Q&A with Shimon Shkury: Follow the Money: Who is Investing in NYC CRE and Why?

Despite interest rate hikes and other challenges, New York City saw 2,700 investment sales transactions valued at $38.4 billion in 2022, the highest number of transactions since 2015 and the highest dollar volume since 2018, according to Shimon Shkury, president and founder of Ariel Property Advisors, citing his firm’s research.

Shkury explored who is investing in New York City commercial real estate and why at Ariel Property Advisors’ recent Coffee & Cap Rates event. The following content was taken from his presentation

Commercial Observer: What were the highlights in the investment sales market in 2022?

Shimon Shkury: Based on our research, we saw two significant takeaways from 2022. First, Brooklyn exploded and accounted for close to half of the transactions citywide. Second, multifamily sales were strong, accounting for 42 percent of all transactions, which is the highest percentage in memory.

Timing also played a crucial role. The Federal Reserve’s aggressive monetary policy to curb inflation drove the federal funds rate up to 4.5 percent last year, which resulted in dollar volume dropping from $22.4 billion in sales in the first half of the year to $16 billion in the second half.

Commercial Observer: Why were multifamily sales so strong?

The entire multifamily sector performed well in 2022 with $16.2 billion in total dollar volume consideration for all multifamily properties (small buildings, buildings with six to nine units, and 10-plus units), which is on par with 2016 market multifamily activity.

However, at Ariel our research shows that not all multifamily assets were created equal. Of the multifamily sales last year, over 75 percent were for free market buildings. Institutional capital was particularly attracted to luxury apartments, new construction and small free market buildings that are tax protected. Investors gravitated to these assets because of the continued rent growth in New York City compared to other locations nationwide; they provided an inflation hedge, especially before interest rates shot up; and New York City’s low inventory of housing due to the lack of government incentives to build, including the absence of the 421a tax abatement, which expired in June 2022.

In contrast, rent-stabilized buildings accounted for only $3 billion of the multifamily sales in 2022 compared to 2015 when $6 billion in rent-stabilized housing traded, not including the $5.5 billion Stuyvesant Town transaction. The decline can be attributed to the Housing Stability and Tenant Protection Act (HSTPA), which took effect in 2019 and eliminated the opportunity to put substantial money into the units and increase rents when apartments turn over, thereby discouraging investment and encouraging vacancies. In fact, 42,000 rent-stabilized units are now vacant, according to CHIP, which represents owners. That’s 4.2 percent of all rent-stabilized units, which is a concerning number of units out of circulation in a city that is short on housing supply, and that percentage will continue to rise unless the law is amended. Clearly the legislators didn’t anticipate the consequences of the rent law.

That said, there was still $3 billion in rent-stabilized building sales in 2022. Buyers were motivated by a drop in the value of these assets and a belief that the current housing policy of HSTPA is unsustainable and will eventually be amended.

Commercial Observer: What is the outlook for new development based on last year’s land trades?

Only $5.5 billion in land traded last year, which is part of a trend since 2015 of declining land volume and values. This downward trend is taking place at a time when New York City is facing a housing crisis, and it’s estimated by REBNY that the city will need 560,000 units of housing to meet demand by 2030.

Capital for land was deployed by experienced developers that are familiar with New York City, with most of last year’s land sales taking place in the first half of the year before the 421a tax abatement program expired in June. The tax abatement is needed to produce affordable housing because New York’s property taxes are high as a percentage of rental income, 30 percent in New York City compared to 13 percent elsewhere in the country. Other challenges in the development market last year included construction costs rising 8.5 percent and slower condo sellouts due to rising interest rates. However, we’re encouraged that Gov. Kathy Hochul supports a successor program to 421a and are hopeful one will be adopted. Therefore, we believe that land presents an opportunity.

Commercial Observer: What is your vision for the future of the office market?

The office market actually did very well last year and accounted for $9 billion in sales, which is a post-pandemic high. We’re encouraged about this sector because more employees are returning to the office. For example, Manhattan’s average weekday office occupancy rate has risen to around 50 percent, and I believe that growth will continue.

When we look at the office sector, we separate it into three categories. First, quality assets with extraordinary locations such as RFR’s purchase of 475 Fifth Avenue, and SL Green’s acquisition of both 444-450 Park Avenue South and 245 Park Avenue. Second, specialty use developed by exceptional companies that see tangible value in building their physical space to enhance their corporate culture, such as Google’s acquisition of St. John’s Terminal, JPMorgan Chase’s construction of a new 2.5 million-square-foot headquarters, and the partnership between Citadel, Vornado Realty Trust and Rudin Management to construct a 1.7 million-square-foot tower in Midtown East. Third, buildings whose owners are trying to figure it out. A PWC study estimates that between 10 and 20 percent of the office product will need to be repurposed, which includes converting offices into residential use or adding a coworking component.

Commercial Observer: What’s on your watchlist for 2023?

We’re watching macro trends including global unrest, the likelihood of a recession or a Black Swan event. We’re encouraged, however, that inflation is trending downward and that mortgage rates seem to have stabilized.

Mortgage resets and maturities will take place in all aspects of real estate throughout the country. However, in New York City they will affect mostly the rent-stabilized asset class. What we predict is some forced sales in that category, which will be an opportunity for the longer term capital to come in and either buy buildings, recapitalize portfolios or buy lender notes. To be clear, we do not predict massive distress, but we do anticipate a significant number of transactions in the rent-stabilized asset class.

We’re encouraged that local politics and housing policies are improving and that the governor and mayor are collaborating and advocating for rezonings and more housing development.

We continue to see investor demand in New York City assets from three different groups: familiar capital and buyers; new capital (since 2020); and everyone else including family offices, mission-driven capital, and overseas investors. Our teams are working with several family offices from overseas that have invested in New York City and are looking to invest more.

Finally, while New York City’s investor demand in 2022 showed exceptional resilience, the city entered a slower period of transactions with a lot of uncertainties in the last quarter of the year because of mortgage rate hikes. This will affect transaction volume in the first quarter of 2023 and possibly the second. However, the abundance of capital, the possibility of lower mortgage rates, the strong fundamentals and the seemingly more aligned housing policy might lead to a much stronger second half of 2023.

Ariel Property Advisors is a New York City commercial real estate services and advisory company, with separate divisions for investment sales, capital services and research. For more market information, please refer to Ariel’s research reports:  2022 Multifamily Year in Review, Manhattan 2022 Commercial Real Estate Trends report, Bronx 2022 Commercial Real Estate Trends report, Brooklyn 2022 Commercial Real Estate Trends report, Queens 2022 Commercial Real Estate Trends report and Northern Manhattan 2022 Commercial Real Estate Trends report.a

See additional articles on Ariel Property Advisors: Multifamily Sales Have Biggest Year Since ’15, Not So Much For Rent-Stabilized Assets, Q&A with Victor Sozio: Latest Trends in Rapidly Changing New York City Multifamily Market, Hot Rental Market Driving Sales for Multifamily Buildings and Development Sites in Brooklyn

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