While we certainly are seeing some encouraging signs of recovery in the luxury sector here in the City, many remain curious what’s driving the moderation we’ve seen over the last several quarters. In fact, some probably are wondering what caused the slowdown in the first place. Sure, the increase in supply driven by rampant new development has been well documented, and that’s certainly a factor. However, this has been going on now for several years, and over that time frame, tremendous wealth has been created through an ever increasing stock market and greater stability in the job market. The finance sector in particular appears to have regained its footing after years of purging, and we all know the health of this segment tends to be highly correlated with NYC real estate prices. So why the change in sentiment now, years after the challenges became evident, and at a time when the aforementioned wealth effect should buffer the impact?
In my opinion, the culprit is a change in the psychology of real estate buyers that quite simply has lagged the challenges that were brewing in the market. As you know, the real estate market is less liquid than others, and as a result, the effects of both positive and negative catalysts often take longer to manifest themselves. Unlike the equity market, which can correct itself in a matter of days if not hours (and oh by the way this market also has been known to go long periods of time pushing bad news to the side), real estate prices and transaction flow tends to move more slowly. Initially, many buyers thought the moderation in high end prices was just a blip, a natural development as supply was absorbed and buyers and sellers caught their breath. After all, that was the trend post the financial crisis; ignoring the head fakes and buying made you money. In addition, given many purchasers were in the midst of their apartment searches or entrenched in the closing process, the early signs of a more prolonged slow down were mostly ignored. After all, if you look back over the last several years, most of the market headwinds had been well publicized for quite some time. Despite quite a bit of banter, none really seemed to slow things down. However, once buyers began to see transaction volume decline for an extended period of time, inventory grow increasingly stale with less competing bidders, and began to understand that just like other markets there is no assurance prices will rise unabated, their psychology shifted appropriately. This took some time to evolve, as one or two quarters does not a trend make and buyers realized this. But, once it became clearer there was a more sustained shift in market dynamics underway, buyers no longer felt the same fear of missing opportunities. In turn, this new disciplined approach fed on itself, as it began to demonstrate waiting for the market to come to you can be a winning strategy. Many also appreciated that sellers had preemptively ratcheted up prices trying to get ahead of demand, and with political uncertainly now creating another excuse for pause, it was only natural to expect prices to moderate. Why did this change begin in late 2015 rather than much earlier when same catalysts existed? The plain truth is bull markets in any asset class often ignore risks until they are more firmly manifested. Being early to a change in market conditions, even when right in the end, can be very costly as well.
All of this said, we are now seeing much greater traffic in the mid-range segments of the luxury market, and quality product has no shortage of interest. While many buyers are waiting for greater clarity as it relates to the President’s economic agenda, I think most will soon realize that the status quo is increasing likely for a considerable period of time. In addition, even if the proposed tax plan (likely in a modified form) is implemented, the benefit to wealthy New Yorkers is increasingly dubious given the potential loss of state and local tax deductions. Therefore, current and pro forma after tax income levels may be quite similar irrespective of a new tax plan. As the likelihood of the status quo grows clearer, I would expect the excuse of political uncertainty for buyers’ “wait and see” posture to dissipate.
Tremendous wealth has been created over the last several years, and real estate will remain a core piece of most New Yorkers asset portfolios. In addition, with the equity market at record highs, the relative value of real estate is only improving. Thus, as sellers continue to adjust prices to more reasonable levels (reducing but not eliminating their gains), existing supply is absorbed, and future new development is better behaved, I expect the early positive trends we are seeing to intensify. Throw in the fact that interest rates astonishingly have remained near historic lows, and my confidence grows stronger. Will we get back to the euphoria of recent years over night? Probably not. But anyone who expected hockey stick appreciation in real estate values in the face of moderate wage growth probably had unrealistic expectations. A plateauing in prices as any market consolidates normally is a very healthy development. I think that is where we are in the New York City real estate cycle.
Have a great beginning of summer!