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  • Issue 77- New taxes, and bridging the psychological divide

    The past month has been a wild ride in New York City real estate, highlighted by the passing of a progressive mansion (and transfer) tax which followed much debate regarding a potential pied-a-terre tax. I wanted to offer a few thoughts on this topic, as well as some broader, more encouraging observations on market trends and buyer/seller perspectives.

    At the beginning of the year, there was the threat of the New York State legislature implementing a pied-a-terre tax on non-primary residences in New York. Billionaire Hedge fund manager Ken Griffin’s $238 million, 220 Central Park South penthouse closing reignited the enthusiasm behind the pied-à-terre tax. Originated by New York Senator Brad Hoylman five years ago, Griffin’s stratospheric purchase thrust the pied-à-terre issue back into the spotlight highlighting the potential of an additional $650+ million in annual revenue to the State. Many feared this would drive a devastating loss to real estate values via weaker demand and, as a result, a strong real estate lobby quickly rose to kill the bill.

    As quickly as the pied-a-terre tax was pushed off the table, the new mansion tax passed. This tax, which consists of nine “progressive” tiers, starts at one percent for homes that sell for between $1 million and $1.9 million, and tops out at 4.15% on deals worth $25 million or more. In addition, the 0.4% state transfer tax increases to 0.65% (an extra ¹/₄-percentage point) for residential New York City properties that sell for $3 million and higher. That brings total transfer and mansion taxes to 4.55% for the most expensive homes, which more than triples the previous rate. It is worth noting the mansion tax, as it existed prior to this change, is a one time tax at closing and does not recur annually.

    The exact percentages at the new rates, and what that translates to into real dollars, is as follows:

    New, revised 2019 mansion and transfer tax schedule

    Unit Price ($) NYS Transfer Tax Mansion Tax Total Tax (%) Total Tax ($)
    Less than 1mm 0.40% 0.00% 0.40% up to 3,999
    1mm – < 2mm 0.40% 1.00% 1.40% 14,000 – 27,999
    2mm – < 3mm 0.40% 1.25% 1.65% 33,000 – 49,499
    3mm – < 5mm 0.65% 1.50% 2.15% 64,500 – 107,499
    5mm – < 10mm 0.65% 2.25% 2.90% 145,000 – 289,999
    10mm – < 15mm 0.65% 3.25% 3.90% 390,000 – 584,999
    15mm – < 20mm 0.65% 3.50% 4.15% 622,500 – 829,999
    20mm – < 25mm 0.65% 3.75% 4.40% 880,000 – 1,099,999
    25mm and higher 0.65% 3.90% 4.55% 1,137,500 and up

    While pied-a-terre and foreign buyers (often one in the same) have gotten tremendous press over the last decade in virtually all New York City real estate conversations, my immediate reaction to the outrage over this bill was one of internal conflict. While this tax would be terribly unfair (these buyers do, after all, pay very high real estate taxes for services they don’t often use), I thought we needed to be careful what we wished for. My fear, very simply, was the alternative to this tax could be a one that hits ALL high end buyers given New York State legislators’ seem to believe that further taxing of the wealthy is the answer to all fiscal challenges. I hoped this time around our politicians would resist the temptation, given the already high State and City income taxes, the elevated real estate taxes, the highest real estate transaction costs in the country (before this increase), and the added stress created by the loss of SALT deductions have had on New York City residents. So much for conventional wisdom . . . the tax increase was passed anyway.

    Now, the costs of living in New York City, as well as those related to buying real estate, have been a fact of life and a known commodity for some time. As such, prices have adjusted up and down over the years accordingly. Even the loss of SALT deductions now has had a full year to be digested, and as I’ve written in past reports, I don’t believe that the “ALL-IN” effect will be quite as onerous as many expected given the offset of lower Federal taxes. My point is, If you assume that the living and transaction costs I referenced pre this increase are mostly reflected in home values, then in theory, we have to try to isolate the impact of the current tax change on the real estate market in the City.

    The general consensus is while the increased mansion tax means more money out-of-pocket at closing, this will be much less of a threat to the market than the proposed pied-a-terre tax. This thesis hinges on the fact that the mansion tax is a one-time cost, and it does not indiscriminately target foreign buyers which would make New York City look like a less appealing investment option. While there is no doubt that the one-time nature of the mansion tax makes it significantly less onerous that the annual nature of the proposed pied-a-terre tax, unlike the latter, the increased mansion tax will hit every single luxury buyer. This is the trade-off that must be weighed in evaluating the relative impact of each on city home values.

    While the jury is out, my current thinking leads me to agree that the mansion tax increase is in fact the lesser of two evils. My conclusion is predicated on the fact that a buyer can adapt to a known, one time cost much better than trying to determine the “present value” of the annual cost of ownership when bidding on an apartment. In the case of the former, the buyer accurately can quantify the impact on his or her wallet immediately, and if necessary, lower the offer or increase the financing amount by this value. In addition, in the case of the latter, foreign buyers would have been skeptical that their annual tax burden would remain at current rates (the tax could be raised in the future), making their valuation decision even more difficult. As a result, many simply would have walked, rather than take on these uncertainties. While these buyers are somewhat concerned the pied-a-terre tax will be revisited as it has every few years, as of now, they are behaving very reasonably.

    As it relates to the mansion tax more specifically (as opposed to relative to a pied-a-terre tax), I would expect any impact to be on the margin. While I am always concerned about the proverbial “straw that breaks the camel’s back,” I think many straws (e.g. oversupply, stronger dollar, loss of SALT deductions, etc.) have already hit the market quite hard and are reflected in current valuations. If prices today were at 2014 levels, I would be much more concerned about this tax increase. But with prices now reset to much lower levels, interest rates near historic lows, tremendous wealth having been created in equity and other asset markets, and a resurgence in segments of the finance industry, I think buyers will react rationally to this one-time increase. However, the “margin for error” to sustain a prolonged real estate recovery, an important driver of economic growth, has just gotten smaller To that end, I do hope our politicians understand that they have asked a lot of New York City residents, and look to curtail spending rather than raise taxes every time fiscal problems develop.

    In terms of sales data, a new Elliman report that compiled sales for March 2018 vs. March 2019, as well as 2019 year to date, is as follows:

    March ’19 vs March ’18 Co-ops Condos
    Avg Sales Price -15.00% 1.00%
    Median Sales Price -3.00% 1.00%
    Discount to Original Ask 2.60% -0.90%
    Discount to Last Ask 1.00% 0.30%
    Initial Index Offer 0.82% 2.36%
    Trades over $1,000,000 -3.00% -4.00%
    Median # Days on Market to C/S -1 day +28 days
    2019 Year to Date Co-ops Condos
    % of Sales Financed 61% financed; 74% are contingent 48% financed; 68%are contingent
    % International Buyers 14% 24%
    % Sold at or above Ask 23% 27%

    A few observations:

    • Despite the numbers show condos spent a month longer on the market in March 2019 than a year prior, 27% of 2019 condo sales have occurred at or above the ask
    • The time co-ops spend on the market stabilized year over year, and thus far in 2019, 23% of co-op sales have occurred at or above the ask
    • Financing accounts for half the market, and as a result, lower interest rates should create a tail wind for purchases
    • You’ll notice that most of the “negative” year over year statistics are now in the low single digits, a sign of market stabilization

    In my daily interactions I continue to see situations where buyers and sellers have different opinions on value (sometimes financially driven, sometimes emotionally driven), however, I also have seen a slow and steady adjustment towards equilibrium. This is a critical development in the health of the real estate market, because it’s near impossible to transact other than in a distressed situation when expectations between parties begin in vastly different zip codes. In these situations, the compromise point to get a trade done is too far a stretch for either party to feel they extracted fair value. I would make one additional point: the days of sellers simply “giving an unrealistic price a try” without any downside risk are gone, at least for now. Buyers have access to tremendous information, and as we know, quite a bit of choice. Often when they see a price that looks off, a potential sign that the seller is unrealistic, they sometimes will skip the property and open house altogether. In a market where generating traffic to properties is so important to establish a dialogue, this can have a material impact.

    With both sides now beginning to embrace a more reasonable perspective (sellers acknowledging we are no longer in 2014, and buyers appreciating sellers of high quality product often simply will take product off the market rather than sell at an unreasonable price), I am encouraged for what the remainder of 2019 will bring. Look no further than the just released Olsh report: this past Easter-Passover holiday weekend saw 19 luxury contracts signed in Manhattan.

    Have a wonderful May and Memorial Day weekend, and I’m hopeful that some of the green shoots I’ve seen in the New York City real estate market take further hold.