Will the Boom Continue Or Is Another Bust Right Around the Corner?

The market’s performance in the fourth quarter was no surprise. We knew it would be extraordinarily active as the pending increase in the capital gains tax rate catalyzed many transactions that either might not have happened or would have happened in 2013 that were accelerated to take advantage of 2012’s capital gains rate.

The natural assumption we made was that this externality would affect behavior and there would be a natural slowdown at the beginning of 2013, as is normal after the externality comes to pass.

In January, there were 253 properties sold, which is the lowest monthly total going back to April 2012. Monthly dollar volume was $1.75 billion, also the lowest total going back to April. However, this activity is still relatively strong compared with monthly totals seen in 2010 and 2011.

The question becomes: Will volume continue to be muted, or will we see a pickup?

At the end of the year, we projected a reduction in the number of buildings sold this year by 20 to 25 percent but, counter-intuitively, an increase in the dollar volume due to an anticipated increase in sales of large office buildings. Typically, the office buildings sold in the city, at very high prices, affect the total dollar volume much more than the number of buildings sold.

We also projected that values would increase by 15 to 20 percent this year as buyers fight over a smaller supply of available properties. Thus far, it appears that our projections are holding.

The activity in the market has been extraordinary as our historically low interest rates have provided the rocket fuel for sale prices to take off. The upward pressure being exerted on property values is tangible as sales are hitting record levels on seemingly successive transactions. The length of time assets are on the market has been reduced, leaving market participants scratching their heads at the prices being paid for assets, yet these assets continue to trade.

So, are we in a commercial real estate bubble? History teaches us that low interest rates, for extended periods of time, create asset bubbles. Last year, average prices per square foot citywide increased by 13 percent. This year we are expecting even higher increases, and these increases are not occurring because underlying fundamentals have gotten significantly better. More than anything else, low rates are the reason.

Currently, the economy is trending upward, fundamentals are improving (albeit slowly), and most economic metrics are so far below their long-term trend lines that we must assume a natural regression toward the norms will occur at some point. We have also had so little new product added to the market in the last several years that pent-up demand is imbedded in the system. Will these positive dynamics trump those that normally create quintessential asset bubbles?

Low interest rates during much of Alan Greenspan’s tenure as Fed chairman directly affected the housing bubble which led to the Great Recession. As William Shakespeare’s real estate broker brother said, “To repeat, or not to repeat, that is the question.”
rknakal@masseyknakal.com

Robert Knakal is chairman and founding partner of Massey Knakal Realty Services, and in his career has brokered the sale of more than 1,300 properties, having a market value in excess of $9 billion.