Prepare for Shock and Awe in the New York City Real Estate Market

by: Jeffrey Bernstein

I have been talking ad nauseam about the imminent threats to the New York City land market, commercial real estate market and ultimately the residential real estate market as a result of the tentacles of the credit debacle going back quite a stretch. We opined over and over that job losses on Wall Street were on the way, the commercial market was going to get smacked despite being a "demand driven market" and that the residential market would go the same way. We have even gone so far as to assert that the near-sacrosanct multi-family rental market will get hurt due to over-use of leverage and, believe it or not, rent declines.

Unfortunately we were right and the world of "...New York is the capital of the universe, we never got overbuilt, they ain't making any more land on the island..." is now colliding with REALITY!

It's lights out. The shock came with the demise of Lehman Brothers and the subsequent stock market crash. But you are about to see the Awe. Or, as Brando says in Apocalypse Now, "The Horror....The Horror".

Just thumb through the latest issue of The Real Deal and you will see that most of the sales professionals in the real estate market have finally started to get real about their expectations. There is still a glass-half-full-mentality and downplaying of the bad news, but sprinkled in with the positive sound bites are some honest comments about the outlook. The denial is over. Here are a few select quotes on topics ranging from the outlook for the real estate brokerage business, to condo development, hotels, office and the retail markets:

  • "I bet we'll see fewer brokers in the business by the end of 2009."
  • "Just as in earlier down cycles when transactions dropped significantly, Darwin will probably apply to the field of brokerage. Shrinkage in the order of 30 to 40 percent would not be surprising, and would be consistent with the cycle of the early '90s. In the past five years, there has been an influx of inexperienced brokers."
  • "I have seen prices drop up to this point anywhere from 10 percent on the low end through 15 percent and up to 20 or 22 percent at the high end. And I think there is probably a little more to go."
  • "I recently drove by projects that were going up in East Bushwick and noticed that construction had stopped on a number of them. It can't get much worse than that. Those properties that are in fringe neighborhoods are not going to do as well."
  • "If a developer is smart, he will do everything in his power to get it sold or rented or a combination of both."
  • "After [the holidays], there may be a bloodbath with retailers both large and small leaving spaces, consolidating or renegotiating their leases."
  • "Investors in large properties with high vacancies, because there are very few deals being done in the $100 to $500 million dollar range and absolutely no prospect of refinancing for the next 24 months. Office buildings will be hit hardest, followed by new hotel or condo construction, which we see disappearing except in extraordinary circumstances."
  • "We currently are forecasting a year-end 2009 overall Manhattan vacancy rate between 13 and 15 percent. Honestly, I feel that the higher figure is more likely given recent data regarding layoffs and the general weakness not only locally, but globally. [That means] there will be no expanded demand from any industry."
  • "Business travel, we know, has fallen off sharply, especially to expensive markets such as New York. Domestic tourism is dropping as well due to layoffs and the overall nervousness of the economy. And finally, foreign travelers to New York are not as plentiful as the dollar strengthens. Hotels should have a difficult time unless they begin a significant reversal to the steep run-ups to room rates that we have seen over the past few years."
  • "Most, if not all, of the money that goes into the real estate sector will be in the form of the buyer looking to buy distressed properties."
  • "Buyers are looking for, in some cases, 30 to 40 percent off of what the price would have been a year ago for an apartment," he said. "They want real estate to mirror the loss in the Dow."

Check this latest commentary by the top building broker in New York City in terms of volume - pay attention to the facts not the spin. If this is what the folks who are habitually positive are saying....guys like Noah and I - who have been warning for almost 18 months about the dangerous imbalances in world economies, markets and the New York City real estate market - can now go a step further and say the debacle we feared is now in progress.


This week's Crain's New York Business features an article Stress and the city, subtitled "New York is gripped by fear. Are we headed back to the bad old days of the 1970s." Now I am by no means suggesting that we are heading back to the those days, but these fears are based on the realty of unemployment, declining business profits, declining real estate profits, declining tax revenue, declining services and a declining quality of life quality. We called the peak in NYC quality of life several months ago in a piece entitled Is The Bloom(berg) Off The Big Apple, so for Urban Digs readers this not a new concept.

In my opinion the next 3 -5 months is going to see a huge step down in prices across the board in New York City real estat,e both commercial and residential to reflect the coming declines in personal income and Net Operating Income from owning real estate. Don't let anyone tell you otherwise.

As a result of declining operating performance of real estate properties, the weak (over-levered) hands are going to either fold on their own or be forced to fold. A significant part of my business is financing commercial real estate and I can tell you that there is very little financing available and what is available is aimed at loaning to own or de-levering over-levered but high quality properties (if you have need for bridge or mezzanine financing or partner equity aimed at de-levering a property or getting to income stabilization we can help). Financing for construction is all but un-available and financing for acquiring properties is only available at very low leverage levels, largely for ultra-safe multi-family property and essentially only to those who don't need it.

With a decline in the profitability of operating real estate just unfolding, few want to speculate on how bad it will get, so providing debt will only be done with a large margin of safety in debt coverage (particularly in the case of the remaining portfolio lenders) and/or collateral value (particularly in the case of hard money lenders). Purchasers of equity in properties can't get much leverage to do it even if they wanted to and are demanding big discounts to provide their own margin of safety. Anyone doing a "market rate" transaction, just hasn't gotten the memo yet.

We are about to see the same series of events we have seen in other markets around the country that led the way down on the residential side. First comes delinquency, then foreclosure, then the bank gets in trouble and finally when the bankers are fired, new bankers come in and punt the properties. Transactions are driven by "foreclosure buyers" and if you are not a distressed seller, you are just out of luck.

We are going to see this process unfold in New York City in a compressed time frame. You see in Florida and Nevada the delinquencies were happening before the actual economy turned down and joblessness started to soar. Banks had not marked to market away as much of their capital bases and world markets had not crashed, so when investors went to the banks looking to buy shaky loans at a discount the banks resisted. In New York City, only the small local portfolio lenders will be able to hold on to REO (real estate owned) and hope to parse it out over time. I am already hearing that one of NYC's premier local portfolio lenders is liquidating their bad construction loans.


CMBS financed properties and large bank-held properties will be in trouble by the second half of this year. The credit rating agency Fitch has identified 1,100 fixed-rate CMBS loans that need to refinance on or before June 30, 2009. They will likely be transferred to special servicing where the holders will be able to extend maturities, while praying for a miracle - and that's the bull case. Most of these loans were performing well and could have been refinanced in earlier times: however, with the credit crunch and economic downturn, no one wants to touch this stuff.

The point being that even reasonable assets and deals will have trouble being refinanced; forget anything with issues (and issues will be widespread). When you talk about New York City and you look at vacancy rates soaring for office space and retail, hotel guest counts plunging and partially sold condos that have to go rental, you are talking about major pressures on Net Operating Income of the properties and not just cap rate expansion (where investors are simply demanding higher returns on their money for existing cash flows because money has gotten more expensive). Now investors are going to demand higher returns on their money while factoring in declining cash flows and property prices.

This is what causes the big markdown in prices in a market. It's a familiar cycle in the stock market. In a bull market, price earnings ratios sometimes compress due to fears of a slowdown or higher interest rates and you get corrections. In a bear market, P/Es get compressed and the E (earnings) get slaughtered, that's why stocks get bombed out. We are about to see real bear market action in real estate. As a market that is discontinuous and doesn't trade daily or smoothly, you should understand that when Wile E. Coyote realizes he has run off the cliff, the first step down is a doozy.

The stealth transmission mechanisms will turn higher vacancies into lower rents and lower transaction volumes into lower prices for residential units despite people's difficulty imagining how everything works in reverse after such a long bull market in real estate. When people lose their jobs some have to move in with other family members, they don't just become renters or move downscale....demand is destroyed.

Grab a bunker and some tinted glasses Manhattan-project style!

Equities with significant NYC real estate exposure include VNO, SLG, AKR, FCE.A, NYB, COF, SOV.

Disclosure: The author has no positions in these stocks.