had a dollar for every time I was told by a listing broker that the 'bid must come in near ask' with no comparables to support that price leve, I would be a rich man.

It seems to me that each price point is now trading at the lower end of the % discount from peak range noted here in earlier posts. So it would look something like this:

HIGH END ($5M+) - down aprox 28% - 38% from peak
HIGH/MIDDLE ($2M - $5M) - down aprox 23% - 28% from peak
MID END ($1M - $2M) - down aprox 18% to 23% from peak
LOWER END (Under $1M) - down aprox 15% - 20% from peak
*NOTE: approximations of where price points seem to be trading must always take into account any one unit's unique identifying features (light, view, raw space, renovations, layout, outdoor space, monthly expenses, bldg amenities, etc.)

If I were a serious buyer today, this is the range I would use to figure out where any one product likely will trade in the marketplace today. Fine tuning the analysis based on the unique features of a property then comes into play. If you compare this to my previous estimates on where price points seem to be getting bids, you will notice that it has been updated closer to the lower end of the range down from peak. The biggest fear I have now is that sellers will get too optimistic and refuse to move property where bids seem to be coming in - that leads to a buyer-seller disconnect and much lower volumes. For now that doesn't seem to be happening as serious sellers acknowledge where the market is today.

You just can't deny that buyers are out there and bids are coming in around the levels I described above. If you are a seller and you got a bid higher than the range I suggested, I say great for you and strongly advise you to take advantage of the confidence boost that comes with a surging equity market and recovery headlines. Always know that confidence can turn on a dime and be shattered at any time due to some unforeseen event or trend reversal. Nobody can predict the timing so we are left to analyze where we are today, where we came from, and where we might be going. I'll leave the future up to you guys and stick to monitoring whats happening out there now. If bids change further, Ill report on it here.

The biggest mistake a seller can make right now is to price their property way ahead of where this market is right now, simply on the belief that the perfect buyer will come in and include a premium in their bid for anticipated future profit potential. I still see many listings out there today that are pricing this way. That strategy is counter productive. Only you and your broker know how traffic has been and where bids are coming in - and this is not a perfect science and I am only one agent out of more than 8,000 doing business in the NYC area. Ask yourself, is the pricing right or are the bids right? If you think your priced right and we are telling you this market is quite active, then why haven't you sold?

The best description I can give regarding my buyer clients mentality right now is that they are more than willing to pay market value for property, but not at all willing to chase for fear of being priced out forever or be swayed into pricing in a future profit potential that has not occurred yet. This leaves sellers and their brokers to figure out where market value is for the property. Price right - get the traffic in - create a sense of urgency - and hopefully get multiple strong bids.

Buyer's seem to be well aware that bids have improved over the course of the last six to seven months, and to get a property today they need to come in around those improved levels. Similar to what Doug said, I find that buyers bidding as if fear of future downside risk should be baked into the purchase price are getting disappointed in the response.

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The Picture of Recasts - Neg Am Speeding Up Recasts

A: The deleveraging process on the consumer and business side will continue. One pressure on the consumer side that should be of concern is the coming recast schedule for all those with Option ARMs. Those using negative amortizing payment schedules will see a recasting of their loan to the new higher principal amount, causing a 'payment shock' that was building up for years - the easier payment schedule was the clear choice for many with mortgages that were barely affordable to begin with. The rate reset schedule doesn't bother me so much given the dramatic improvement in LIBOR and other credit indexes that the reset is tied to. But now it seems the recasts schedule is approaching faster due to the rate at which borrowers are reaching their balance cap.

The new T2 Presentation out, some 155 pages of doomy charts and graphs, showing us a glimpse of the Option ARM recast schedule (sorry, the file is too large to upload here and I'm looking for a outside link).

First, let's revisit what this recast vs reset thing means:

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

According to the latest T2 report, "Option ARMs are Recasting Much Faster Than Expected Due to Negative Amortization":

Nobody is denying that the worst is likely behind us in terms of price destruction in many hard hit residential markets - a combination of government subsidies on the mortgage side, first time buyer tax credits, monetary stimulus, and a natural deceleration of unsustainable fierce price declines. The less-worse reality will be with us for a while given unprecedented measures taken by the Fed, the FDIC, and the government. But what we need to keep our eyes on are variables like this that contribute to the prolonging of the deleveraging process. The recast wave was thought to be a few years out but with more borrowers utilizing the negative amortizing payment option to keep costs as low as possible, the recast is hitting earlier than expected. This is one of many reasons why the side effects of this housing/credit crisis will feel like it never goes away.

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Corus Bank Shut Down - $16 Trillion in Govt/Fed Programs

A: One of the remaining biggies was just shut down. Check in with Bill over at Calculated Risk as he covers all these bank failures individually, along with commentary. Bill is wicked smaaat!

From the FDIC, "MB Financial Bank, National Association, Chicago, Illinois, Assumes All of the Deposits of Corus Bank, National Association, Chicago, Illinois":

Corus Bank, National Association, Chicago, Illinois, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with MB Financial Bank, National Association, Chicago, Illinois, to assume all of the deposits of Corus Bank, N.A.

As of June 30, 2009, Corus Bank had total assets of $7 billion and total deposits of approximately $7 billion. MB Financial Bank will pay the FDIC a premium of 0.2 percent to assume all of the deposits of Corus Bank. In addition to assuming all of the deposits of the failed bank, MB Financial Bank agreed to purchase approximately $3 billion of the assets, comprised mainly of cash and marketable securities. The FDIC will retain the remaining assets for later disposition. The FDIC plans to sell substantially all of the remaining assets of Corus Bank in the next 30 days in a private placement transaction.

The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $1.7 billion. MB Financial Bank's acquisition of all the deposits was the "least costly" resolution for the FDIC's DIF compared to alternatives.

"The issue is the liquidity of their assets. A huge chunk of their balance sheet is made up of assets received from failed banks. REO, toxic loans, etc. That’s not cash they can use to finance bank seizures and sales. If they run out of cash, they may have to borrow from Tim Geithner."

No way they use it all and a wind down of programs is expected sometime in 2010; but you can see the bazooka brought out to fight this episode of debt destruction. The question that matters most is when perception changes and confidence changes ever so slightly - and what changes it. One sign will be a reversal in credit markets and if/when equities selloff on positive news that we know is coming.

Via Tom Joyce's latest presentation from Deutsche Bank Securities - "One Year After the Shocks of September 2008: Over $16 Trillion in U.S. Government Programs" - View Larger Image

Yes, unprecedented actions were taken to save our banking system and yes it is having an effect on our dollar, credit & equity markets. I'll try to get more info from that report up here next week.

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Deflation Will Partially Negate Extreme Inflationary Policies

A: One can easily describe the environment today as one of extreme inflationary policies to combat deflationary forces and mass deleveraging from years of excess. That is how I like to look at it in terms of inflation or deflation. It gets more confusing when you start debating how one defines inflation. Some simply view inflation as a weakening of the relative currency. It is all relative right? If the US dollar is to get destroyed, it must do so against other stronger currencies. So really it is a question of which currency is the weakest at any given point in time. In other words, we can have extreme inflationary policies yet see a strengthening dollar relative to weaker major currencies. If anything, let us at least admit that a definition of inflation needs to take into account a few other dynamics. And in doing so, you will realize the bigger picture phenomenon at play right now...that deflation will partially negate extreme inflationary policies that are in place to support asset prices, a banking sector recapitalization, a smooth deleveraging process and economic stability that hopefully leads to a recovery.

Or you can say it this way --> extreme inflationary policies are in place to negate a deflationary spiral. I guess it boils down to how you define inflation. I tend to side with Mish that inflation is a expansion of the money supply and credit where credit is marked to market. While the money supply has surged as the fed responds to deflationary forces, the destruction of wealth in the shadow banking system is approaching $1.7 trillion or so. As a result, banks are contracting lending to consumers as credit quality deteriorates amidst a rising unemployment environment.

Take a look at the latest fed report on consumer credit and you will notice that there was a month to month decline of $21.5Bln (the largest monthly drop on record), and a fall of about $70Bln over the past year - non-revolving debt contracted at a 11.7% annual pace:

This trend is likely powered by a combination of consumers paying down debt balances and banks seeing rising charge-offs. Credit contraction of this magnitude is certainly not inflationary in a fiat universe with a fractional reserve banking system designed to have a money multiplier effect. Back to Mish:

"In a fiat world which we are clearly in, not much happens unless credit is extended or money somehow makes its way into the economy. Realistically "debt deflation" is about all one is ever going to see in a fiat regime. The reality is "Debt Deflation = Deflation" in a fiat regime. Indeed it is the destruction of debt that matters most.

Those who stick to a monetary definition of inflation pointing at M3, MZM, base money supply, or even Money AMS, are selecting a definition that makes absolutely no practical sense."

Now, lets get creative here. What if inflationary policies end up having some unintended deflationary side effects - the effect of higher rates, higher taxes, and higher commodity inflation come to mind and their combined effect on both consumers and corporations. I think that is part of endgame and will be the new reality once we get through this mess.

I really think that any inflation we see first will be of the 'crunching' variety right as unemployment reaches its peak across this country. That is, I think inflation will first show up in the form of higher energy prices, higher food prices, higher health care costs, higher rates, higher taxes, higher commodity prices, etc..the stuff that we need to live on day to day. Those expecting wages to rise and housing to surge as a side effect of inflation will likely be disappointed due to the credit shock we have been through and the residual damage that was done to the banks balance sheets, the securitization model, the consumer balance sheet, elimination of exotic loan products, tighter lending standards and the speculative/move-up/move-across home buyer.

It gets confusing when you start talking about how inflation will support housing prices, especially those hyperinflationists that see housing price levels surging to peak levels as a result of the weakening dollar. I disagree with this 'inflation induced home price surge' for a number of reasons but I do not discount the possibility that we will see natural rebounds off the trough from the hardest hit markets! After fierce destruction, one would expect a bit of a rebound as past housing reports including high amounts of distressed sales are ultimately compared to.

Housing is tied to the availability and cost of credit in addition to fundamentals like a strong labor market, rising wages, and simple supply/demand imbalances. Add in a host of other dynamics like securitization of loans, easy appraisals, exotic loans allowing affordability to surge, no underwriting standards, govt subsidized lending rates, first time buyer tax credits, housing programs and a speculative bubble component and you have the makings of an asset class that is festered with outside interference. Its not just about the house being priced in US dollars. Rather it is a amalgam of forces that can affect which direction housing prices drift. Sure the dollar may weaken, but in no way will the engine that powered housing growth over the past decade work like it did as we approached the peak in credit.

Therefore saying a weaker dollar IS inflation and in times of inflation housing SHOULD rise because the asset is priced in dollars, will have some flaws to it because the recipe for housing success has greatly changed in today's world.

With deflation the US dollar should swell. This is what happened during the course of 2008 which since has been negated some by inflationary policies and a rush out of dollars to higher yielding asset classes; doesn't mean we have an inflation problem now though. The net move in the US dollar was muted because of deflationary forces and the rise that our currency saw when the crisis reached its zenith.

Already we are hearing talk of possible exit strategies by our fed to limit any whiplash inflation resulting from the extreme policies put into place to stem this crisis. The most recent is the potential for tighter capital requirements for our banks - Greenspan on Bloomberg:

Former Federal Reserve Chairman Alan Greenspan said banks should be forced to hold more capital on their balance sheets, reinforcing a weekend push by finance chiefs from the Group of 20 nations.

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Prime Deliquencies Accelerating: A $4.5Trln Market

A: The delinquency problem has been spreading to higher quality debt classes for some time now. It is not new but seems to be something lingering out of mind right now. Since prime loans make up '80% of US bank exposure to mortgages + credit card loans', its something worth keeping our eyes on. According to the latest T2 Partners report the total size of the prime market is about $4.5Trln. As the lower end of the national housing market starts to stabilize and even improve from uber distressed levels, its the higher end market that is yet to see the same level of re-entry activity. This is probably a force that will last for a while as move-up buyers are not part of any near term housing recovery.

First the news via WSJ, "Troubles For 'Prime' Borrowers Intensify":

Rising delinquencies on prime mortgages helped drive the total mortgage-delinquency rate to a record 9.24% in the second quarter, according to the Mortgage Bankers Association. The data reflect loans at least one payment past-due.

Such delinquencies on mortgages made to prime customers rose 5.8% in the second quarter, compared with a rise of 1.8% among subprime customers. Still, the delinquency rate for prime loans was 6.4%, far below the 25.4% rate for subprime loans, according to the Washington-based trade group.

I believe that total includes all whole loan originations + all refinancing activity for prime borrowers. The scary thought lies in the appreciation levels that some of these higher end properties saw during the boom. How much of that was cashed out when MEW was the hot thing to do? Now that the high end home is worth significantly less, the debts still remain. In a rising unemployment environment, its only a matter of time for prime borrowers to start running into debt service problems. And we are seeing that now.

Its the lower end to mid end of the national housing market that is seeing the most activity and the most stabilization. The pace of destruction in home prices for these segments were not sustainable and a natural market rebound can be expected as investors and first time buyers take advantage of attractive prices and government tax credits. But the higher end is still adjusting. This is due to a combination of lack of credit availability in the high end market + tighter lending standards for higher end property + misaligned price/rent affordability ratios for higher end + a shrinking buyer pool that can qualify and close for a higher end property.

One major element that is missing from the higher end market nationally are the move-across and move-up buyers! No longer are people taking profits from their mid sized homes to put that towards a higher end move-up purchase and financed by an easy credit system.

Calculated Risk has covered this absence of move-up buyers in detail as 70% of total sales in Q2 were first time buyers taking advantage of gov't tax credits and investors (click for larger image):

"According to the Campbell survey over 70% of sales in Q2 were to first-time buyers and investors.

Although we don't have historical data for distressed properties - or buyer types - this does suggest a market that is far from normal with few move-across or move-up buyers. "

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So, Is This The Time Gold Breaks Out?

A: You know my feelings on gold here and how if there will be another bubble in our future, precious metals is the asset class at the top of my list for going parabolic. There are different theories on the gold trade from inflation/dollar hedge, to safe haven play in times of uncertainty, to a coming default at the Comex. I'm of the camp that likes gold because of the insane amounts of fiat money printing that is going on as a coordinated effort to stave off the same deflationary forces. Add in that the fed's balance sheet was likely compromised big time by all the credit facilities put in place to avoid a systemic financial event. Gold tried and failed to break out three times now leaving many gold bugs pulling out their hair in frustration. So is this it?

There is one noticeable difference that comes to mind about this time around compared to past times when gold approached $1,000 --> the need to delever and level of fear. The first time gold approached $1,000 was around February of 2008 when Bear Stearns was about to be rescued by the fed and JP Morgan for $2/share. The 2nd time was in early 2009 as the stock market approached its lows in a fierce selloff ridden with margin calls, fear, wider credit, and redemption requests. Both of these times saw the need to delever big time and raise cash, perhaps limiting the potential breakout of gold. In other words, those that needed to raise cash took advantage of the one asset class that was performing at the time of stress; and that was gold.

But this time around equities are in the midst of a 50% surge, fear is non-existent, credit dramatically improved, corporate bond spreads much narrower, and tons of money was made on the reflation trade momentum - not really an environment conducive for fear based forced selling. Look at the chart to the right and notice where 3MTH LIBOR was the last two times gold approached the $1,000 mark:

February 2008 --> 3MTH LIBOR at 3.111%
February 2009 --> 3MTH LIBOR at 1.184%
TODAY --> 3MTH LIBOR at 0.34%

Clearly fear is not contributing to gold's rise right now. I think a large amount of deleveraging was already done in past episodes of fear and we may not see the forced selling to raise cash this time around as gold approaches that $1,000 mark - in short, the need to delever may not constrain gold from popping this time around. I deep down believe that one of these days gold is going to go ballistic and kill the shorts and surprise many. Whether that move is to 1,200 or 1,500 I don't know and when it happens I dont know, but it will be impossible to time and trading dynamics will kick in giving it that extra uumph to reach levels once thought impossible - similar to the move in oil from $100 to $145 in mid 2008 over a very short period of time that was mostly speculative momentum.

In my "How IN is Gold, huh?" piece back in February:

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

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.

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.

What To Watch For: Gold to rise even as the dollar rises. This disconnect occurred early 2009 as the US dollar index approached its most recent high of 89 right as gold approached 1,000 for the 2nd time. Gold is usually a dollar inverse trade so keep an eye out for another disconnect there.

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Stuy Town / Peter Cooper Village CMBS Downgraded

A: And here we go. Fitch ratings downgraded four CMBS transactions due to exposure to $4.5Bln in commercial mortgages tied to Stuyvesant Town / Peter Cooper Village. The downgrade reflected the likelihood of default as debt service cushions are almost depleted.

Via Housingwire.com, "Fitch Downgrades Four CMBS Transactions on Likely Default":

Fitch Ratings downgraded four commercial mortgage-backed securities (CMBS) due to exposure to pieces of a $4.5bn commercial mortgage that is likely to default.

The loan secures Stuyvesant Town/Peter Cooper Village, a collection of 56 multistory buildings on 80 acres with a total of 11,227 apartment units. The Stuy Town loan continues to underperform, along with other loans in the affected transactions, Fitch says.

Of the $4.5bn loan, $3bn is securitized and the remaining $1.5bn of mezzanine debt held outside the trust. Fitch determined cash flow generated from the property remains well below the amount needed to service the current outstanding debt, and the borrower as a result must use debt service reserves to cover operating shortfalls. Fitch notes the general reserve and replacement reserve are “essentially depleted” and the debt service reserve balance fell to $49.3m, from $400m at issuance.

Tishman, along with the now bankrupt Lehman, also purchased Archstone Smith for $22.2Bln in what was the industry's largest public to private merger in the multifamily REIT sector. But it didn't end there, Tishman also went after the CarrAmerican real estate portfolio in late 2006 for $2.8Bln. Clearly they were on board the credit gravy train that ended up taking Lehman down. Add them all together and what you get is a story in Bloomberg last week that Tisman Speyer's real estate holdings fell by approximately 33.5% from peak. Ouch!

Whatever model the buyer used to rationalize the purchase at the time needs to be adjusted now that Manhattan real estate caught up with the credit dislocations that occurred less than one year after the purchase. Today's rental market is one that is trending down, while at the time of the purchase rents were rising to their ultimate peak around Fall of 2007. I would estimate rents today in that area to be down a minimum of 10%-15% from peak, with further downside possible as NYC's unemployment rate continues to rise.

The entire complex houses about 11,200+ apartments, 70% of which are rent stabilized. The rent stabilization rules require the tenant to use the apartment as their primary residence + earn less than $175,000 for two consecutive years + rent below the $2,000/month threshold. Tishman Speyer, along with the real estate arm of Blackrock, agreed to buy the land + buildings for $5.4Bln in late 2006. MetLife was the timely seller.

Tishman Speyer was sued by the Stuy Town tenants association earlier this year for improper practices to find tenants in violation of rent stabilization laws. The goal was remove as many rent stabilized tenants as possible so that market rate rents could be collected.

The reserve fund has about $49.6 million left and the burn rate quoted in the NY Post a week ago was $11.3M a month. However, this burn rate that is depleting the reserve funds should fall as we enter September. September is known to be one of the busiest rental months in Manhattan as the school year kicks off, so time will tell how many vacancies are filled and if rental rates stabilize.

Alex Finkelstein over at The Real Estate Channel chimes in:

"Based on current performance and the uncertainty surrounding ongoing litigation, we do not expect property performance to improve sufficiently to service the securitized portion of the $4.5 billion debt before reserves are depleted', says Fox. Capital expenditures for converting stabilized units to market rents have ceased because of a moratorium on conversion imposed by the Court of Appeals as a result of the litigation.

While this has reduced capital expenditures, the use of debt service reserves has increased because the Court also requires the borrower to separately escrow the difference between stabilized and market rents on former stabilized units, Fox says.

Previously, this difference was available for debt service. Once debt service reserves have been depleted, the borrower has the option to replenish them or cover the operating shortfalls out of pocket.

Fitch's analysis is based on updated expectations of limited unit turnover and stabilized expenses. Based on this estimate of cash flow, losses could be as high as 20% of the $3 billion A note balance.

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Has Complaceny Set In? China Rolls Over

A: One of the trickiest thing about equity trading is figuring out when stocks have fully priced in all available information - this is one reason why stocks are both not rational and not always right. The concept of when a stock has fully priced in or priced out information is one that will always baffle even the best traders and research teams. With that said, what type of recovery has this market already priced in? And has the market priced in future exit strategy announcements from our fed? Anyone watching the global markets probably has noticed the rolling over of China's Shanghai Index lately in response to the governments threat of pulling the punch bowl away from the banking sector. I find this very interesting because the Shanghai market seems to have been leading other markets in regards to the reaction to major stimulus and now the reaction to possible 'more restrictive' policy. Could this be a glimpse of how equities will react when our fed has to take the same path? Since policy actions taken to stem this crisis has been gargantuan to say the least, the debate will rage between whether the fed slowly and methodically conducts their exit strategy or if we are in for a swift pull of the punch bowl too.

China's Shanghai index is now down 23% in the past month or so; shown on the chart to the right. This is worth watching because it looks like China will be the first test case of sterilizing uber lending that took place in the first half of 2009. Imagine if our Dow falls to 7,400 or so in a months time - do you think people would notice!

According to this Bloomberg article 10 days ago, "China plans to tighten capital requirements for banks, threatening to curb the record lending that’s fueled a 60 percent rally in the nation’s stock market, three people familiar with the matter said."

The gov'ts plan was to require the banks to 'deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital', forcing the banks to raise more capital and possibly sell shares. The immediate reaction was that this was the government's way of taking away the Kool-Aid that powered the equity markets up over 103% since the lows. China is taking a different route to toughen capital requirements to curb aggressive lending that was previously encouraged to re-stimulate the economy, and its equity markets are reacting to this new information. It's quite nice to see proactive actions taken to prevent another speculative bubble from forming.

2010 and 2011 will no doubt be the years that sees our unprecedented stimulus eased back in. So what will our fed do? Here are my thoughts in order.

1. First they will slowly remove emergency credit facilities, starting with those of least interest, which were aggressively used to curb the debt deflationary crisis on our banking system. The added liquidity kept our system afloat and avoided systemic collapse that would have brought a much more painful shock to the global financial system. Lehman Brothers was a mini-atom bomb test that showed the fed and gov't would could happen - seeing that result all but solidified the 'too big to fail' mantra.

2. Second, they will be forced to raise rates - that's right folks, 0% - 0.25% fed funds rates is getting closer and closer to being a hindsight policy. However, I still think rates stay low until early 2010 or unemployment proves to be stabilizing. As rates rise, watch gold for a move up on perceived future inflationary pressures.

3. Third, they can sell securities to primary dealers via POMO at the NY Fed, thereby draining liquidity from excess reserves. I think this will be a solid part of their exit strategy down the road - perhaps later in 2010 or early 2011. As of now, some $760Bln is being hoarded in excess reserves by depository institutions. That number will likely come way down once this process starts. The question is, will banks rush to lend money that was hoarded rather then be drained of freshly minted dollars from the debt monetization experiment. For now, this money is being hoarded to absorb future loan losses, cushion capital ratios and take advantage of the fed's paid interest on excess reserves - the banks choose to hoard rather then aggressively lend to a deteriorating quality of consumer/business amid a rising unemployment environment. This is a good move by the banks as the political cries for more lending grow louder. The last thing we need is for banks to willy-nilly lend to struggling borrowers that will only prolong the pain by later on.

4. And finally, as a final and more aggressive measure, we could see capital or reserve requirements tightened on banks to hold back aggressive lending that may cause inflationary pressures and money velocity to surge. Right now, banks must retain 10% of deposits as reserves and maintain capital ratios set by regulators. Either can be tweaked to curb lending and prevent $700bln+ from entering the economy and being multiplied by our fractional reserve system.

These are the things we will start to see in 2010 and into 2011. I do not think stocks have begun the pricing in of possible fed exit strategies. This cycle will prove much different than past ones and the fed may have to act aggressively to start the exit strategy, and then move to a slow and methodical approach to maintain the policy. Time will tell if the initial shock causes a disruption to this equity surge.

Whether we reach #4 (tightening of capital/reserve requirements) is a big question mark and when #3 (reversal of POMO operations to drain liquidity from excess reserves) happens is a question of later rather than sooner. For now, the stimulus remains in place and the fed is finishing off its outright coupon purchases through permanent open market operations at the NY Fed. Lets see whether our fed and banking regulators have the political will to do what they need to when the time comes to get this economy off life support as the equity markets price in future recovery.

I am in the double dip recession camp and I think the 2nd dip is a way off! First we have to get through the good economic data that comes from the side effects of a surging equity market, 'less worse' trends, restocking of inventories, gov't stimulus programs, and a dramatic improvement in credit. As a result, I expect the second dip to come in early 2011 or perhaps 2012 and the banks to deal with a second wave of pressures from losses associated with commercial, prime, jumbo, whole loans, private equity financed leveraged buyouts, etc.. - in addition to less accommodating decisions from the FASB regarding off balance sheet accounting rules. It started with the banks, it seems the banks are leading the way out now, and I think the banks will once again lead us into the second dip in a few years. I expect the next wave to be significantly less fierce than what we just experienced, but perhaps be more drawn out. For now, the banks raised a ton of money and the fed has engineered an environment for banks to earn their way to a healthier balance sheet. Will this go too far and has complacency set in? Now that we saw what happened to China's indexes, are we prepared for a similar fate?

Watch for good news to hit the headlines, but stocks to selloff - the opposite of what happened in early March when stocks rallied on bad headlines. That is when you know the market probably fully priced in the near term expectation and is now adjusting to the possibility that the expectation may not be sustainable for the longer term. After all, they don't say 'buy the rumor & sell the news' for nothing!

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Putting Manhattan Into Perspective

A: Everyone wants to know what is next for Manhattan. Geez, can't we even go a month or two and just focus more on where this market is now and put into perspective the wave down we just experienced? NAH, that's no fun! A few days ago I discussed why I think we will see quarter-to-quarter improvements in sales volume that will lead to a new round of bullish headlines and bottom calls - this is due to the delayed seasonality trends as a result of the first wave down in prices. But when it comes to analyzing real estate trends, its always best to put things into perspective by comparing year-over-year data to filter out any noise that comes from seasonality. In other words, how did the 2nd quarter of 2009 compare to the 2nd quarter of 2008 and so forth? The short answer is that regardless of how active this marketplace became after the wave down, the first half of 2009 has proven to be the weakest in the past ten years. Since real estate is about sales volume, commissions, and spinning of data to increase the number of deals, expect the focus to be on the short term trend and NOT on year over year comparisons.

Let me remind all of you what this downturn looked like in terms of # of sales so we can put our market into perspective:

That IS the data, and you can't deny the data. Clearly, the first half of 2009 for the Manhattan residential marketplace shows to be the most sluggish compared to the past 10 years. Take a close look at the above chart and do your best to focus on the relative performance of each color (representing a quarter); this makes it easier for you to dissect year-over-year trends. In doing so, you will notice the blue + red bars trend since the peak as being down.

We should be comparing Q3 2009 (green bar) to Q3 2008, in which case we would need to top 2,650 sales or so to represent an improvement from year ago periods. Instead, headlines will probably focus on comparing Q3 2009 data to Q2/Q1 2009 data in which case we only need to top 1,550 sales or so to support a bullish argument of three consecutive quarters of improving sales. That should be easy as pie to accomplish given the activity and contracts signed over the last few months that will ultimately get recorded in the upcoming Q3 report. For the record, I would expect sales for Q3 to come in around the 2,000 - 2,250 level or so.

Comparing the upcoming Q3 sales number to year ago levels, I don't think there will be enough umph in the pipeline to beat the 2,650 deals closed in the same period last year. Therefore, I think the y-o-y trend for the first 3 quarters over the past two years since peak will continue to be down.

We were expecting a wave down, and we got it. As a result, I am less bearish on our markets. It certainly is a better time to buy today than it was only 18-24 months ago as you get a discount due to general market conditions. Looking ahead, I expect this market to muddle around the comfort zone reached in the first wave down for a while, reflecting the new realities of our real estate marketplace and macro environment. Should a dislocation occur somewhere, I'll report on it here. For now, credit is still dramatically improved from the distress levels seen late last year. Buy for the right reasons, know where the market is and where your target product should trade off peak levels. Do not buy because a broker convinces you that three quarters of improving sales data warrants an uber aggressive bid over market value or else you will be priced out forever!

The decline in total inventory is being affected by:

1) removal of existing listings - 2,342 Manhattan listings removed from market since July 1st
2) fewer new listings coming to market - 1,696 new Manhattan listings came to market since July 1st
3) rise in contracts signed activity - 1,890 Manhattan contracts signed since July 1st

The first two are seasonal trends and the surge in activity is due to a delayed seasonality effect as a result of the first wave down in prices. The threat to activity levels sustaining itself lies with sellers' willingness to continue to do deals in the comfort zone range down from peak in the face of a surging equity market and a general boost in confidence now that Armageddon seems off the table. If sell side optimism rises too high and expectations increase for significantly more aggressive bids, its up to the buyers to play along.

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Fed Ordered To Reveal Emergency Program Details

A: Not quite the audit that many are looking for of the Fed's balance sheets, but a step in the right direction I guess. Manhattan US District Judge Loretta Preska ruled against the almighty central bank rejecting the notion that..."loan records aren’t covered by the law because their disclosure would harm borrowers’ competitive positions.". The Fed's fear was that this information would rattle shareholders and possibly cause a run on any specific bank. Since we are currently in a fed engineered banking recapitalization environment, the last thing the fed wants is to disturb its efforts to help the banks earn their way back to health. This information is coming way way late (the way the markets like it), and I am most interested in who needed the most help and the quality of the collateral that was posted for the short term funding.

Bloomberg reports, "Court Orders Federal Reserve to Disclose Emergency Loan Details":

The Fed has refused to name the financial firms it lent to or disclose the amounts or the assets put up as collateral under 11 programs, most put in place during the deepest financial crisis since the Great Depression, saying that doing so might set off a run by depositors and unsettle shareholders. Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, sued on Nov. 7 on behalf of its Bloomberg News unit.

“The Federal Reserve has to be accountable for the decisions that it makes,” said Representative Alan Grayson, a Florida Democrat on the House Financial Services Committee, after Preska’s ruling. “It’s one thing to say that the Federal Reserve is an independent institution. It’s another thing to say that it can keep us all in the dark.”

The judge said the central bank “improperly withheld agency records” by “conducting an inadequate search” after Bloomberg News reporters filed a request under the information act. She gave the Fed five days to turn over documents it told the reporters it located, including 231 pages of reports, and said it must look for more at the Federal Reserve Bank of New York, which runs most of the loan programs.

The U.S. House may vote as soon as next month on a bill to require the Fed to submit to audits by the Government Accountability Office, said Representative Scott Garrett, a New Jersey Republican on the Financial Services Committee.

Bank repurchase agreements hit $120Bln in late 2008 and are way way down from those levels today. If this court order came out 10 months ago when the facility was being used to prevent a liquidity crisis, trust me the banking world would probably look a lot different today. Its not surprising that this news comes out now, when the credit markets have improved so dramatically as a result of these emergency facilities. Always remember, a healthy banking system does not need rescue plans, bailouts, shotgun marriages and a host of lending facilities to provide liquidity to prevent systemic collapse. We are where are right now because of unprecedented policies combined with insane amounts of fiscal and monetary stimulus. Many tend to ignore how we got here and just assume that the economy is naturally healing itself. That's not quite the case here.

As an out of sight - out of mind economy, it is no wonder this news comes out much later and at a time when it will matter much much less for the tradable markets. Who cares if Wells Fargo or another big bank posted complete garbage as collateral 10 months ago when they needed access to cash! We are at now now and now is much better than 10 months ago - the rest is behind us. Out of sight, out of mind continues, until the markets can handle the news. Calls to audit the fed will no doubt rise as this information is dissected and reported on.

Oh by the way, Bernanke was re-appointed to a 2nd term yesterday. Timely.

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Manhattan Charts / UrbanDigs LLC Its Own Brokerage

A: UrbanDigs Manhattan Charts that follow total inventory / price reductions / new listings / contracts signed are now fixed and working again. We apologize for the delay. The charts tell the same story that is being reported here in regards to the front lines of Manhattan real estate: it is still active out there, fewer new listings are hitting the marketplace which is in line with seasonality trends, inventory as a result has come down, and contracts signed trends are still active although down from the levels seen in May & June. Lets get right into it.

As was announced in The Real Deal article last week, UrbanDigs is now its own entity!! UrbanDigs LLC will be doing business as UrbanDigs Analytics & Consulting and is currently in development of a suite of analytical tools for enhanced analysis of Manhattan's residential marketplace. We expect launch and BETA testing to begin in Q1 2010. I would love to say it will be sooner, but Id rather be conservative.

My partner Jeff Bernstein, an investor in UrbanDigs, will be an integral part of this new project. "We expect radical changes to the New York City residential real estate brokerage market, driven by the Internet and the new realities of New York City's most important asset class", says Mr. Bernstein.

Mr. Bernstein adds, "Already an acknowledged thought leader on New York City residential real estate with a focus on transparency, UrbanDigs hopes to be a catalyst for change through the roll out of information centric software tools, market data/analysis and a la carte consulting and education services to the residential markets. UrbanDigs will enter alpha test of its first set of tools within six months and expects to be in live customer beta testing by the first quarter of 2010. Other tools and services will be rolled out on a continuous release basis, thereafter."

Certainly exciting times. The charts we display now is only a fraction of what we hope to offer in the very near future, to analyze and interpret trends as they happen here in Manhattan. So lets get right to it. Here is a look at Manhattan Total Inventory trends over the past 6 months:

The combination of seasonality, removal of listings, fewer new listings hitting the marketplace and above normal activity for this time of year are all contributing to the decline of total active inventory. For now our system only goes back 6 months but our new system will certainly expand time coverage.

Moving on to the weekly moving averages (to remove spikiness of data) of New Listings vs Contracts Signed trends:

I see a chart like the one above and it reminds me just how valuable having access to real time analytics could be for buyers & sellers of Manhattan real estate. Buying when fear is high, transactions are low (represented by the wide gap above in FEB/MAR) and supply is adding pressure to the sellers certainly can be looked upon as a contrarian move that in hindsight usually turns out to be a great opportunity.

As you can see the gap between new listings hitting the market and the pace of contracts being signed has narrowed significantly over the past 5 months. This is one reason why buyers who did not pull the trigger yet may have noticed some of their top value listings go into contract. As I stated 10 days ago in my quick update, "The market is still considerably more active than it usually is for this time of year yet, it doesn't seem as crazy as it was during the months of May & June". This statement still stands today.

Make no mistake about it, lower prices were the main catalyst to the surge in buyer activity. While the equity rally helped in boosting confidence and removing the Armageddon fears, it was the wave down to the first comfort zone that was most responsible for the activity over the past 3-4 months. Pricing is still the key to moving property and just because activity has been solid doesn't mean sellers should expect near peak level prices again - if you price right you will move your unit, if you don't you will find bids coming in closer to comfort zone discounted levels. More on this another day.

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No Inflation in Manhattan Office / Mixed-Use Markets

A: Hyperinflationists' need to explain their logic to me when it comes to the mixed use and office market in Manhattan. News that came out a few weeks ago from from Massey Knakal and yesterday from CB Richard Ellis, reminds us of the deflationary environment that has hit all segments of the Manhattan property market. Hit especially hard was luxury residential high end, mixed use, and office markets. Due to the nature of the downturn, the lower end price points have not been as affected. Its hard to argue that hyperinflation is just around the corner when your dollars can buy twice as much mixed use & office space as it could only 18 months ago. There will be a time to talk about the unintended dangers of uber-stimulative policy, but for now that policy is in place as a desperate attempt to stop a deflationary spiral.

If you get into an argument about how inflation or hyperinflation is very near, just remind them of what is actually going on out there and the increase in purchasing power of their dollars as a result of deflationary pressures on our housing markets.

Case in point, Massey Knakal's report from a few weeks ago discusses how "Manhattan Mixed-Use Property Values Fall by Half":

A buyer could get twice as much mixed-use space in Manhattan in the first half of 2009 than in the same period a year earlier, according to a new citywide mid-year report from commercial sales firm Massey Knakal Realty Services. The prices for mixed-use properties fell 53 percent to $535 per square foot from $1,135 per square foot in the first half of 2008, the firm's data show.

Company Chairman Robert Knakal said he expected prices would continue to fall even as the numbers of transactions increased. "Even with a significant increase in volume, we expect prices to continue to drop as fundamentals deteriorate, caused by continuing increases in unemployment,” he said in a statement.

Sales in the first six months of the year in Manhattan, in all categories of buildings priced higher than $500,000, were down 82 percent to $1.9 billion, from $11 billion in 2008, and $30.8 billion in 2007, the firm reported. The transaction volume fell 74 percent from the first half of 2008 to 95 sales, totaling 122 buildings.

As for the office market, Bloomberg reports "Manhattan Office Sales Ground to Halt in First Half":

Manhattan office sales came to a near standstill in the first half, with less than one-tenth the average number of transactions seen during the same period in the previous five years, CB Richard Ellis Group Inc. said.

Three office buildings valued at more than $30 million sold from January to June, down from an average of 32 in the first six months of the prior five years, said the Los Angeles-based firm, the largest publicly traded commercial real estate broker.

Buyers and sellers are far apart on bids while low interest rates on existing loans mean many sellers can afford to wait, CB Richard Ellis said. “When the CMBS market shut down, that really shut off the financing mechanism that allowed a lot of these large transactions to get done,” said CBRE’s Enoch Lawrence, senior vice president of capital markets in New York.

In the near term, most property sales will be forced by distressed financial conditions, CB Richard Ellis said.

CMBS issuance has been virtually non-existent for about a year now after peaking in early to mid 2007 - the height of the credit bubble. Since charts sometimes tell the whole picture, take a look at Commercial MBS Issuance By Type via the Atlanta Fed:

Calculated Risk says it all when he states..."The increase in cap rates suggests more than half off the peak prices of a few years ago - and probably even more since rents have fallen too (reducing operating income) and vacancy rates are rising sharply (pressuring rents more)."

Does this look like inflation or deflation to you guys? With the fierceness of the destruction, you can't expect the pace of these levels of decline to continue. Naturally, the market will react to an overshoot on the downside that will cause many to mis-interpret this equalization as a new trend supporting sustainable upside in prices. Falling 53% and then rising 5% is the market adjusting to a dislocation - overshoots to the downside are common in these scenarios.

After all, we saw it in our residential marketplace as prices overshot to the downside in FEB-MARCH, and then naturally rebounded slightly as buyers got comfortable again in the months of MAY-present - in essence, pricing OUT Armageddon. It would be silly to use the 'slight rebound' from this overshoot as a bullish argument to support a new bull market ahead. I should also add that as bad as this looks and as painful as the cycle is to consumers and our banking system, it is healthy, it had to happen, and lower prices and lower rents will ultimately stabilize the markets. It is for these reasons that one must be 'less bearish' today than 18 months ago when the excess was not yet purged from our marketplace.

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Some Color on Delinquency Rates

A: Calculated Risk, a daily read by the way, delves into the latest Fed data on delinquencies at Commercial banks. No sign of green shoots here, folks. So for those not really into a dose of reality, look away.

From CalculatedRisk via latest Fed Report:

Here is a quick summary:

RESIDENTIAL DELINQUENCIES: 8.84%, up from 7.85% in Q1 and 4.45% in Q2 2008

COMMERCIAL DELINQUENCIES: 7.91%, up from 6.46% in Q1 and 4.19% in Q2 2008

COMMERCIAL & INDUSTRIAL DELINQUENCIES: 3.73%, up from 3.12% in Q1 and 1.74% in Q2 2008

CONSUMER CREDIT CARD DELINQUENCIES: 6.7%, up from 6.68% in Q1 and 4.86% in Q2 2008

Expect the fed to maintain stimulus until unemployment stops rising and delinquencies start to level off. Since the two are inter-related, the fed is pretty much likely to maintain a zero interest rate policy until unemployment stops rising. I would expect them to know more information than us, or at least earlier information. So, if we see the fed raise rates the first thing that will pop into my head is their confidence that the unemployment rate is nearing its peak for this cycle.

Credit card delinquencies seem to be stabilizing but commercial delinquencies are really surging. Not sure about you, but I will be glued to the CMBX indexes for a while!

For now, as unemployment continues to rise and insurance benefits set to expire for so many without work, expect delinquencies to continue to rise. With U3 at 9.4% and U6 at 16.3%, there is a reason it feels worse than what some green shoot headlines suggest. One difference with this cycle versus past recessions is the massive growth of part-time workers; as 8.8 million people are working part-time for economic reasons. Checking in with the Atlanta Fed, you can see how different this recession is from previous post WW2 cycles:

This is not your average recession and is the deepest slowdown we have faced since TGD. It is what it is.

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Bank COPs and Bank Robbers

We have been seeing and feeling the impact of the bank robbers for a couple of years now. It is time that we contemplate the reactions of the bank cops. Noah's post on the accounting shenanigans going on in the banking industry are part of the age-old back and forth of real estate cycles, financial market crises and banking system resuscitations. For those with a mind for history it is worth noting that the real estate market, which was riding a wave of speculation centered on Florida, peaked in 1926, 3 years before the stock market peaked and well before the Depression set in. Only after the Depression set in did waves of bank failures follow.

The rolling regional real estate crashes of the mid- to late 1980s, precipitated a savings and loan crisis that dragged on and on, but the true credit crunch didn't hit until the early 1990s well after the stock market crash of 1987, when recession finally took hold. It was during this period that regulators "got tough." It was actually 1989 when the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) regulation went into effect. It was following this that bank regulators began cracking the whip on financial institutions, in effect forcing the clean-up of the toxic assets that had been collecting for half a dozen years. Some would argue that they also precipitated the credit crunch. In fact, banks eventually ended up reversing billions in charge-offs they were forced to take by regulators in those days.

It is clear that bankers are anticipating a repeat of history this time around. Unfortunately I think they are likely to be wrong and I will discuss a few reasons why in a future piece. Today let's just focus on the current state of affairs in the banking system.

The cataclysmic mix of Lehman and AIG going under, interest spreads blowing out, credit default swaps imploding and money market funds busting the buck collaborated to force the government to switch from a policy of remediating bad debt through "resolution" as they did in the 1990s, to throwing a TARP over them so that banks could claim solvency and forestall a massive bank run. As noted in the recent report by the Congressional Oversight Panel (COP) on the continued risk of troubled assets:

Given such market conditions, Secretary Paulson and Chairman Bernanke recognized that Treasury needed to use the authority and flexibility granted under the EESA as aggressively as possible to help stabilize the financial system. They determined the fastest, most direct way was to increase capital in the system by buying equity in healthy banks of all sizes. Illiquid asset purchases, in contrast, require much longer to execute......

Now, ten months after its creation, TARP has not yet been used to purchase
troubled assets from banks, although the capital infusions have provided breathing space for
banks to write-down many of these assets and to build loss reserves against future writedowns
and losses.

The report goes on to comment on the undesirable effect that TARP is having on bank lending (as predicted here way back in our January 5 2009 piece entitled "Excess Reserves Go Berserk As Lending Flatlines")

The uncertainty created by the financial crisis, including the uncertainty attributable to the troubled assets on bank balance sheets, caused banks to protect themselves by building up their capital reserves, including devoting TARP assistance to that end. One byproduct of devoting capital to absorbing losses was a reduction in funds for lending and a hesitation to lend even to borrowers who were formerly regarded as credit-worthy.

The report rightfully points out the continued risks to the economy and financial system that are not being addressed as long as losses are not taken and cleared off banks' books. But why clear these loans if you are not forced to and you believe that these assets will be worth more in the future?

If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate in value. Banks will incur further losses on their troubled assets. The financial system will remain vulnerable to the crisis conditions that TARP was meant to fix. The problem of troubled assets is especially serious for the balance sheets of small banks. Small banks' troubled assets are generally whole loans, but Treasury's main program for removing troubled assets from banks' balance sheets, the PPIP, will at present address only troubled mortgage securities and not whole loans. The problem is compounded by the fact that banks smaller than those subjected to stress tests also hold greater concentrations of commercial real estate loans, which pose a potential threat of high defaults. Moreover, small banks have more difficulty accessing the capital markets than larger banks. Despite these difficulties, the adequacy of small banks' capital buffers has not been evaluated under the stress tests.

Why will the banks who were stupid enough to make these loans....and we all know now that it wasn't just sub prime credits or highly leveraged corporate buyout loans, but also aggressive lending across the board from credit cards to commercial real estate.....be smart enough to predict when these values will come back?

Circling back to Noah's piece on the changes to GAAP accounting for loan losses, the COP report also touches on the negative effects of letting the foxes guard the proverbial chicken coop of bank accounting:

The details of these accounting issues are less important than their impact. As a result of the crisis, asset values are uncertain. By increasing bank managements' use of discretion in valuing assets, the new rules reinforce the underlying uncertainty in valuation, especially because banks may not apply the rules in a uniform way. Thus, there is no way of knowing whether a bank's assets are of a sufficient realizable value to support the bank's liabilities, let alone to preserve the capital necessary to support lending. To lower the risk of this uncertainty, banks, especially large banks, have reduced participation in the credit markets. Whatever the merits of the new accounting rules, their application adds to the sort of uncertainty on which financial crises feed.

I will make a prediction right now. At some point the government, unhappy about further deterioration of banks' balance sheets and or their inability to lend to individuals and businesses who at some point will want to borrow again, will force the issue through the use of regulatory pressure. When this happens we will see another leg of the liquidity crisis. The tough love approach was untenable during the heat of the financial crisis of late 2008, but the Treasury was later forced to make a show of its largesse being justified, through the "stress tests" that followed the bailouts.

Until regulatory reform is accomplished, following the obligatory turf wars of course, the persecution of the banks will not begin. So we have some time before the bell tolls for the banks. In fact, we may go right through the period of inventory restocking and "renormalization" of the economy to a new equilibrium level of GDP and consumer deleveraging. Of course, bankers' optimism relative to loan values will only increase over that time, making them more recalcitrant in dealing with their likely losses.

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Prechter: Next Wave Down May Be Bigger

A: The Elliott Wave International founder that was a bear turned bull in Feb 2009, just weeks before the market made its most recent lows and started a fierce 50% surge lasting 5 months, is now turning bearish again. The wave technician is most famous for calling the 1987 market crash and most recently telling shorts to cover in FEB as he predicted a sharp rally in the S&P to about 1,000 - 1,100. Well, we hit just above 1,000 and now he is changing his tune again calling for a bigger wave down. Is he right? Will the next wave be bigger than the first?

Now Prechter has not been so good at his short term calls for equities and recent calls for gold, so lets not just ignore the critics of his calls. But to get the general calls right starting from the rally into the summer of 2007, turning bearish in July 2007 (a bit early) and then turning bullish in late Feb 2009 (spot on) predicting a large B-wave rally, is noteworthy. Now he expects the rally to be near its end and for a larger wave down to be ahead of us. The problem with technical analysis is the backward nature of it and the lack of clarity upon making interpretations. What may look like an a-b-c corrective price movement could in effect prove later on to be something totally different. So, you always must use caution. Nevertheless, calling to take profits and to exit long positions after a 50% move up is simply very hard to argue; even if you miss out on another 10% upside.

Before the next wave down comes though we must first get through the 'restocking of inventories' and the natural leveling off of the pace of economic declines (the so called second derivative). The fierceness of destruction we experienced simply was not sustainable. As you see data get less worse, markets equalize and appear to be on the road to recovery - behavior changes and optimism grows further feeding the move. It seems the 'less worse bull market' that Jeff predicted over a year ago has been in full gear since early March - a 45% move higher and here we are wondering what's next?

If anything, I think the next wave down will be more drawn out and will usher in the next phase of this crisis that gets into the unintended consequences of policy actions already taken to stem the first wave of this crisis - at the same time that we have fundamental pressures with balance sheets. This is where you see bankruptcies soar, unemployment reach its peak, defaults reach their peak, state budget issues coming to a head, govt contraction of jobs after almost 2 years of surging job creation, rising tax implications of such high deficits, spreading of toxic assets to higher quality debt classes, fed unwinding of stimulative policy, and accounting changes reversed that helped us through the first wave. I am still in the deflation camp for 4 major reasons, with inflation concerns largely just that, only concerns, right now. Commodity inflation is quite different than inflation created by credit expansion, wages rising, and capacity constraints causing too few goods - just because the price of oil rises, doesn't mean we face inflation problems like we did in the 70s; we learned that lesson big time last year. I recall many arguing to the death that speculation played no role in $145 oil, and that it was all supply & demand - ha, yea right! How could you have inflation when your dollars today can buy almost twice as much house (in the most hard hit markets) and only a few months ago almost twice as much stock as you could near the 2006 & 2007 peaks respectively? Food for thought.

I think this episode of severe debt deflation will come in stages and the next stage may be defined by pressures on banks in the following ways - again, timing is the unknown:

PRIMARY PRESSURES

a) whole loan (accrual) book marks coming down as these assets do not have to be marked to market
b) commercial mortgage back securities
c) prime, jumbos
d) financed private equity LBOs

SECONDARY PRESSURES

e) off balance sheet accounting changes that may see assets moved back onto balance sheet, and affecting capital ratios
f) HELOCs
g) continuing problems in alt-a
h) alt-a recasts, NOT resets
i) loan modification re-defaults
j) credit cards

Now, should these pressures manifest itself in another wave we will likely see the following happen as traders start to trade out, delever to raise cash, and rush to safety:

1) Dollar Will Strengthen
2) Treasuries Will Rise

Recall Fisher's Debt Deflation Theory that sees dollar strength during the course of the deflationary episode. A strengthening dollar can put pressure on future earnings for the large multinationals and that could feed the down move further - recall that during the period of July 2008 to March 9th, the US Dollar rallied about 25% while equities fell about 45%. Clearly the markets didn't like a strong dollar as the fear level hit its peak and investors rushed for the safety of the almighty greenback.

In regards to the fed printing and the dollar negative policies of the administration, that is where I am torn. On one hand, I think that these policies are very dollar negative and will produce unintended consequences yet on the other hand this money is being partially sterilized and hoarded in excess reserves - not lent out; therefore it is NOT producing the multiplier effect that our fractional reserve banking system was designed to do. So, if credit is contracting, defaults/unemployment rising and printed money is being hoarded, how could you support an inflationary argument? If we do have another wave down the deleveraging process that is usually ridden with fear will have the 'Lutnick Effect' of constraining treasury yields. So a rush to dollars and a rush to treasuries may make credit indicators once again go out of whack, thereby feeding the animal behaviors that engulf the tradable markets.

I dont think the wave down will be nearly as fierce as what we just experienced, but I do think it could be more drawn out and painful as the real effects of this debt deflatonary tsunami take hold. We just need to go through it and heal balance sheets by writing down toxic loans properly, getting through the defaults, restructuring, and reorganizing the business to this new world. We cant expect a 'less worse' dynamic to yield a sustainable new boom; thats just silly. Markets are not always rational and they may temporarily ignore the depth of this crisis that will last years, not quarters. If all was well again with our banking system, we would not need a zero interest rate policy, a quantitative easing policy, and 19 other credit facilities to help provide more liquidity to the credit markets. Yet we continue to see those policies in place. Why? Because the banks continue to need to be recapitalized back to health and the fed is trying to engineer an environment suitable for that to happen. The unwind of all these policies and the rising of rates may in fact be the catalyst that sends us into that double dip. The question is when do we feel it?

For the record, I do feel that the recession that started in DEC 2007 is likely over or will be declared to be over within a month or two from now. That would put this recession length at about 21-22 months or so, the longest since WW2. Looking ahead, we can easily see stimulus / restocking of inventories induced growth for 3-4 more quarters before seeing that die down and the pressures I noted above revealing themselves again - fundamentally you can't call America healthy yet. Don't forget how much money the banks raised over the course of this rally that could get them by for a while longer. Looking ahead, double dippers will have to push out their predictions for a 2nd, less fierce recession to the 2011 - 2012 timetable. That is about where I am at now.

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Quick Manhattan Update

A: Content will be light for a while folks as Jeff & I work on the next phase of UrbanDigs. For now, here is a quick update on the Manhattan market as this one broker/blogger sees it. The market is still considerably more active than it usually is for this time of year yet, it doesn't seem as crazy as it was during the months of May & June. My thoughts on that are a combination of the timing of sharply lower prices, buyer control during negotiations, reflation trade mentality, and a confidence boost that the deep recession is nearing an end as stocks surge and price in recovery. By far the most important part of the equation was lower prices across all price points. In short, this market had a wave down in prices once thought impossible that reached a comfort zone where buyers were confident enough to jump back in and buy property.

The change in psychology affects both buyers & sellers; buyers, while more confident with Armageddon seemingly off the table, still want the discounts that this market seems to offer and sellers want the highest price possible now that stocks have rallied and green shoots are being discussed everywhere. It takes two to tango so if either buyer or seller psychology get altered too much in one direction, we may see another disconnect in our marketplace leading to much slower sales volume than what we saw over the last 4 months or so. The rise in contracts signed + the number of listings removed from the market has had an effect on total active inventory; with what appears to be a 15% drop since the recent top of about 11,200 listing in early June.

Here are a few month-to-month comparisons (comparing the periods of Mid-June to Mid-July against Mid-July to present) of important metrics for all Co-ops & Condos in Manhattan; this is the closest thing I have to real time information as it happens so do your own interpretations - generally speaking, for seasonal markets its best to derive interpretations from year over year trends to filter out a seasonality effect:

AVERAGE LISTING PRICE - $1,391,247, or down 0.42% comparing prior two 4-week periods
NUMBER OF PROPERTIES SOLD - 731, or up 51% comparing prior two 4-week periods
LISTINGS REMOVED FROM MARKETPLACE - 1,348, or up 50% comparing prior two 4-week periods
NEW LISTINGS - 942, or up 0.21% comparing prior two 4-week periods
CONTRACTS SIGNED - 1,030, or up 4% comparing prior two 4-week periods
LISTINGS WITH PRICE CUTS - 955, or down 15% comparing prior two 4-week periods
AVERAGE PRICE PER SFT - $1,088, or down 0.91% comparing prior two 4-week periods

Again, imagine if you have two four week periods (6/15/2009 - 7/13.2009 against 7/13/2009 - 8/10/2009) and you want to compare how the market has changed. Above is the answer and unfortunately I don't have any access to more data prior; I wish I did!

So what are we seeing:

a) average listing price is down
b) number of properties sold is way up - this is reflecting contracts signed 2-3 months prior and shows the activity we had during the months of May & June compared to the frozen few months before; never forget the lag this market has between contract signing and closing.
c) basically the same amount of new listings hitting the marketplace
d) big increase in listings removed from the marketplace either for personal or seasonal reasons; this is certainly affecting inventory trends too
e) significant drop in price cuts - hmm, interesting, perhaps sellers really are getting less motivated to lower their prices with the recent surge in equities and MSM's green shoots
f) still a healthy number of contract signed that will likely lead to a solid Q3 and even a Q4 report when they come out; the Q4 or Q1 report will be especially interesting as it is compared to Q4 of 2008 and Q1 of 2009 that were practically frozen and defined the correction

All in all, it's proof that more activity is not a sign of rising prices. Prior to Lehman, prices were still near peak levels and were disconnected from the reality of this crisis. The market froze up and buyers disappeared UNTIL prices came to a zone that were more in line with the reality of our new world. That freeze up lasted roughly six months, perhaps with denial playing a big role for sellers in the beginning of that corrective wave down - leading to such light sales volume. Then reality set in, sellers were willing to accept that the market was discounting their property at a certain % down from peak levels, and deals started to happen! The natural forces of the marketplace at work - a wonderful and healthy thing.

With the average listing price still down, real sellers know that the market is still trading in that comfort zone reached with the first wave down in prices. If that comfort zone represented a range 'down from peak' (see my tiered price adjustment opinions here), then I would argue that this market recouped some losses and is trading at the lower end of those ranges down from peak depending upon price point. This was the markets way of equalizing itself from the Armageddon / Fear trades that occurred in February & March - in short, the market has priced OUT Armageddon as it overshot to the downside when it was pricing in Armageddon earlier in the year.

That's the best I can offer you guys right now. Working on delivering a better system for you in the future!

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Here Comes the Long Hangover..But First a Few More Drinks

I'm feeling better about the economy! Despite the fact that my wife was recently laid off and our world is being rocked by forces beyond our control, I am actually feeling much better about life for the rest of Urban Digs readers, in the short term.

I was driving back from a long weekend upstate when Bloomberg played some interviews with Timothy Geithner and the Maestro himself, Alan Greenspan. Geithner was interrogated by ABC's "This Week" interviewer George Stephanopoulis on the budget deficit and how the administration was going to deal with our staggering debt load. Now my predilection, from reports about Geithner prior to this crisis, was to like him. My understanding was that he was a fair-minded individual, firm in his convictions and adult in his conduct. But hearing him interviewed, I couldn't help but feel he was another silver-tongued bureaucrat (and apparently not always so). Despite being completely backed into a corner by the interviewer and asserting several times that "We will do what must be done" regarding not only decreases in spending but also the obvious need to raise government revenue, Geithner steadfastly refused to admit that taxes needed to be raised. He was clearly hiding behind the idea that once the economy is stabilized then we will do what must be done, when he said:

“We can’t make these judgments yet about exactly what it’s going to take and how we’re going to get there.”

That attitude unfortunately seems to embody a relentless optimism that still lurks in the American psyche - one that I am not sure is justified, given the financial pickle we're in. I see this optimism in banks that are routinely reporting much higher non-performing assets, but raising their charge-offs much less than those increases. It seems that they think that when they get the properties back and sell them, they will end up being made whole. This thinking rests on the idea of a durable recovery that boosts rents and convinces buyers to lower the risk premium they are currently demanding to provide liquidity of any kind in this environment. It also embodies a belief that debt to bolster purchases of assets will be made available, by someone whose balance sheet hasn't blown up (anyone fitting this description please contact me, particularly if your current plan isn't to sit on the sidelines for a good long time before putting any of your carefully shepherded capital at risk).

Of course, fixing healthcare was paramount on Geithners' list of what the administration hoped to do to address the long-term financial problems of the U.S., but paying for the "fix" was not something he would elaborate on. Geithner had only praise for even the detractors like Robert Altman, the past Deputy Treasury Secretary, and the office of OMB, who are challenging the fuzzy math on healthcare reform and deficit reduction. He explained why they didn't get it and the administrations' great respect for all dissenting opinions (at least when they come from persons who might matter to public opinion).

The Geithner interview was followed by an interview with The Maestro, who in his prior appearance averred that the financial system meltdown was by far the worst he had ever seen and still had a long way to go (this was of course right about the time of the bottom in world stock markets). I know it will come as a great relief to all of you that Greenie the Great One now says that "collapse, I think, is now off the table." While he worries about a potential double dip in the housing market which could cause "a significant acceleration in home foreclosures," Greenspan believes that we have likely already hit bottom on the economy and that we will soon see positive year-to-year growth in GDP, as soon as this quarter, albeit accompanied by continued, though decelerating, job losses. Greenspan, though noting Geithner's praiseworthy diplomacy, voiced certainty that the government will need to eventually raise revenue in order to fund the Medicare shortfall being imposed by the negative demographic effects of aging baby boomers. His belief being that the least-worst solution would be a VAT (value added tax). Greenspan also speculated that interest rate increases could be needed sooner than Ben Bernanke's forecast of a couple of years out.

So with the S&P 500 just points away from a 38% Fibonacci retracement of its recent crash, let's step back and reassess. Economies overshot on the downside due to the CNN effect of collapsing markets. Inventory liquidation, coupled with a lack of financing for big-ticket items, caused a draconian cutback in industrial production, well below even recession-adjusted demand. Let's do a little quick math on how this worked. As an example, in the U.S. we scrap about 12 million cars annually due to obsolescence and we add about 2 million new drivers each year, so base demand is maybe 12 million automobiles per year. If we knock 1 million off this for a wicked recession, we get to base demand of 11 million units per year. Now the rate of sales fell to an annual rate of less than 10 million earlier in the year.

With some rays of light on the economy shining through, some return of financing and the cash for clunkers program (pulling forward future demand), JP Morgan analyst Himanshu Patel says demand could rebound to a 13 million annual sales rate. This situation has occurred throughout supply chains across the world. Electronic supply chain management and just in time inventory practices almost assure that in a shock situation - which few would deny the Lehman/AIG/Money Market Funds debacle was - inventory and production will be cut well below sustainable demand, even when that sustainable demand has been significantly reduced.

As I have discussed here recently ( "Every Upturn Starts with Restocking") it's going to take quite a restocking effort to get back to a reasonable rate of economic activity despite the actual decline in consumer purchasing power. Not only that, as Greenspan pointed out in the interview, consumer purchasing power is highly variable, as the stock market has just re-instated some $3 trillion of consumer wealth that was previously taken away.

It is for this reason that I believe that we will see at least a couple of more quarters of strong economic rebound and one to two quarters of public companies surprising to the upside on earnings estimates. Let's look at the puts and takes:

Positives:

Inventory rebuilding

Continued stock market increase and wealth effect

Capital raising/balance sheet bolstering

Exports and commodity demand

Stimulus money still to come

Restructured industries regain pricing power/margins (e.g., banks, brokers, auto dealers)

Negatives:

Business cash flows which are paradoxically bolstered by declining needs for working capital while shrinking, start consuming working capital as they begin to gear up production again

Energy/Commodity cost rebounds

Interest rate increases

Increased savings rate

Continued losses on longer-tailed assets like real estate hamper banks' ability to provide credit to meet additional demand

Government size/budget deficit reduction a drag on the economy

State size/budget reduction drags

Higher taxes

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It Takes Two To Tango: Are Buyers On Board?

A: It takes two to tango and to make a deal happen both buyer & seller must have a meeting of the minds. So we went from a frozen market in late 2008, to a fear based market in early 2009, to a reflation trade market over the past 4 months. Is it right? Who knows, its the market and the best I can do is tell you what I see out there now and where we may be in the cycle. I don't see a sustainable uptrend in bids just because stocks say so, as buyers don't seem to be fully on board the gravy train. But this fierce equity rally may just be enough to alter the psychology of sellers and slow this market down a bit. Unless buyers change too we will see a disconnect again leaving brokers and those same buyers wondering what the heck is going on.

We had a nice down move with prices more accurately reflecting the macro pressures than they did at this time last year; even though the warning signs were everywhere in AUG 2008. So, the process started and that is healthy. But as equities rallied, and rallied hard I might add, we saw a surge in deals recently and a subsequent 15% drop in active inventory - below is a 6-month chart of Manhattan Active Inventory:

Is the bottom in? Well no doubt there are real arguments to be made about that with Jeff's 'less worse bull market' seemingly in play - a great call almost 3 months ago by Jeff. Given the amount of fiscal/monetary stimulus in the system we no doubt will see improving economic data outside of the unemployment rate - which will lead most, including me, to think that the worst is behind us. I actually can see this spurt lasting a good 3-4 quarters and who knows how confidence will be affected. But why doesn't it feel over? Well, because unemployment is rising, people are cutting back spending, jobs are not so easy to find, some developments are stopping work, retail is showing signs of the distress, etc.. So for many, there is no reflation. But for stocks, reflate away!

Combine reflation hopes and less worse data with an unstoppable equity market and it could easily affect both buy side and sell side confidence in the following ways:

1) Buyers - buyers could be convinced to throw in a stronger bid or be motivated to pull the trigger on reflation and recovery hopes; the old 'buy now or be priced out forever' is likely to be replaced with the broker tagline 'buy now or miss the bottom'.

2) Sellers - sellers may not be as willing or motivated to hit a bid that is deemed too low and otherwise depicts where our market currently is trading. As stocks fly and reflation hopes dig in deeper, this mental change may be exaggerated. Crazy, but true. Pricing in downturn risk gets increasingly difficult when stocks surge as sellers don't bite if they feel their property was improperly valued with the first wave down. Sellers will look to anything to rationalize that their property is worth more than it was only 3-4 months ago.

Combine the two and you have confused buyers and more hopeful sellers. Which will be the stronger force? Its all fine & dandy if the effects on both sides of the deal are equal, but in my humble opinion they are not. I am finding buyers to be very confused right now and choosing to be cautious rather than aggressive in dishing out a strong bid to entice the seller to accept. While buyers seem fine paying market value for properties today, they do not seem fine paying a premium over that just because stocks are flying - yet some sellers are demanding that. This has happened a few times to me in the past couple of weeks - as sellers seemed to change their tone and expect a bid significantly higher than only a few months ago to move property. Has the market really bounced that much OR is this market simply pricing out fear and equalizing itself? My bet is the latter. Stocks and real estate are two different animals and just because one is rallying doesn't mean the other has to. Real estate is more closely tied to the jobs market, incomes, lending rates/affordability, credit, rental rates, supply trends, and confidence in the asset class. Stocks can move for a variety of different reasons.

Keep in mind one thing: this equity rally may have an unintended consequence for Manhattan sales volume IF buyers refuse to get on board with the reflation gravy train! This is what may surprise some out there. Its easy for a homeowner to argue for higher housing prices but if your a potential buyer, you need to have strong beliefs to put your hard earned money where your mouth is. And in the end, it's all about the buyers willingness and capacity to pay higher prices and close that deal.

You need two to tango so if sellers get more optimistic, buyers must too or we will have a stalemate/disconnect! For now, the 'less worse' rally continues and this spurt will feed on itself and likely produce better numbers in the near future that can ingrain the recovery mentality. Those expecting a double dip, including myself, must push back any predictions for a 2nd wave down by at least multiple quarters as it is easier to dip down from much better levels than it is from uber-distressed levels - now is the process that sees data get better or less worse, what I question is the sustainability of it over the longer term.

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Condos More Clearly Showing Manhattan Real Estate Excess

A: The condo market will more clearly show the pain/excess that this market experienced for obvious reasons. In a market like Manhattan where 70% of the housing stock is co-op, you don't expect there to be high levels of speculation that often marks the top of an asset bubble. After all, the island of Manhattan certainly didn't experience a development boom to the extent that say a Miami did. But we did see a development boom and we did see a credit and housing bubble deflate - in the end, no market was spared. So what is Manhattan in store for? Well for one, the basic structure of the majority of our housing stock will help to blanket the depth of pain that may be felt by those that purchased near peak and have lately become distressed sellers. Its impossible to quantify this real time so I really don't know how many sellers out there absolutely must move property, and fast. As you know, co-ops have a much more stringent process of approval that has since got even tougher. As a result, condominiums will likely show the sharper rate of decline as the first wave down fully reveals the excess this market experienced.

Co-ops differ from condos in legal structure, by-laws, and to whom the product may be right for. For example, an investor/speculator or even a buyer that intends to use leverage to buy as much house as they can afford is much better off buying a condo rather than shares in a corporation with a strict approval process and restrictive by-laws for use. In short, co-ops don't want too many investors in their building or buyers that don't meet financial guidelines set by the board. Coops can also reject without providing a reason. Condos do not have such restrictions and enjoy a 'waiver of right of first refusal' system that allows the board to either let the deal through or to be matched by the building and its reserve funds - usually that does not happen as the hit to the reserve fund will negatively impact the financial stability of the building.

These days, co-ops seem to be getting stricter in regards to:

a) the quality of the buyer that seeks to buy shares into the corporation
b) the quality of employment - all of a sudden working in the financial industry is a higher risk
c) quality of salary - too much reliance on past bonuses will be looked at negatively
d) price of the transaction - coop boards are beginning to monitor the price level of deals, especially deals done in the months of March and April that may have been influenced by fear or severe desperation. The building can reject a purchase application without providing a reason, so don't underestimate the boards willingness to 'act as the market' and attempt to set a price floor on deals they deem as too low that in their eyes would adversely affect shareholder value on future deals and refinances.

Back in March, at the height of the fear, I wrote about whether or not coop boards wold try to influence deals in my piece, "Price Flooring? Will Boards Try To Stop Price Discovery":

"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. 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.

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."

The reasons you will see sharper adjustments in the condo market, rather than the coop market, include:

1) Investor Friendly / Less Invasive / More Lenient Financing - condos trade at a premium to co-ops because of the investor friendly structure, less restrictive policies, ease of use, less invasive approval process, more lenient financing policies, and real property nature of the product. You own your apartment and not shares in a corporation with a proprietary lease to live in the unit. As a result there is a larger audience, what I refer to as 'buyer pool', that are interested in buying condos and can afford to buy condos with less money down and less money in the bank required. Condo transaction fees on the buy side are also quite higher than co-ops, especially when financing 80% or more. Higher values and higher transaction fees could mean what went up faster might also fall faster when buy side demand dries up as it did in Q42008 - Q12009.

When it comes to speculation, excess, use of leverage/debt to get in on the game, look no further than the condo market that was more exposed than restrictive co-ops at the height of the boom.

2) Development/Conversion Boom - the development/conversion boom is where you see the clearest signs of the euphoria reached at the height of the credit/housing bubble. The priciest deals in Manhattan, excluding prime existing co-op products on the best blocks, were for new developments and conversions that offered luxury products in a luxury setting. Paying $1,500/sft+ became normal in 2007 - especially for foreigners that just wanted IN on the party. It's hard to get that type of premium for a co-op unless it was on Madison/5th Avenue or Central Park West.

So, those who bought into new devs and conversions (especially investors/speculators looking for a quick buck as the market boomed) may have over-extended themselves and are seeing their equity deflate and their debts getting cumbersome. Combine individual distress with a pressured market and you will see sharp downward pressure on the final deal price if the market is allowed to act without outside interference. Because its a condo, the board can either let the deal through (assuming the buyer/pet is not a convicted felon) and waive the right of first refusal OR match the deal and dip into building funds to buy the property; and that usually will not happen! In short, condos offer buyers and sellers more freedom and flexibility and that in turn allows the product to be marketed to a wider buyer pool.

3) Nature of this Crisis - The excess was in the high end and the boom was marked by very expensive new developments and conversions. Peak buyers of these products that have to sell will find it hard not to take a significant hit as the buyer pool for $3M+ properties is no where near what it was 2 years ago.

4) No Outside Interference - Barring a very unusual situation, most condos deal will go through to closing as long as the buyer can secure financing as needed. The fact that there is no aggressive review by the board in terms of buyer quality and deal level means the data will more closely reflect the sharp wave down that we experienced

Look no further than some of the quarterly reports from our biggest brokerage firms to see this 'condo clarity' effect in action:

CORCORAN Q2 MARKET REPORT:

DOUGLAS ELLIMAN Q2 MARKET REPORT:

If I look at the Corcoran Luxury co-op data above, one may wonder if the market really is down only 8% compared to the same quarter in 2008; yet the 32% adjustment for condos more accurately reveals how the high end got hit. The Plaza unit that just sold for 40% below its original sponsor price (granted it was gifted to the New York-Presbyterian Fund and then resold) exemplifies the excess in the high end perfectly.

The high end / new dev boom artificially inflated the data on the upside and will likely artificially deflate the data on the downside as this cycle plays out. You will probably see another pressured report in Q3, only to tick up in Q4 when its released in JAN 2010 reflecting the lagging nature of our marketplace and the recent pricing OUT of fear that will ultimately show deals happening at 'less worse' levels than those earlier this year. Year over year analysis will continue to be pressured until we reach Q2 or Q3 2010 or so; which will be compared to reports that showed the biggest adjustments downward. Interesting times indeed.

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Morning Shocker: So Ambac Really Wasn't AAA?

A: Remember the days in early 2008 when Charlie Gasparino was on the air every day with the 'bond insurer' saga and whether or not they would get downgraded from their AAA rating! The insurers adamantly backed their AAA standing and the credit rating agencies were hesitant to downgrade them even though we all knew their portfolios were garbage and the claims made on them would be tremendous. MBIA Chief told us that insolvency risks were 'without merit'; MBIA trades at $4 today. UrbanDigs first discussed the bond insurers in 2007, why it was important if they were downgraded from AAA bullshit rating at that time, the saga that ensued in early 2008 and finally the affirmation of the AAA ratings for Ambac & MBIA in late February 2008 that was good for about 400 Dow points. Today we see Ambac get cut to Junk Status - out of sight, out of mind was in full force in early 2008 as we now see beyond the garbage that was dished out to all of us when the markets were on the verge of chaos.

The reason the bond insurer saga was so important was because if some of these guys failed and/or lost their AAA rating resulting in a big hit to capital raising plans and operations, the ripple effect in the financial system would have made the problem worse - at the time our banks were forced to take billions in write-downs and this would have made the problem worse. So what did we do? What we always do, affirm that all is OK at the time and then later reveal that it was all a bunch of crap. Since the markets are forward looking, it is easier to digest the news later when it no longer is the center of the media universe. Out of sight, out of mind, the way the markets like it.

Today's headline, "S&P Slashes Ambac to Junk on Expected Losses", no doubt is not news at all! Amazing isn't it:

"Bond insurer Ambac Financial Group (ABK: 0.78 -6.02%) this week estimated statutory impairment losses on credit derivatives for its Ambac Assurance segment rose by $1.6bn to a total $4.9bn in Q209. These losses, which the firm expects to report on August 5, are tied to collateralized debt obligations on asset-backed securities, the underlying collateral of which continues to decline in performance.

In light of its capital troubles and the declining quality of its insured books, Standard & Poor’s on late Tuesday slashed Ambac Assurance to double-C from triple-B, effectively lowering it to junk status.

“This rating action reflects our view of the significant deterioration in Ambac’s insured portfolio of nonprime residential mortgage-backed securities and related CDOs,” said S&P’s credit analyst David Veno in a statement. “This has required the company to strengthen reserves to account for higher projected claims.”

The credit crisis we experienced developed from an amalgam of events, mainly:

a) deregulation - especially with regard to the use of leverage
b) fed mismanagement of interest rate policy
c) quantity vs quality securitization model that rewarded 'factory-like' behaviors with exorbitant fees - the 'originate + sell' model that didnt care about who got the junk MBS
d) a flawed ratings agency model that saw a conflict of interest and erroneous AAA ratings wrapped onto junk assets so they can be resold to the biggest investment pools
e) extreme loosening of lending standards / mortgage fraud - easy credit
f) explosion of exotic lending products designed with one thing in mind - allow the weakest buyer to be able to afford the most property possible
g) use of excess leverage up to 30:1 and at times 40:1; GSEs were levered even more
h) greed on a corporate and consumer level

...which all led to the disaster that we are now facing and the destruction of tremendous wealth both for the American people and our shadow banking system. Nobody wanted the party to end. This Ambac news today is not a shock and its not surprising. We knew it back in late 2007 and early 2008, yet nobody wanted to listen because of the negative ramifications that might have occurred.

This is why we must keep on asking questions and not just assume that what we are told is accurate and reliable. If we did, Countrywide would still be here today as the CEO told all of us in late 2007 that they would be profitable in Q1 of 2008. Instead, Mozilo is now being charged with fraud for failing to warn investors of the risks the company really faced. When will we learn that potential pressure on the markets should never compromise integrity, honesty, and the fiduciary responsibility of these executives to the shareholders of their company!

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A Record $115Bln Being Issued: Watch The Bond Markets

A: Just talking out loud here. Now that the credit indicators have come in big time and it seems lending rates are once again following the bond markets, I would keep an eye on those markets this week; especially if you are considering a rate lock. The 10YR yield has quietly risen about 20 basis points in the past week, likely in response to two factors: anticipation of the upcoming record treasury issuance + a shift into stocks as the rally's momentum continues. As always, the markets have a way of equalizing themselves when one move gets a bit long in the tooth. We may have the makings of an interesting bond market week, similar to late May when fears over auction demand rattled the markets for a few weeks. Combine concerns over record supply with a strong move in equities recently, and you could see the setup that may lead to a repeat of that pattern.

Mortgage rates are tied to the price of mortgage bonds (read Dan Green's 'Where Do Mortgage Rates Come From?' for more on this) but more investors tend to look at the treasury market rather than what the FNMA 30-YR notes are doing intraday.

But when the treasury market sees a big move or intraday jolt from an auction gone bad, it could quickly affect the mortgage markets by sending rates higher and hurting consumers that are not locked and lenders that are committed but not hedged. It may also cause bottlenecks and slow the backlog of loan processing. On May 29th, The MortgageMan explained his wildly volatile week like this:

"This week might have been the most volatile period of time I've ever seen in the mortgage markets. Not only did I watch interest rates soar from 4.875% to roughly 6.25% in under 4 days, but I now find myself asking the billion dollar question: What's next?"

At that time, treasury issuance was enormous and the market overreacted on the concern. Next weeks $115Bln of planned auctions is even higher than that week! So yes, its worth keeping an eye on given the record treasury supply on tap.

Via Bloomberg, "U.S. 10-Year Note Falls Most in 7 Weeks as Record Supply Looms":

Treasuries declined, with 10-year notes falling the most in almost seven weeks, as stocks rose and the U.S. announced plans to sell a record $115 billion in notes in four auctions next week.

“The amount of supply needing to be sold still carries a lot of shock value,” said Eric Lascelles, chief economist and strategist at TD Securities Inc. in Toronto. “Throw the stock rally on top of that and you have a good argument for selling Treasuries.”

“Taking down supply hasn’t been an issue, but it is another $115 billion in paper,” said Charles Comiskey, head of U.S. Treasury trading in New York at primary dealer HSBC Securities USA Inc. “That’s a lot of paper, so the market will have to find the right yield.”

Harmonic how markets work sometimes as this was the exact case in late May to early June leading Mish to write about the "Mortgage Markets Locking Up": first sell treasuries and buy stocks and then when yield gets to where it needs to be, sell stocks and jump back into treasuries. This is not a prediction, just an observation that the setup may be there for this pattern to repeat itself.

On the flip side, should the auctions be oversubscribed you may easily see equities rally even further as a sign of confidence that the treasuries record need for money is resulting in no problem from the markets. Either way, its worth keeping your eyes pealed.

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Out of Sight - Out of Mind: The Way The Markets Like It

A: Have you ever noticed that the markets sometimes act with the instincts of a 6-month old baby? For the longest time I have waited for the markets to reflect some sign of 'object permanence'. The stock markets are an irrational near term discounting mechanism that continuously prices 'in' and prices 'out' the perceived value of any one company's future growth prospects - that's one way I look at the markets, and a definition you probably won't see in any book. The key to this mechanism is the availability of information at hand regarding business conditions, earnings potential, clarity, confidence, and willingness to accept what is out of sight (i.e. takeover potential, hiding losses, accounting tactics, etc). The market generally is not very good at getting right this out of sight acceptance thing. Enron's offshore entities that hid losses and Worldcom's inflated accounting entries are two examples of companies that the markets first completely overlooked what was hiding out of sight - only to later find out and crush investors as the scandal is revealed. How does this happen over and over again? Because executives whose fiduciary responsibility is to the shareholders know all to well that it is easier for markets to accept the damaging information 'later', rather than 'sooner'. Maintain/increase confidence, and the stock will rise.

Here are the most common examples of how our 'out of sight, out of mind' system works:

1) Economic Data - ever notice how the BLS issues 'negative revisions' to nonfarm payroll unemployment statistics almost every month? How could this be? How could they tell us for 9 straight months, AUG 2008 - APRIL 2009, that the data is 'x' yet one month later announce that the previously reported data was really 'x minus y'. How do they get away with it? Well, if they announced the real bad data at first, the markets may not like that - as markets move based on analyst estimates! Its easier to report better data today, and revise it lower later on. The reason is because markets look AHEAD, not behind, and as a future discounting mechanism it is easier to accept negative data when it was revised lower for a date that has already came and went!

Via Floyd Norris at NY Times:

Robert Barbera, the chief economist of ITG, points out a more disturbing trend: The Labor Department keeps concluding that its initial estimates were too optimistic. Here are the total job losses reported for recent months, as originally reported and as shown in the latest revisions.

August 2008: Initially 84,000, revised to 175,000

September 2008: Initially 159,000, revised to 321,000

October 2008: Initially 240,000, revised to 380,000

November 2008: Initially 533,000, revised to 597,000

December 2008: Initially 524,000, revised to 681,000

January 2009: Initially 598,000, revised to 655,000

February 2009: Initially 651,000, as released today.

On average, from August through January, the first estimate was too optimistic by 112,000 jobs.

JAN - revised again to -741,000
FEB - revised down to -681,000
MAR - revised down to -652,000
APR - revised down to -519,000

May/June are preliminary and yet to be revised. Out of sight, out of mind! Yet markets continue to move on BLS data releases, mostly in a positive way on signs of deceleration of job losses. As the truth comes out later, who cares what happened in the past because the markets are forward-looking! Don't even get me started on the birth/death model that has miraculously added 1,348,000 jobs to our nonfarm payroll stats since April of 2008; source here at bls.gov!

Now, I hear what your saying: the agency doesn't have all the data yet and has every right to fine tune reports in the future when more information is collected. Fine, so why is the bias always to the positive side? Why don't we see a pattern of worse than expected data released today, that is later revised downward a month later? I think we all know the answer to this one!

2) Off-Balance Sheet Vehicles - when you hear terms like 'SPVs', 'QSPEs', 'VIEs' and 'SIVs', you get a bit cautious because you know the banks are using these vehicles to park deteriorating/mismarked assets off their balance sheet. The hope is that out of sight, out of mind will kick in and create the illusion that the company is strong. While Enron got caught setting up offshore entities with different tax codes and methods of hiding losses, the goal was the same - out of sight, out of mind and maybe the market wont care. Confidence is restored, the stock goes up.

Now we have a situation where banks are using special purpose vehicles (SPVs) and structured investment vehicles (SIVs, ironically invented by Citigroup in 1988 - Citi reportedly had over $1trln parked in off balance vehicles). Why would they do that? What would these assets do to their balance sheet if they were on the balance sheet? Would the bank capital ratios need to be recomputed? Would writedowns have to be taken? Would confidence in the company erode? Would the stock price fall?

John Carney reports:

"The SIVs were off-balance sheet entities that owned long term debt and were funded with short-term debt. It's very possible that instead of buying credit default swaps on its mortgage backed securities, Citi was just selling them to the SIVs it managed. Since these were off-balance sheet, Citi wouldn't have faced the capital requirement constraints that often prompted other banks to buy credit default swaps. Citi could lend and securitize, then sell off any extra inventory into its own SIVs, freeing up the capital it got from the SIV to make more loans. Lather, rinse, repeat."

Citi isn't the only one, as BAC is estimated to have $150Bln in off-balance sheet assets that will have to come on by Q1 2010. Now the FASB says it may expand the use of fair-market values on corporate income statements and balance sheets in ways it never has before. Even loans would have to be carried on the balance sheet at fair value, under a preliminary decision reached July 15. The board might decide whether to issue a formal proposal on the matter as soon as next month. The scope of the FASB’s initiative, which has received almost no attention in the press, is massive. All financial assets would have to be recorded at fair value on the balance sheet each quarter, under the board’s tentative plan.

This would mean an end to asset classifications such as held for investment, held to maturity and held for sale, along with their differing balance-sheet treatments. Most loans, for example, probably would be presented on the balance sheet at cost, with a line item below showing accumulated change in fair value, and then a net fair-value figure below that. For lenders, rule changes could mean faster recognition of loan losses, resulting in lower earnings and book values.

3) Estimated Global Credit Losses - an easy one. Start out with low estimates, gradually increase them, and hold off for as long as possible on disclosing an estimate that may rattle markets. If you revise your loss estimates higher with time, the negative impact will be muted and the hope is that the markets completely overlook the most recent revisions because of a change in psychology on the short term nature of the markets.

IMF is the latest example here and the latest update was an upward revision to estimates for global credit losses from initially $1Trln, then to $2.2Trln, and finally the most recent update to a staggering $4.1Trln. If its raised again, Im sure nobody will care anymore unless object permanence is learned by the markets. But if they came out originally and said $4.1Trln, rest assured, markets would have reacted way more dramatically at that time.

Feel free to add more datasets or instances where we seem to kick the can down the road, to worry about the real data later on rather than today. The purpose of this post is not to scare, not to offer doom & gloom (in fact, Ive noted many times since NOV 2008 how less bearish I have been since this process started), but to keep it real and to be cognizant of what was done to keep us out of a much more severe situation - especially in regards to the banks and their M2M/Off-Balance sheet accounting tactics. Just because they are out of sight, doesn't necessarily mean they are out of mind. By the way, has anyone checked in on the GSEs lately? Since being put into conservatorship, we don't really hear much about them or the total losses they may accumulate for taxpayers. Yet, the 23% gain taxpayers received from GS warrants gets full attention! Kind of mis-represents the bigger picture if you ask me.

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Every Upturn Starts With Restocking

As I survey the destruction that this downturn has wrought, I continue to wonder about the timing and shape of any upturn. I know many of our readers will say, get real! It's already under way, while many others would vociferously argue that we are merely seeing a dead cat bounce (Wall Street lingo for even a drowning man can bob his head above the water a couple of times before going to Davie Jones locker), with the truly cataclysmic impacts of our over-indebtedness and failed policies yet to come.

Earlier this week the Conference Board's leading economic indicators (LEI) were reported. The index rose 0.7 percent, vs. economists' expectations of 0.4 percent. Economist Josh Shapiro at research house MFR Inc. put it well when he was quoted on CBS Marketwatch saying "We're now getting data which points to stabilization, the overall signal they're sending is the slide in economic activity is poised to end. The jury is still very much out in terms of what happens after that."

Interestingly, as this corporate reporting season progresses I am seeing the impact of the reversal of the CNN effect that occurred last fall. Since the world has not ended, and some amount of consumption, maintenance, repairs, etc. is being done in the economy, supplies, parts and inventories that have been drawn down are having to be replaced. This is being evidenced by data points like:

Now all of these "positive" data points or green shoots are really just evidence of a snap back from unsustainably low economic activity; however, every upturn starts with an inflection point and it usually involves inventory re-stocking. What is actually shocking to me is how many companies were able to absorb 15, 20 or 30 percent hits to their top lines and remain profitable during this collapse. This is a testament to the management prowess of U.S. companies and how well they have used information technology, lean principles, flexible manufacturing and supply chains to create resilient business models.

The markets are finally showing resilience as well. So far the green shoots have not been mowed down by California moving to pay its obligations in IOUs, or CIT Group being allowed to go potentially belly up. I would contend that either of these scenarios would have caused a major bad hair day for the markets a few months back. Indeed, after a little fake out correction move, which was actually incredibly mild considering the historically large rally off the bottom, the market indices are all moving higher, exceeding their 50- and 200-day moving averages. In fact the 200-day moving average lines are now close to hooking up and turning outright bullish.

Does this mean that it's onward and upward for the stock market? Does it mean that it's onward and upward for the economy? While there are no guarantees in life or the markets, I believe that the necessary, though possibly not sufficient factors are in place.

So you say, Jeff, the banking system is still in tatters! To which I say, it is, but for now there are sufficient excess reserves to absorb the rather minor loss taking the regulators are in the mood to force. Meanwhile, the Fed is forcing a steep yield curve, while paying interest on reserves, thus giving mouth-to-mouth resuscitation to bank profits.

What about the government? They're bust also! I can't argue this point either, but our primary lenders - Japan, China and now the American public - are apparently still willing to support our growing debt burden in hopes of saving their own economies and their savings, which have unfortunately been stashed in Govvies and other dollar-denominated assets.

What kind of economic growth do you expect coming out of this anyway? This is perhaps the most important question to be pondered. Back in the day when I was a Wall Street analyst (I am back doing some consulting for an equities shop, which I will admit is definitely coloring my opinions some), I always believed that it was the areas that no one was looking at or where there wasn't very good data that caused the biggest upside and downside surprises. Urban Digs readers know that it's a second derivative world and surprises drive everything.

Way back then I remember being really interested in Japan's move off of DOS to Windows and the explosive growth in the Japanese PC market, which no one seemed to be noticing. Later, after the tech bubble burst, I was sure growth from China would eventually be the biggest "surprise" because it was so hard to get good numbers on. So today I wonder, where are the good sources of surprise in economic growth? I certainly think that growth in Africa and Latin America could be a surprise and that the agricultural complex is an area to watch closely, because incomes and diets are improving in the emerging markets and they have come through this storm better than the "old world," suggesting that their demand for food and ability to pay for it will continue to grow. As a result, economic growth in the U.S. bread basket is apt to surprise. So too the U.S. energy business, where new shale gas and oil plays are coming on and driving economic growth in out-of-the-way places like eastern Pennsylvania and central New York (Marcellus Shale). One of the sources of upside in the economy that folks may not be giving enough credit to are exports.

As is visible from the chart above left, which I borrowed from last weekend's BusinessWeek, U.S. exports are already getting a lift from China and the Pac Rim's resurgence and the weaker dollar. I won't belabor the point, but Barron's did a great article last weekend about how slowing imports (due to Americans' declining consumption) and increasing exports would narrow the trade deficit with a salutory effect on GDP figures. Will 3% GDP growth driven by belt tightening and increased exports save us from a jobless funk? I'm not too confident about that, but we are going to get some runway at least to see whether American ingenuity can once again rise to a challenge and allow us to re-create ourselves for a new millenium.

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3-Month Reflections: Those That Wanted To Buy, Did....

A: I think its safe to say that the 'pent up' demand from the brutally slow Q4 2008 - Q1 2009, re-entered this market over the past 8-12 weeks and made their purchases. Many brokers I speak to are telling me that their most motivated clients already signed deals and now its feeling a bit more like summer again - as in, the change in the past few weeks that is typical of the transition to seasonally slower summer months. Make no mistake about it, I think the pent up demand for the most part pulled the trigger over the course of the past 12 weeks. This is very clear when looking at 'inventory' and 'contracts signed' trends since early May or so. In fact, the action over the past 2-3 months was more typical of the bubbly 2007 levels; as I'll get into below w/ contracts signed data. But for those that come here for real time conditions, combined with a little gut feeling, my opinion is that the wave of activity has peaked and that we are now slowing down the way it usually does for summers in Manhattan. Take the buy side motivation and general activity down a notch or two from where it was in May and June and adjust expectations on both sides of the market. This observation/opinion should not be a surprise to anybody and reflects the seasonal nature of this market.

When I look at my internal systems, I see there were about 2,120 contracts signed in the past 8 weeks or so dating back to the last week in May for Manhattan co-ops and condos - two weeks ago I checked this same data trend and it was closer to 2,350 when comparing the last 4 weeks to the 4 weeks prior, so you can confidently say that the bulk of the activity was in May and that it is now being timed out of the recent data trends. If you look at my ticker for 30-DAY contracts signed, it is just under a thousand. However, I rely more heavily on the internal sharing systems when it comes to contracts signed data - as the source is direct with the agent that is maintaining the listing and when a contract is signed, usually the broker doesn't want to deal with 'other co-brokers' anymore!

Looking back at the past 8 weeks (limited by data I have available to me), 2,120 contracts signed is quite a lot! Its as if we saw peak-type levels of activity in the past 8-12 weeks or so with the first wave down in prices for our market. Talk about buyers coming in! But I don't think the 'fierceness' of this action is sustainable and the past 2-3 weeks already seems to me to be more like summer - slower buy side requests and motivation to pull trigger down a notch or so. Lets just be real, if this pace of action were to sustain itself, that is an average of about 1,060 contracts signed per month putting us on pace for over 12,700 contracts to be signed for all of 2009 - a level that was achieved at the height of the credit boom in 2007 for Manhattan. Trust me that is not going to happen! The spurt was due to a combination of factors that I discussed before and is our markets way of equalizing itself after a sharp drop in prices and a subsequent shift from Armageddon to well, something brighter. We are at now now. The perma-bears expecting a one shot move down 50% were wrong and the perma-bulls that promised sideline buyers/foreigners would never let this market down were wrong.

This dropoff in activity is a normal thing and these are observations that I, Noah, one man in a big industry, currently sees out there right now. Manhattan is a seasonal market and we are normally slow during the summer. Adjust accordingly if you are a seller that must sell and are noticing a tick down in traffic from say 6-8 weeks ago.

Looking ahead at what this spurt of action will do to future reports, you should see a tick UP in sales activity (especially as the prior quarter saw the 50% plunge in activity so the future quarter will easily look way more positive in comparison), contracts signed, and perhaps even deal levels from quarter to quarter as this market seemed to price OUT Armageddon - so the bulls, brokers, and execs will likely have some supportive quarter-to-quarter data coming to build bottom call arguments in Q3 or Q4 in comparison to Q1's ugly discoveries. For me, I need to see fundamentals improve before jumping on that ship; so Ill remain considerably less bearish than I was only 18 months ago now that process has started, yet still cautious that the economy and likely our market may have another wave to deal with.

Breaking down the activity, most of the deals were for 1BR and 2BR properties, with 3BR properties seeing a nice tick up in action as well. The biggest driving force? Cheaper prices, hands down.

Like I said, I feel that most of the people that wanted to buy, did. So where does that leave us now looking ahead? Well, that's the story. You cant look ahead by peeking into the rear view mirror, which is what you would be doing if you look back at the past action to try to predict future activity. So, I think we have a period of normalcy ahead, seasonality if you will, where this market will naturally slow down a bit until after Labor Day or so. I would expect:

a) contracts signed going forward to drop from past monthly levels - not quite as low as Q1 but not quite as high as Q2
b) new listings hitting the market to slow down a bit as sellers wait for seasonally more active months to maximize profit potential
c) properties to be taken off the market for various reasons if seller couldn't sell and doesn't have to
d) listing inventory to muddle, if not, rise a bit with the slowdown in action that is typical for this time of year

The wild card is equity markets affect on confidence and how that may make some view our markets - especially the higher end that got hit the most. This stock market is reflecting a stimulus induced recovery that who knows how long can last - the amount of stimulus is unprecedented. Its very likely we see the effects of stimulus on economic data in 2nd half - perhaps further boosting confidence. The loop can feed on itself and that may lead to higher stock prices and higher confidence for businesses. My fear is that stimulus induced economic recoveries are usually both not sustainable and not without its unintended consequences from financing them. For now, people just want the reflation party to roll on and stocks to rise making everyone feel a bit wealthier. After what we just went through, can you blame them? Party on Wayne, party on Garth!

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Breaking Down The Manhattan Tiered Price Adjustment

A: This market really is the fastest, and most enjoyable market to work in; so lets have some fun with today's look back on what we just went through. Over the past 10 years, Manhattan has been averaging about 7,500 - 8,500 transactions a year or so; excluding the 13,000+ transactions in 2007 which marked the peak of the credit bubble. But over the past 3 quarters, this market has seen some extraordinary moves that is worth reflecting on for a moment. In short, the market went from sustaining near-peak trades all the way up to the Fall of 2008 --> to, freezing up completely with a huge plunge in sales activity --> to, a fear based market with sellers hitting low bids --> to a market that saw increased activity and priced out fear and Armageddon. All of this happened in the past 9 months or so and it was crazy, frustrating, and exhausting all at the same time. Lets break down how it happened.

It's all about buy side confidence and sell side motivation/desperation. Combine the two and you have a market, or lack thereof with a disconnect between the two parties needed to do a transaction. The buyer-seller disconnect was in full force in 4th quarter of 2008 after Lehman failed, and continued until about the end of March - then something happened. As the equity rally continued from the March lows, contracts started to be signed and activity accelerated as the rally continued - boosting confidence amongst buyers who were more than comfortable to put money to work at significant discounts from only 18 months earlier. This is an observation of our marketplace since April or so.

But the nature of this recession hit our market's varying price points much differently! The best way for me to give you real time range approximations on where product was trading at the height of the fear, was by price point (stated March 9th, 2009, so put yourself back into time & place when the DOW closed at 6,547 and S&P closed at 676):

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

Lets create a chart that looks at discounts from peak kind of like how we discuss where a mortgage backed security is trading at from par - "i.e., 60 cents on the dollar". So we will use '100' to denote the peak to see where each price point seemed to trade DOWN FROM PEAK as this market adjusted to the reality of the credit crisis (so if you see a drop from 100 to 70 on the vertical axis, that would represent the price point was trading down approximately 30% from peak levels - best I can do on such short notice to get point across):

*unofficial, rough mock up of what I saw happening to each price point since Lehman's failure - simply for sake of this discussion! You must use a general range due to the many variables that affect an individual product's market value here in Manhattan

It's as if you can summarize this wave down by three periods:

Period 1: THE FREEZE UP - the sharpest of the adjustment occurred in this period, as the world changed after Lehman failed and AIG had to be rescued. This is the period from mid-SEPT to about late JAN that basically defined the initial snap down from peak levels. Although the market seemed to be trending slightly lower by the time Lehman failed, this was really when bids disappeared and brokers/sellers were scratching their heads on how difficult it was to get a deal done - the markets work in mysterious ways even though the writing was on the wall for many many months before the fall of 2008. As the freeze up continued into January, fear levels started to rise as equities adjusted downward in response to what turned out to be quite a failure in the financial system. A negative feedback loop hit buy side confidence, causing many to just sit back and wait. Sales volume was low.

Period 2: THE FEAR TRADES - ahhh, the very small period that I would argue lasted between mid-FEB and mid-MARCH or so, as equity indexes approached lows. This was when the DOW JONES index hit 6,576 and blood was on the streets. Sales volume here was still very light and those that did occur, were sellers hitting low ball bids out of fear; hence the phrase, 'fear trades'. This period marked the final move down in the first wave, defined by the low ball bids demanded by buyers that were asking for 'additional downside risk' due to the uncertainty of the near term at the time. Since traffic was so light and bids nowhere to be found for 5-6 months straight, sellers feared that time may cost them more money and hit bids. We are seeing the last of these trades clear now due to the lag from contract signing to closing.

Period 3: THE PRICING OUT FEAR: you can't deny that this market saw an acceleration of contracts signed and a decline of inventory as the first wave down finished itself off. I discussed reasons for this confidence boost a few times, so now I will just point out that this market did indeed PRICE OUT ARMAGEDDON in regards to the 'additional downside risk' demanded by buyers during the prior period just discussed. As activity accelerated with the equity rally, confidence rose, buyers were out shopping for discounts and felt more comfortable submitting bids - the natural market forces at work as perceived clarity increased! Many buyers missed out on a few places, saw saved listings go into contract, and noticed sellers not as pressured to entertain or hit low ball bids as they were only a few months earlier when fear levels' were much higher. The market has a way of equalizing itself and this is exactly what happened for each price point. The first comfort zone was reached and deals started to happen again!

Now the interesting thing is we will have to wait to see where the deals that occurred in PERIOD 3 happened at, as lagging reports will catch the beginning of this period first - the real action was from mid-APRIL to end of JUNE which will be registered in Q3's or Q4's data depending on the time lag to closing. So, when we look back at the end of this year, we may see some quarter-over-quarter increases in prices that no doubt many will build bottom calls out of! Lets check back here in JAN 2010 or so to see if this turns out to be the case! Real time market conditions likely will continue to be different than the picture painted by these quarterly reports - so stay ahead of the curve!

And there you have it, my unofficial, official interpretation of the past 9 months! Will discuss some exciting news and thoughts on where we may go from here over the next few weeks. Enjoy the weekend all!

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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

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.

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