Manhattan commercial property prices have fallen 6% from their peak levels in this cycle. This drop in prices has not been matched in the other major markets of the U.S., according to the RCA CPPI. Should you lose sleep over Manhattan’s decline? Is it time to brush up on your survivalist skills and stockpile food in anticipation of Global Financial Crisis 2.0?
In a word: no.
Every market cycle is different. There are characteristics that rhyme across each cycle over the decades, but each has unique drivers as well. Just as it was a mistake in the aftermath of the Global Financial Crisis to assume that you could become the next Sam Zell by buying up assets on the cheap in a new version of the RTC, it is a mistake to assume now that this Manhattan price decline is a sign of a calamity on the horizon. In fact, there are some positive aspects of this price move.
The fact that this price drop is only seen in Manhattan and not in other major U.S. markets is one telling feature that distinguishes this cycle from the last. The downturn into the GFC was a coordinated drop in liquidity and prices across all markets, assets classes and deal sizes. In the current expansion, however, commercial property prices continue to push to new highs in Los Angeles, San Francisco, Chicago, and Boston. DC saw a drop in prices starting in 2015 but has been climbing over the last year.
Why the disparity of performance in this cycle? It is a story of changes in investor preference and income fundamentals unique to each market. Individual market features were masked in the last cycle by the weight of the withdrawal of liquidity from the debt portion of the capital stack across all markets.
In Manhattan, my suspicion is that the pullback of Chinese investors is behind some of the recent change. While these buyers were not the biggest portion of the market, they were often top bidders for trophy assets in Manhattan. The presence of these bidders may have helped reset price expectations for the market overall. The market has been in limbo with falling deal volume since early 2017, as buyers and sellers tried to come to grips with a new market landscape.
And therein lies the good news behind this price drop. Office deal volume, for instance, is on the rise again in Manhattan. Deal activity hit a high $30 billion on a 12-month trailing basis in Q2’16 and fell to a $13 billion pace by Q3’17. Volume was back up to the $16 billion range by Q2’18. Average cap rates for Manhattan offices have moved up 20 bps from the low water-mark in Q2’17. Even the best of the best assets saw a 10 bps increase in cap rates, with an average 4.1% for the top 25% of office assets in Q2’18.
Manhattan is dancing to its own tune. Is it a good tune though? The answer to that question depends on one’s position in the market. For potential buyers who thought that the market was just a little too pricey the changes are healthy. Sellers have come down on their price expectations and more transactions will be possible.
Jim Costello, Real Capital Analytics