The investment sales activity in the Manhattan submarket is generally a barometer of broader activity citywide. Due to current market dynamics, the rest of the market is performing very differently than the most prime of the city’s marketplaces.
We define the Manhattan submarket as being south of 96th Street on the east side and south of 110th Street on the west side. If you are a frequent reader of Concrete Thoughts, you know how impactful capital gains tax policy had on sales volumes last year. In fact, last year in the Manhattan submarket, there was a record number of property sales recorded. A total of 1,194 properties traded hands; more than 4.2 percent of Manhattan’s 27,649 buildings sold, eclipsing 1998’s total of 1,078 (1998 was the year the Clinton administration reduced the capital gains rate from 28 percent to 20 percent). The dollar volume of sales last year was not as stellar comparatively as there was $31.4 billion of sales, only the third highest total behind 2007’s $52.5 billion and 2006’s $34.8 billion.
We knew that the impact of capital gains tax policy would artificially inflate last year’s totals at the expense of this year’s, and, thus far, things are playing out exactly that way. Through the first three quarters of 2013, we have had $16.9 billion of sales in Manhattan. On an annualized basis, this would lead to $22.6 billion for the year, a 28 percent reduction from 2012. With regard to the number of properties sold, through the first three quarters of the year, there have been 516 properties sold. On an annualized basis, this leads to a projected total of 688, 42 percent below 2012 levels. Of all submarkets, this is by far the largest drop, with the Bronx suffering the second largest drop, running at 19 percent below last year’s volume.
This seemingly lackluster performance in the Manhattan submarket is easy to reconcile by looking at two factors: supply and value. It is clear that a higher percentage of Manhattan sellers took advantage of last year’s low capital gains tax rates than sellers in any other part of the Big Apple. This cleared out many of those who would have normally sold this year, leaving an extraordinarily low supply of available properties for buyers to choose from. We fully expected the number of properties sold to be down, and, on a citywide basis, we are about 20 percent below last year’s levels. However, we are surprised by the significant drop in Manhattan.
The impact on the market of the low supply has exerted tremendous upward pressure on property values. Demand drivers are all currently in overdrive and, of course, the low interest rate environment is adding fuel to the fire. A combination of these factors has pushed values up 50 percent since 2010, to approximately $990 per square foot this year, the highest average ever recorded. This average price increase has been driven by significant cap rate compression. In 2010, the average cap rate in Manhattan was 6.7 percent. That has dropped to 4.5 percent in 2013. Interestingly, cap rates, while continuing to drop, are dropping at a decreasing rate, a sign that they may be nearing a bottom.
This significant increase in value is pushing an increasing number of buyers into Northern Manhattan and the outer boroughs. In these markets, cap rate compression is growing at an increasing rate—the opposite of what we are seeing in Manhattan. Manhattan’s rising values are also forcing investors to climb the risk ladder, increasingly looking at value-added opportunities and development sites. In fact, thus far in 2013, the dollar volume of development site sales in the city has reached 17.2 percent of the market, nearly triple the activity seen in recent years.
This push in the land market has the 2013 average price per buildable square foot in Manhattan hitting $437. As strong as this number is, it is really not indicative of today’s land market. In Q3 alone, the average has risen to $510 per buildable square foot, and we expect this average to continue to rise significantly as the number of sites sold, for $800, $900 and even $1,000 per buildable square foot, continues to grow.
From a broker’s perspective, we would rather have higher volume than rapidly increasing values. However, I remind my brokers each day that, as values rise, selling becomes a more compelling proposition, and the more compelling it becomes, the more supply will come to the market.