Despite treading near historic highs, there seems to be a feeling of uneasiness in the global markets. Volatility has become the norm, and most believe it is here to stay. Whether it’s the trade war with China, uncertain Fed policy, the impeachment inquiry, Brexit, recession fears, or the potential for a market unfriendly presidential election result, there is no shortage of concerns. All of this makes for interesting “bull-bear” debates, which there is no shortage of on CNBC. As you might expect, my focus is narrower in scope, and is the topic of this month’s Katzen Report: What’s the state of play in the New York City real estate market given broader market uncertainties? Hopefully, this proves timely as we enter a traditionally busy season in the real estate market, particularly given weakness in the third quarter numbers just released.
In formulating a view (admittedly my crystal ball is as cloudy as most) I’ve looked at the numbers and historical trends, coupled with an overlay of what I’m seeing on the ground in real-time. I believe neither can be viewed in isolation, as the numbers for example, while interesting, often turn out to be lagging indicators and poor predictors of what’s to come. Things such as feedback from buyers and sellers, the tone of negotiations, number of bidders, and open house traffic often can shed important light on future numbers and real market conditions.
The New York Times reported recently that “One in Four of New York’s New Luxury Apartments is Unsold.” They cite the most troubling signs include the growing share of condos sold in recent years being quietly re-listed as rentals by investors who bought but are reluctant to put them back on the resale market and extended timelines to sell new product vs. years past. While growing inventory certainly is a concern and has been highlighted ad nauseam in recent years, I think the “one in four” ratio is as good as one realistically could expect given the absolutely explosive growth in new development. As a result, the historical paradigm of what is acceptable in terms of “sellout timelines” and “remaining inventory at construction completion” has to be redefined and built into developers’ costs, prices, and return expectations. However, it’s also important to look at the numbers at a more micro level and focus on trends project by project rather than just the headline numbers. For example, a portion of unsold new development inventory is in less than prime locations and/or outer boroughs, where developers bet on continued gentrification and Manhattan sprawl. In addition, a number of projects in prime locations and at the right price points are doing quite well. Finally, there are continued signs of a “race to the bottom” via developer price cuts and increased sales incentives in certain segments of the market. “Ripping off the band-aid” and pricing to fair value, while painful for some in the near term, could be a long term positive as remaining inventory is sold and supply/demand dynamics recalibrate.
Then there is the demand side of the equation. According to CNBC, the rich aren’t spending. They report that a “sudden pullback in spending among the wealthy could cascade down to the rest of the economy and create a further drag on growth, high-end real estate is having its worst year since the financial crisis, luxury retailers are struggling while discounters like Walmart and Target thrive, and in the first half of 2019, art auction sales were down for the first time in years.”
Douglas Elliman’s Q2 and Q3 contradictory data further clouds the picture. Q2 numbers appear to corroborate a potential bottoming, with slightly higher average sale prices from Q2 2018 to 2019 ($2,090,567 vs. $2,095,734) and prices per square foot ($1,733 versus $1,762), with a 12.5% increase in the number of units closed (2,629 versus 2,957). However, recently released Q3 numbers suggest a material decline in both prices and sales volume, both sequentially and year over year. This already has received a lot of press, with some suggesting sellers are now capitulating and accepting lower prices (which as mentioned above, if true could be a long term positive to get to equilibrium more quickly). However, material shifts like this sometimes can be driven by shocks that make the “trend” harder to extrapolate. In this case, NYS’ progressive increase in the Mansion Tax took effect on July 1st, the first day of the third quarter. As a result, one can speculate that a number of buyers, particularly at the high end which are hardest hit by the Mansion Tax changes, accelerated closings to avoid the higher tax bill. Given the numbers mentioned in the reports are average vs. median prices, a few large outliers at the high end could move the numbers meaningfully. Therefore, my guess is Q2 numbers may be a bit better than they would have been otherwise, while Q3 may be skewed more negatively. Either way, I think the next few quarters will be very informative as to the steady-state trend in prices and volume now that the Mansion Tax has fully phased in.
Then there are fears of recession, and what this might mean for real estate performance. There is no shortage of recession debate, with many assuming economic headwinds will be offset by President Trump’s crystal clear realization that the economy is critical to his reelection hopes. As such, his top priority will be preventing economic weakness, even if this means actions like striking a deal with China that is less than he deems ideal. After all, as the statistician and election predictor Nate Silver points out, the last incumbent president to face a recession in an election year was Jimmy Carter in 1980 when he lost to Reagan in a landslide. However, rather than debate whether the US economy is headed towards a recession, and if so when, let’s focus on how real estate has performed during past recessions. As tempting as it might be to look at the 2008 financial crisis for guidance on how a future recession may look, this could prove misleading. Remember, real estate, and more specifically lax lending standards and extreme leverage in both households and the financial system were at the heart of the Great Recession. Jonathan Miller is quoted in a recent Brickunderground article saying, “conditions this time are different and housing isn’t a leading force as it was during the subprime crisis. ‘Last time it was all about leverage, this time it’s about affordability.’”
ATTOM Data Solutions, a leading real estate data provider, examined home prices during the five recessions since 1980 and found that only in 1990 and 2008 did home prices come down during the recession, and in 1990 it was by less than a percent. During the other three, home prices actually rose. Aaron Terrazas, Zillow’s director of economic research, wrote, “People’s incomes get squeezed [in a downturn], but they still need a place to live. Usually what that means is that they are still in the market if they need one, but their price-point is lower.” While history doesn’t always repeat itself, it’s certainly a good reminder that one should not simply assume real estate will perform poorly during periods of economic weakness.
So now let’s put the numbers and history aside and turn to what I’ve seen in the market since late summer. After a surprisingly busy August, I’ve seen a further increase in traffic at a number of properties post-Labor Day. In particular, there has been a noticeable pick-up in activity in the $2-5 million sector. While the luxury market remains sluggish, I have found pockets of demand materializing. In addition, first-time buyers are dipping their toes back in the water, which is an encouraging sign. As I’ve said before, this segment of the market often is the first to exit and the last to return given they often have the most to lose. Thus, I watch these buyers closely for what may be a leading indicator of things to come. Finally, I’ve seen the continuation of a trend I’ve noticed for quite some time-empty nesters leaving the suburbs for the conveniences and limited maintenance of New York City living.
So what’s driving this activity? Some of the more prevalent comments I’ve heard from buyers are:
· Real estate as an asset class now offers attractive relative value following its underperformance vs. equities since ~2015
· Prices finally may be bottoming following the potential seller capitulation mentioned above. Now, many sellers simply will take their product off the market rather than cut prices further, either renting it or delaying their relocation plans altogether (in practice, I have witnessed this behavior many times)
· Lower interest rates since the beginning of the year (e.g. the 10-year Treasury has fallen by over 100 bps) has increased affordability (while most impactful in the non luxury market, many high-end buyers that otherwise would pay “all cash” are now using some leverage as they see value in how mortgage rates compare to other investment alternatives)
Whether you agree or disagree, a case certainly can be made for each.
There is no doubt that the real estate market still faces a number of challenges, whether it’s excess supply, increased taxes, and transaction costs, affordability, or economic uncertainty. However, I am quite pleased to see signs of increased activity, and buyers seeing solid value in the product they once viewed as overpriced. I’m looking forward to a busy fourth quarter, one which will be quite telling in terms of expectations for 2020.