Issue 80 – Making heads and tails of 2020 news flow, and what it means for NYC real estate

News flow in 2020 sure has started with a bang. Each week has unveiled developments that may have a real impact on the New York City real estate community; some promising, some not so much. In this edition of the Katzen Report, I will to do my best to summarize these new developments, which include policy shifts, global health concerns, environmentally-driven initiatives, and income, in an effort to make sense of this whirlwind year and understand how these issues could impact the landscape of New York City real estate. And to think, it’s only February . . .

Sunset clause

Before getting into the aforementioned 2020 news flow, I wanted to take a quick minute to highlight something in the 2017 tax reform that may not be widely appreciated based on my conversations with clients.  As you know, in high tax states one of the most controversial parts of this tax plan was the severe $10,000 cap on the ability to deduct state and local income taxes (known as “SALT”) against Federal income taxes (for a refresher on the topic, I dedicated a full Katzen Report Issue 74 to this when the tax reform was enacted.). It is important to note that this not only includes real estate property taxes but state and local income taxes as well. While the latter is more of general cash flow and affordability issue (and technically not specific to real estate), in states with high-income taxes (a la NY and NYC), it can be a much more significant blow than property taxes. Given real estate tends to be one of a consumer’s larger purchases, less after-tax income, regardless of the driver, is less than helpful. While some of this effect is offset by lower Federal tax rates that were enacted, many high earners are “net-net” slightly worse off, and the cosmetics and publicity of the SALT cap initially created uncertainty and fear.

Now, what I wanted to highlight today is a subtle difference in the business and personal elements of the tax reform changes. As it relates to the tax changes for businesses, those were made permanent.  In other words, new legislation is necessary to make changes. However, what seems less obvious to many is the tax changes on the personal side “sunset” on December 31, 2025.  This means that even without the introduction of new tax law, tax policies will revert to those that existed prior to the 2017 changes.  While this means that federal income tax rates with rise, it also means that the cap on SALT deductions will disappear. To me, this opens up a greater number of paths for this to become reality-a Democratic White House and Congress, OR simply gridlock.  The latter is something we’ve seen quite a bit of in recent years, and in a “sunset” construct such as this, a “do nothing” Washington actually would yield change.

While I realize this is several years away, in my experience, smart buyers, sellers, and investors begin reading the tea leaves and making decisions well in advance of the actual changes.  Thus, if this is the direction the market begins to anticipate a year or two out, real estate should feel an anticipatory bounce. Of course, given 1) a number of Republicans in high tax states also oppose the SALT cap, 2) there are a number of Congressional elections before then end of 2025, and 3) we live in a world of (re) negotiation, you can’t rule out an actual proactive rewrite before 2025 (let’s just hope the cap is not removed only for lower- income earners).  One can dream . . .

Coronavirus Outbreak

While we’d all agree that the coronavirus is very sad as a health matter, the true global economic impacts are widely debated.  To this end, on February 11 th the South China Morning Post published an article titled, “Property markets reel from coronavirus outbreak as Chinese investors pause transactions.” The article states some of the preferred destinations of Chinese property buyers are witnessing a lull in activity as they surmise it is more difficult for Chinese investors to buy property overseas. Markets such as Thailand and the US are reeling from the halt in activities and interest coming from the Chinese, underscoring the impact of the outbreak on the sector.”

This is a very logical conclusion, as the virus clearly has impacted travel and stolen focus from other activities (like real estate buying I would presume).  After all, health risks usually take priority. Personally, I already have seen a closing delayed as a result of travel complications. The real question surrounds the longevity of this serious situation, which remains a wild card.  I certainly will be monitoring this situation closely and will pass on any relevant developments as they unfold. If it’s any indication, the performance of the equity and credit markets suggest a belief that the virus impacts will be relatively short-lived. I guess the same could be said for all other geopolitical risks as well . . .

Recalculating property values

According to the Preliminary Report by the NYC Advisory Commission on Property Tax, the committee led by Mayor de Blasio and Speaker Corey Johnson recommends potentially drastic changes to the way residential properties are taxed across New York City. The committee “is proposing a major overhaul that would fundamentally shift the tax burden to those wealthier neighborhoods and lessen it for low- and moderate-income homeowners.” According to the commission chairman, the changes could affect 90 percent of all homeowners in New York City but these changes will not raise tax revenue for the city, they will “redistribute it.”

The Daily News explained that, “Every residential building in the city would be taxed the same way and all those properties would be assessed by the city at their full market values. Co-ops, condos and rental buildings with at least 10 units would be in the same tax “class” as one-to-three family homes. The city would also use a “sales-based” methodology to determine the value of properties in the new residential class.”

The commission will hold public hearings on the proposals over the next few months before issuing a final report, which would have to win approval from Mayor Bill de Blasio and the City Council before heading to the State Legislature and Gov. Andrew Cuomo. At the moment, the proposals are still missing key details, including what the tax rates would be, the length of the transition period for existing homeowners before they see the full effects of the change, and various provisions and abatements for primary homes and low-income residents.

There are a number of issues with this methodology, including dramatically raising taxes on individuals that may have lived in a home through years of appreciation with limited growth in their liquid assets no doubt will lead to forced selling.  In addition, one has to hope that piling on higher taxes right after an increase in mansion tax, transfer tax, and the introduction of the SALT cap will give politicians that depend on a healthy real estate market reason for pause and evaluation.

Rental broker fees

In the first week of February, the real estate community was hit with an unexpected massive blow as the State of New York said they were making it illegal for real estate brokers to take the standard 15% brokerage fee for finding, showing, and negotiating a lease.  Beyond that, landlords would have to pay any broker fees, possibly increasing rents by 15% to accommodate that new cost.  According to the rental platform Doorkee (cited by the Wall Street Journal), these fees amounted to $600 million in total revenue last year. The following week, news broke that a New York State judge temporarily blocked the ruling in response to lawsuits filed by the Real Estate Board of New York and a number of real estate groups and firms.

The Real Deal published a report on brokers and landlords’ reactions to the rental fee change and cited AJ Clarke’s Michael Rothschild, whose company manages roughly 150 rental properties in Manhattan and is actively leasing out apartments in 10 to 20 buildings, said his firm has agreed with owners to increase asking rents by 5 percent to cover the cost of broker fees. “We don’t really know if that will hold, but we didn’t know how else to handle it,” he said. “Most of our buildings are not full-service buildings. It’s all leg work by our brokers to show apartments.”

In my opinion, there seems to be some wood to chop before this is truly enacted.  In addition, unless there are restrictions on the ability to increase rent, it seems likely that consumers will see a rent increase for those units that depend on the broker community’s services.  While some may say it’s still better for a renter to pay over time than upfront, I’m pretty confident landlords can run the proper PV calcs if they are fronting the fee.  Higher rents potentially could dissipate, as prices landlords are willing to pay for units they intend to rent fall given these increased friction costs.  This most likely will occur in those buildings where developers/landlords are unable to pass on the commission to renters.  In theory this dynamic could hit condo resale prices as well (more easily rented than coops), to the degree investors deem the cost of renting their unit to have risen.

There remain a lot of moving pieces here, and a potential trickle-down effect that must be analyzed properly.  While it’s good to be prepared, I think it may be prudent to see if this proposal has legs.

Wall Street pay, investment returns

Although most of the Wall Street banks’ 2019 profits beat expectations, headlines suggest bonuses are under pressure.  According to Crain’s New York, “JPMorgan Chase is keeping annual bonuses at its corporate and investment bank roughly flat for 2019 even as workers across Wall Street brace for a drop in payouts.” Bonus season has proven to have a direct effect on New York City’s real estate, as many financiers receive a large portion of their total annual compensation in a lump sum early in the calendar year.  Bigger bonuses, no surprise, usually means more spending. However, I would counsel folks not to lose sight of a few points:

• where bonuses are down, the percentages are not rumored to be severe,
• the equity markets are up over 30% since the beginning of 2019,
• and the vesting stock of many of these professionals has performed extremely well over the last several years

All of these should serve to (more than) buffer a modest softening in 2019 comp, and as a result, I wouldn’t expect this to be the deterrent for those looking for new homes.

Street closures

All across the world, cities are closing their streets to cars. Following suit, late last year, 14th Street became a car-free zone. According to the MTA, since the ban, “bus speeds are up by 38 percent and ridership is up by 37 percent.”  But, as is so often the case, there are trade offs. According to WCBS news radio, residents believe, “14th Street busway causing a traffic nightmare on surrounding streets. Beyond the traffic, a local resident reported, ‘Cars backed up all day—7:30 in the morning, 11 o’clock at night. We’re starting to get panhandlers who can now stop on that street corner because the cars can’t move through four or five lights.’”

Additionally, a few weeks ago, news broke that another transportation reduction plan is in effect to help NYC’s clogged roadways. The current plan would reduce the Brooklyn-Queens Expressway by one-third. Congestion pricing also is in our future, as well as the ongoing effort to add more bike lanes.  While the environmental motivation for limiting/discouraging cars (and thus encouraging the use of mass transit) in parts of the city is noble, there certainly will be locational impacts on real estate performance.  For example, the values of properties close to subways stops should increase if taxi use becomes more cumbersome and increasingly expensive.  As referenced above, the surrounding grid of car-free zones that are drowning in traffic might suffer due to increased noise and inconvenience.  Also, areas were bike lanes are replacing parking spaces could make those areas marginally less desirable for those that hope to park cars on the street.  The trade-off, of course, is better sound quality and fewer fumes in areas that are being “de-auto-ized,” which certainly could be value-enhancing for those that do not need to hail a cab right in in front of their building.

In summary-every prospective buyer should do proper due diligence on neighborhoods of interest as it relates to the impact of both CURRENT and CONTEMPLATED plans to limit traffic and encourage the use of mass transit.  Or, you can just ask your trusted broker . . .

Summary

We live in unique times, and the last month and a half have given us a lot to consider. When I add all of the above together, it seems to me the jury is out on the cumulative effects. I will point out three trends I’ve seen of late that I find encouraging. First, with one year of the tax reform under our belts, I have seen buyers gain a better understanding of their after-tax cash flow, and thus find greater comfort in buying new properties. Secondly, I have seen sellers begin to capitulate and adjust prices to meet market demand. In one building I traffic in, five apartments just went into contract as prices were modestly reduced. Thirdly, interest rates took a leg down since the start of the year, resulting in an uptick in mortgage applications. There are buyers out there, but they will remain very discriminate and price sensitive. Dumb money was priced out of this market years ago, so sellers and developers alike will need to be thoughtful about approaching the market.

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