Investment Sales: Never Mind the Adjectives, Look at the Numbers
Tom Acitelli Oct. 21, 2009, 1:25 p.m.
When people talk about the building sales market in Manhattan today, and how slow things are, they often speak in adjectives. Here is a sample of some used in the past four months in various news articles: slow, anemic, horrible, inert, quiet, sluggish, creeping, apathetic, inactive, stagnant and lethargic. Rather than ask you to suffer through interpreting the degree to which these words apply, let’s look at some numbers. I have always preferred numbers to adjectives.
Massey Knakal recently completed our analysis of the investment sales market in Manhattan through the first three quarters of 2009. The results were, unfortunately, in line with our expectations; however, we believe we may have already bottomed out in terms of a low point in the volume of sales.
Through the first three quarters of 2009, the aggregate sales consideration in Manhattan (south of 96th Street on the East Side and south of 110th Street on the West Side) was $3.2 billion. This figure is down 82 percent from the $18 billion in sales in the first three quarters of 2008, and down 92 percent from the $40 billion peak in sales in the first three quarters in 2007.
There were 209 Manhattan sales through the first three quarters, down 60 percent from the 528 sales during the same period in 2008, and down 75 percent from the peak over the first three quarters of 2007, when there were 829 sales. Interestingly, the reduction from the peak in the number of buildings sold (75 percent) was less than the reduction in aggregate consideration (92 percent), showing the bias toward smaller transactions recently. This is a function of financing markets in which financing for smaller, income-producing properties is much more readily available than for larger transactions. Our community and regional banks have been actively providing financing throughout the credit crisis, and their active participation continues today. These lenders prefer to make individual loans of $30 million or less, creating a majority of transactions in the small-to-midsize range.
In fact, 92 percent of all transactions in 2009 thus far have been below $25 million, and the average transaction size has been a mere $15.3 million.
Another reason for the bias toward smaller transactions is the significant amount of equity required to acquire property today. Loan-to-value ratios have been reduced from 75 to 85 percent to 50 to 60 percent. The impact of this on a $50 million sale is that an investor needs $25 million to $30 million of equity today as opposed to the $7.5 million to $12.5 million required pre–credit crisis. This difference is significant and cannot be overlooked as a tangible factor affecting the fundamentals of our building sales market.
IN THE MANHATTAN MARKET, we have 27,649 properties (excluding co-op and condo buildings). Over the past 25 years, the average turnover rate in the New York marketplace has been 2.6 percent of that statistical sample. The lowest turnover rate we have ever witnessed was 1.6 percent of that total stock in both 1992 and 2003. These were both years at the ends of recessionary periods and were years in which we experienced cyclical peaks in the unemployment rate.
If we annualize the 829 sales that occurred in the first three quarters of 2007, the turnover rate was 4 percent. Annualizing the 528 sales in the first three quarters of 2008, the turnover rate drops to 2.5 percent; and, if we annualize the 207 sales in the first three quarters of 2009, the turnover is running at about 1 percent.
We believe, very strongly, that the reason for this low volume of sales is not because there are not buyers willing to invest in New York City properties. The low volume is created by a market that is extremely supply-constrained, as distressed properties have been stuck in the pipeline and discretionary sellers are, typically, not choosing to put properties on the market at this time. Demand drivers are significant and are led by high-net-worth individuals and old-line New York families that have been investing for decades. High-net-worth foreign investors, who believe today is the time to buy in New York, have also been extremely active and more noticeable in the market than at any time since the mid-1980s.
Over the past couple of months, we have also seen a resurgence in institutional capital, which has, essentially, been on the sidelines since the summer of 2007, when the credit crisis tangibly took hold of the marketplace.
An interesting dynamic within the turnover rate of sales is that we appear to have exited the low point, as turnover has been steadily climbing this year. If we annualize the sales that occurred in the first quarter of 2009, the turnover rate was running at 0.72 percent. Annualizing the sales in the first half of the year, this figure increases to 0.90 percent, and annualizing the first three quarters of the year, turnover increases to 1 percent. Based upon the preceding, we believe that we are past the bottom in terms of a trough in the volume of sales and anticipate that the volume for the year will reach about 1.2 percent.
This 1.2 percent level will be about 25 percent below the lowest levels recorded during the past 26 years and would likely be an all-time record low for sales volume. We have only kept sales records going back to 1984, when Paul Massey and I began our careers. It would be very interesting to see what the volume was like in the 1970s, when the city was on the brink of bankruptcy.
WE ANTICIPATE THE SALES volume rising in 2010. Price levels have come down significantly, stimulating interest in the marketplace. Much of the patient capital that has been on the sidelines waiting for the right time to get in the game is now actively seeking opportunities. Additionally, distressed assets will start to come to market with greater frequency than they have been. Advantageous mortgage terms, including interest-only periods and interest reserves, will begin to burn off, exacerbating distress and creating transaction flow.
With regard to prices, in the first three quarters of 2009, the median price per square foot, across all property types, is down 32 percent from its peak. To fully understand pricing trends, we must look at various property types, as they have been impacted differently. The best performing product type has been multifamily properties, which have seen prices fall only about 16 percent from their peak.
Mixed-use properties, which are multifamily buildings with a retail component making up at least 20 percent of the building’s square footage, have seen prices drop 49 percent. Retail properties have seen prices fall by 46 percent. Weak consumer confidence and consumer spending figures have affected the retail sector significantly as evidenced by the drop in mixed-use and retail property values.
The office building sector has experienced a reduction of 62 percent in value off its peak. Interestingly, we must look at the office building sector more carefully because there are two clear trends emerging. Properties that are well leased with long-term, good-credit tenants have experienced reductions in value of only about 25 percent. Properties with significant vacancy and or market exposure, caused by significant lease rollover in the short term, have seen their values fall more drastically, in some case by 70 percent.
While we believe that the volume of sales will pick up over the next several quarters, we believe that there will be continued downward pressure on pricing, as rising unemployment continues to degrade our fundamentals. As the fundamentals degrade, it is natural for prices to decline. As the market goes through its necessary de-leveraging, we will see a protracted period of transparent distress, which will create buying opportunities.
In 2010, we anticipate increases in sales volume with prices stabilizing some time during the second or third quarter of the year, at approximately the same time that unemployment peaks. After this, we anticipate a period of stable pricing, as relative equilibrium will be reached between supply increases, caused by the de-leveraging process, and the significant pent-up buying demand.
Robert Knakal is the chairman and founding partner of Massey Knakal Realty Services, and has brokered the sale of more than 1,000 properties in his career.