New York City has been at the fore of the current recovery in multifamily and commercial real estate investment activity. Signaling institutional investors’ renewed confidence in the city’s broader economic and employment outlook, the recent rebound in property sales has provoked deals that recall some of the most visible acquisitions from before the financial crisis. Bolstered by a cluster of large year-end transactions, Manhattan alone accounted for nearly 10 percent of the nation’s commercial property sales in 2010.
The market’s re-acceleration was particularly pronounced over the fourth quarter, with investors seizing upon improving credit conditions as well as legitimate concerns over pending tax policy debates. Owing to the late rush of activity, Real Capital reports that Manhattan sales volumes, for office and apartment properties alike, increased more than threefold between 2009 and 2010.
Still, volume remains low in comparison to pre-crisis levels. And while the market’s momentum is backed by strong tailwinds as we enter 2011, challenges ranging from rising interest rates to Albany’s gaping budget deficit still warrant a considered assessment for the city’s investment outlook.
Diversity of Investors Drives Uneven Gains
The headline indicators of market activity certainly tip the balance to optimism. Of particular importance, acquisitions for investment have been just one contributor to the New York real estate market’s reinvigoration. A necessary condition for a balanced recovery, buyers and sellers are engaging with a range of motivations. The diversity of domestic and foreign investor objectives is observable in many of the past year’s most high-profile transactions, such as Google’s just-completed purchase of 111 Eighth Avenue for its own growing space needs; Caisse de Depot’s sale out of distress of 1330 Sixth Avenue; and the Canada Pension Plan’s partial interest investment in 1221 Sixth Avenue.
While they have featured prominently among Manhattan’s current buyers and sellers, Canadians are not the only cross-border investors vaulting New York City to the upper echelons of the global market rankings. Nor have foreign investors been focused exclusively on direct property acquisitions. Diversifying its real estate exposure far beyond its increasingly frothy home markets, the Bank of China is only one of the foreign lenders that have quickly positioned themselves, at least among strong sponsors, as potential sources of large-scale financing.
In addition to foreign lenders, life companies and conduit originators, a notable subset of regional banks has also reengaged the market, enjoying the regulatory flexibility to make new loans by virtue of well-managed balance sheets.
For the range of lenders, the willingness to extend credit against prime assets coincides with investors’ continuing aversion to some dimensions of risk. Mirroring wider geographic disparities, the headline gains in New York’s volume and pricing metrics also belie uneven gains across property quality, location and sponsorship. While higher-quality and well-tenanted properties will tend to lead any investment recovery, the current imbalance is exaggerated, reflecting the idiosyncrasies of the lagging economic and labor-market recovery.
What to Watch for in 2011
Investors’ and lenders’ avoidance of undue exposure to the broader market’s vagaries hints at the challenges that still present headwinds for investment, including the potential for a sharp increase in interest rates that could impact lending and asset pricing across the country.
Foremost among the risks that take a particular shape in New York, the city has yet to measure significant job growth in the sectors that are most relevant for space demand. On the one hand, New York’s job losses during the downturn have been far less severe than originally projected. At the same time, however, the return to meaningful and sustained job growth has been similarly muted in its magnitude.
From its late 2009 nadir, employment in New York City expanded by roughly 60,000 jobs through May. Since then, employers have resisted adding net new workers. Private employment has picked up, which is a welcome sign on its own, but has been offset in part by declining government payrolls. Financial services employment, one of the city’s economic keystones, has yet to reverse its previous losses in a significant way. If asset prices continue along their present trajectory, the potential for a decoupling from fundamentals grows more likely.
A measure of caution is warranted in anticipating downside risks to employment and related fundamentals. There is an unusual degree of opacity around the city’s employment outlook as concerns financial activities and its adjacent professions, in part because of the shifting regulatory and policy environment. Over the course of the next few years, implementation of a host of new measures–including the loosely defined provisions of Dodd-Frank and the Volcker Rule–alongside a newly empowered Consumer Financial Protection Agency could fundamentally alter the profit calculus of many banks. Exactly how the industry will reshape itself on this new landscape is unclear. Credit availability and financial services job growth both depend on this new shape.
While policy makers in Washington are working toward new governance for the financial system while also girding for the looming budget debate, challenges in managing budget deficits closer to home present a different headwind for the city, raising the specter of higher taxes. There is general consensus that the extension of federal tax cuts will support a stronger rate of economic growth nationally over the coming year. Private and public macroeconomic forecasters have tended to revise upward their economic projections following the agreement in Congress late last year. The dire fiscal outlook for many cities and states, however, has meant an increasing temptation to offset the federal cuts with local increases. In Illinois, for example, income taxes have been raised dramatically, reversing much of the positive impact from the federal extension. In Albany and in New York City, pressures to either cut services or break with promises to hold the line on taxes are very real. Significant property tax increases are already pending, hurting the jobs outlook.
Tax adjustments present real threats to the city’s competitiveness if they are not offset by an improvement in services, in the same way that under-investment in infrastructure–the cancellation of a much-needed tunnel, for example–when public transportation costs are rising ultimately damages the cost-benefit trade-off of locating jobs and residents in the urban core.
Preserving the competitiveness of our cost-benefit trade-off is key to ensuring that New York’s real estate fundamentals remain aligned with current real estate pricing. Sound public-policy choices will be instrumental in this regard. The risk over the next year is in the potential for fundamentals and pricing to diverge, either because pricing runs further ahead or because fundamentals, under pressure from the choice of policy alternatives, falls behind.
Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.
