What are the new reporting requirements affecting transactions in the high end Manhattan real estate market, and more importantly, what impact might they have on prices, process, and demand?
If you work in the real estate industry long enough, one thing you can count on is change. Mortgage rates rise and fall, supply-demand characteristics are rarely static for very long, economic conditions and the relative performance of competing asset classes ebb and flow, tax policies are subject to governmental modification, and interest from global investors comes in waves. In this month’s Katzen Report I wanted to comment on a change in certain reporting requirements that took effect this week, and its potential impact on the high end sector of the real estate market here in the City.
On January 13, 2016, the US Treasury Department’s Financial Crimes Enforcement Network issued geographic targeting orders (GTOs) that will temporarily require title insurance companies to identify and report the legal entities that pay “all cash” for high-end residential real estate (defined as properties over $3 million) in Manhattan (as well as $1 million purchases of similar type in Dade County). This order is the latest in a slew of requirements (mainly implemented in the banking industry to date) aimed at identifying and eliminating potential money laundering activity. Via an all cash transaction through shell companies, a buyer may avoid the scrutiny imposed by financial institutions during lending transactions. This pending requirement of title insurance companies is the first time “persons involved in real estate closings and settlements” have been included in formal anti money laundering requirements, and as of now this does not apply to other real estate professionals such as brokers and lawyers. The GTOs went into effect on March 1st, and will run through August 27th, unless otherwise renewed.
So what does this mean for high end real estate, and the transaction process? In our opinion, the effect will be muted, and unless the GTOs are renewed, temporary. While it’s true that over 50% of the properties sold in Manhattan for $5 million or more were purchased with shell companies, wrong doing is not the motivation for doing so in the vast majority of cases. In my experience, general privacy or other practical (and not to mention legal) motivations are behind the use of these purchase vehicles. Hopefully, buyers in this camp will take comfort that the information gathered by the title insurers is not intended to be publically disclosed, and the level of due diligence conducted by the title insurer is likely no more invasive than that done by a mortgage provider.
To the degree there is any noticeable impact on prices, it likely will be more prevalent in the condominium market where the use of these vehicles is more prevalent and the percentage of foreign buyers is greater. That said, with the supply side pressure and current valuations already causing a moderation in prices in this market, any direct impact from this reporting requirement will be difficult to isolate. For those interested in the Brooklyn market, you may be wondering if high end product there (the only other borough with significant properties in the affected price point) will be a beneficiary of any buyer concern since the reporting requirements currently only target Manhattan. Again, any meaningful effect there would surprise me. In a test of my thinking, I was happy to see that it seems Howard Lorber, Chairman of Douglas Elliman and an active developer, agrees. As quoted in the Real Deal, “We think that this will have little effect on the market. It is de minimis.”
In terms of process, high end cash buyers using LLCs should be prepared for a potentially longer due diligence process to provide sufficient time for the title insurer to gather all necessary information. This could influence timing arrangements made between buyers and sellers prior to signing purchase agreements. In addition, while a low priority for most buyers in this price point, closing costs may increase should title insurance companies increase their fees in light of these heightened requirements.
Finally, I’d be remiss if I didn’t look past the potential near term impact on prices and the transaction process and comment on these GTOs more fundamentally. The intent is fair and reasonable; criminal activity should be identified and shut down. In addition, while I believe marginal, these purchases can diminish affordability and availability for honest buyers. I think if you ask anyone in the finance industry, they’d tell you these AML requirements pale in comparison to those they’ve needed to comply with for over a decade.
Whether it’s City Hall proposing increased mansion and new pied-a-terre taxes (so far shut down by Albany), rising general real estate taxes, the aforementioned new reporting requirements, a stronger US Dollar, or global economic headwinds, there always will be challenges that face the real estate market. The same can be said for any asset class. Nevertheless, the historical resiliency of the NYC real estate market coupled with the fact that many of the tenants that traditionally support solid real estate prices remain in place (e.g. low rates with steady domestic job growth), leave me optimistic 2016 will be yet another solid year in the City.