Will 2015 Be More Like 2008 or 1998?
The result of the November elections could have a lot to do with answering that question
Last week, I wrote about the potential fate of the rent regulation system in New York, which is highly dependent upon the outcome of several senate races in our state elections in November. The reaction to this column was more animated than to any other I remember. Some readers agreed that “the end is near,” fully understood the gravity of the issues and sympathized with the points I raised. Others were simply not aware of the profound implications of the senate races on housing policy while some accused me of outright fear-mongering and trying to induce sellers to unload properties before the chocolate pudding hits the fan.
This latter group, surprisingly made up of owners of multifamily properties, felt that our elected officials understand the devastating impact that setbacks in our rent regulation system would have on our housing stock and simply pander to the hundreds of thousands of rent regulated voters who can put them in power. I’m not so sure that is the case.
One thing that is not debatable is the significantly intertwined relationship between economics, politics and commercial real estate since the onset of the credit crisis in late 2007. Financial markets and our commercial real estate market have been more highly correlated to policy established by elected officials than at any other time I can remember in the last 30 years. Interestingly, many market participants believe we are at the top of the present cycle and an equal number believe this market run has several more years to go before a disruption occurs. This market dynamic makes for a robust trading market and is one of the main reasons why 2014 is on pace to see more properties trade hands in New York City than ever before. We are on pace for about 5,300 sales this year, which would break the previous record of 5,018 set in 2007. The dollar volume of sales is also likely to be just over, or just under, the $62.2 billion in 2007.
So the question for market watchers is whether 2015 will be a replay of 2008 or 1998. The bears, who believe we are at, or near, the end of the up cycle, feel that the inevitable downturn will occur next year as the disconnected chasm between underlying fundamentals and property values is irrational and unsustainable. Several normally active buyers have decided to withdraw from the market and wait for the correction. The overwhelming inflow of new buyers from around the country, and around the globe, has made this withdrawal all but invisible.
The bulls are feeling like the market is in a replay of 1998 again. For those of you who were around, 1998 was a fascinating year. The Clinton administration dropped capital gains taxes from 28 percent to 20 percent and the volume of sales spiked to a cyclical peak as sellers rushed to take advantage of an overnight increase in “value.” (Sellers should only care about what they are left with after selling, not what the gross sales price is.) Simultaneously, real values continued to escalate to the point where many investors decided that they were too high and sitting on the sidelines was the right idea. For those who adopted such a strategy, their wait for the inevitable downturn was 10 more years! The recession in the early 2000s caused a slowdown in the volume of sales, but had no impact on property values. The bulls believe there are, once again, years to go before the market hiccups.
There are great arguments to support the perspectives of the bulls as well as the bears. However, for various reasons, there is a tremendous amount of political risk, both locally and nationally that could impact the market in the system today. As discussed last week, rent regulation could be reformed to be even more tenant friendly and, more importantly, a repealing of the Urstadt Law could take the fate of rent regulation out of the state’s hands and deliver it to the city. City Council control of rent regulation would likely mark “the end,” as some readers put it.
Also on the local level, Mayor de Blasio’s affordable housing initiative could significantly affect land values in the city. Details have only been made available on a macro level. Without granular detail, figuring out the impact of the initiative is impossible. As I have said before, if the incentives are appropriate, the private sector will build all of the affordable housing the mayor desires. If not, values will fall, properties won’t sell and affordable units won’t be created. Additionally, the mayor’s need for revenue to implement his agenda could significantly impact real estate tax policy, particularly given Albany’s position on providing more revenue to the city.
On a national level, tax reform is the biggest of all political risks for our industry. Modifications to depreciation schedules, tax treatment of carried interests, capital gains rates, mortgage interest deductibility and the deductibility of state taxes paid would likely all be on the table. Most importantly, the fate of 1031 exchanges could have a dramatic pull on our investment sales market.
Regardless of your political leanings, the November elections will be most interesting to watch, as their results will likely determine whether next year is more like 2008 or 1998. Stay tuned…
Bob Knakal is the chairman of Massey Knakal Realty Services and has brokered the sale of nearly 1,600 properties having a market value of approximately $11.5 billion.