Thoughts About the Holidays

 

What a wonderful time of year it is. Holiday season makes us think of many of the things that have become synonymous with Christmas and Hanukkah: holiday music, gift-giving, an exchange of greeting cards (emails today), church and synagogue celebrations, special meals, holiday cookies, egg nog, singing carols, and the display of various decorations; including Christmas trees, menorahs, wreaths, colored lights, garlands, mistletoe, holly and nativity scenes. It is the time of year that many of us still enjoy watching Frank Capra’s 1946 classic, “It’s a Wonderful Life” starring Jimmy Stewart, Donna Reed and Lionel Barrymore.

It is a time of year to spend time with family and loved ones and a time to count all of our blessings. It is a time of year to remember those who are less fortunate than we are. There are many, particularly today, who need assistance and it is a time of increased charitable giving. Anything that can be done to help, should be done, especially when it comes to helping disadvantaged children who may be particularly sad at this time of year. A helping hand or an act of kindness can go a long way. It is a time when people devote time and energy to causes which are most meaningful to them.

Generally, at this time of year, people are in better spirits and “goodwill towards man” is commonly exhibited. On busy streets and in crowded stores, people tend to be more courteous and kinder towards each other. The holidays tend to put us in a good mood and cause us to think about others and their feelings more than we might at other times of the year. It is a time when we often put ourselves into the other person’s shoes to think about things from their perspective. When we do this, it encourages all of us to treat others with courtesy, dignity and respect.

To illustrate, I would like to share a story with you:

Years ago, a 10-year-old boy approached the counter of a soda shop and climbed onto a stool. “What does an ice cream sundae cost?” he asks the waitress.

“Fifty cents,” she answers.

The youngster reached deep into his pockets and pulled out an assortment of change, counting it carefully as the waitress grew impatient. She had “bigger” customers to wait on.

“Well, how much would just plain ice cream be?” the boy asked.

The waitress responded with noticeable irritation in her voice, “Thirty-five cents.”

Again the boy slowly counted his money. “May I have some plain ice cream in a dish then, please?” He gave the waitress the correct amount and she brought him the ice cream.

Later, the waitress returned to clear the boy’s dish and when she picked it up, she felt a lump in her throat. There on the counter the boy had left two nickels and five pennies. She realized that he had enough money for the sundae, but sacrificed it so that he could leave her a tip.

The moral of this story, before passing judgment, first treat others with courtesy, dignity and respect.

So at this wonderful time of year, I take a break from thinking about real estate and would like to wish each of you and your families a happy, healthy and joyous holiday season filled with love, hope and goodwill towards others.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties during his career.

Economic Recovery Likely to be Subdued

The U.S. economic recovery is very important to the commercial real estate recovery. As the economy recovers, corporate revenues will grow and companies will make profits. These profits will allow hiring to resume and as unemployment shrinks, people who get good jobs will resume renting apartments, buying residences and the companies that expand, will need more office space. Our commercial real estate fundamentals will improve and we will all be in a happy place once again.

How is the economy doing?

Equity markets have rallied, credit spreads are much better than they were a year ago and U.S. employment is showing signs of easing. The banking industry is making profits and consumer spending in November was up 1.3%, substantially better than the 0.7% that was projected. In the third quarter of 2009, GDP grew by 2.8% (revised down from an initial announcement of 3.5%). The housing market has expressed some positive signs as inventory is decreasing and it is suspected that as manufacturer’s inventories shrink, factory output will increase to restock bare shelves. In fact, the Institute for Supply Management reports that manufacturing had expanded for three months in a row. This may all sound pretty good but let’s not get too excited.

With regard to GDP growth, following postwar recessions, real growth, in the four quarters after the recessions were declared over, averaged 6.6%. During the five years following those recessions, the average growth rate was 4.3%.  While growth was 2.8% in the third quarter and is expected to be about 3% in the fourth quarter, most economists project growth to range from 1.5% to 3% for all of 2010.  If growth is limited in this fashion, it will be a new event for our postwar economy. There has not been a single deep recession that has been followed by a moderate recovery.

This may no longer be the case. The recession we have just emerged from (many believe we are still in the recession) lasted a record seven quarters and experienced a near-record average GDP decline of 1.8% per quarter. Based upon this, and history, we should be witnessing the start of a powerful and sustained recovery. However, all signals and projections from economists are that the recovery will be subdued at best.

Why all of the pessimism? There are economic reasons that support this pessimism and there are some philosophical reasons.

There appears to be a growing fear that the federal government is retreating from the free-market economic principles of the last 50 years. We have seen tangible evidence of this in many ways, most notably the anti-business and anti-Wall Street sentiment in Washington.

Some argue that the $787 billion stimulus was successful in that things did not get worse than they did. Others argue that only $86.5 billion of the stimulus money was targeted towards encouraging broad-based private investment and thus failed to stimulate true economic growth. With interest, the stimulus will cost the taxpayers $1.1 trillion. While this spending succeeded in temporarily and marginally increasing disposable personal income, it left personal consumption spending virtually unchanged.

Given the massive deficits created by the printing and spending of money in Washington, taxes will be going up across the board. We will see this in marginal income tax rates, capital gains rates, dividend rates and death-tax rates. Almost everyone will pay more taxes – significantly more. Hardest hit by these increases will be the new and small businesses whose investment and hiring decisions either drive or starve recoveries.

Business investment may be curbed due to the uncertainty created by extraordinary events like the administration’s intervention in the GM and Chrysler reorganizations. The mechanisms used by the government upset decades of accepted bankrupcy law by placing unsecured and lower priority creditors, like the United Auto Workers, in front of secured and higher priority creditors. This intervention has arguably had the effect of stifling investment as wary investors watched political considerations cast the rule of law aside.

Corporate earnings have been positive causing the equity markets to rally. However, earnings have been created by cost cutting and the productivity gains which generally follow prior to real recovery in the form of growing revenues. Thus far, revenue growth has been disappointing. Therefore, growth in corporate output will be far lower than what would normally be expected in a solid economic recovery. A crucial reason for this is the fact that bad assets on institutional (as well as personal) balance sheets are like a ball and chain strapped to the economy.

Near-zero interest rates are also creating some potential problems for our market. More than a year after the heart of the panic, the Fed is still promising near-zero interest rates for an extended period. They are buying over $3 billion per day of expensive mortgage-backed securities as part of a $1.25 trillion purchase plan. With the system somewhat stabilized, the Fed hopes that artificially low interest rates and its purchases of MBS will stimulate growth. Instead, they are pushing dollars abroad and wasting precious growth capital in asset and commodity bubbles.

Ironically, the near-zero rate policy, coupled with Washington’s preference for a weak dollar, has created a glut of American capital in Asia and other foreign markets as corporations and investors borrow in dollars and invest in other currencies and foreign assets. This creates a shortage of capital in the U.S.   For small businesses and new workers this capital rationing is devastating, advancing business failures and painful layoffs. Thousands of start-ups won’t launch due to credit shortages.

In a ninth consecutive decline, consumer lending shrank at an annual rate of 1.7% in October. This extended the dramatic evaporation of financing available to help fuel the economy. The $3.5 billion decline, calculated by the Fed, results in a 4% drop in consumer lending from its July 2008 peak. As our economy is 70% consumer based, curtailed lending to consumers could harm the chances for a strong recovery.

Moreover, it is not just consumers having trouble borrowing. Notwithstanding the perception that the economy and financial markets are recovering, many companies lack easy access to borrowing. All of the debt overhanging consumers and companies is the pivotal reason that we are seeing a free fall in bank lending. The nation’s lending markets have changed significantly as they adapt to post-crisis realities.

Markets where the U.S. government is either a big borrower or a defacto guarantor are ballooning. Simultaneously, corporate lending and consumer finance markets have shriveled. A Wall Street Journal report shows that these markets have shrunk by 7%, or $1.5 trillion, in the two years ending October 31st. The result of tighter lending is that consumers spend less and businesses are more reluctant to hire and invest.

Some of the decline in lending is due to lower demand as borrowers focus on paying down debt that they already have. In the past 25 years, household debt has exploded. It is now 122% of total disposable income, up from just over 60% 25 years ago. At the end of the third quarter of 2008, household debt began to decline as Americans started belt-tightening.

The most recent data shows that credit tightness peaked earlier this fall to the worst levels in 23 years. What we are all enduring, and what small businesses, workers and consumers continue to be pummeled by, is the dismantling of the great credit boom of the early 2000’s. This grueling, but necessary, deleveraging began last year and is now in full swing. We are seeing it in our investment sales market and expect that it will continue for 2 to 3 years as we face today’s problems and anticipate 2006 and 2007 vintage loans maturing.

In October of 2008, bank credit peaked at $7.3 trillion and is now down to $6.72 trillion. Banking sector debt, it is estimated, must fall by another $2 trillion or so and this should take over 2 years to complete. Since the peak, this 8% drop is enormous and it is accelerating. By comparison, the peak-to-trough drop during the Savings & Loan crisis in the early 1990’s was only 1.3%.

The last thing the central bank wants is a decline in the broad-based money supply. The Fed’s asset purchase program is not only about driving down mortgage rates. It is also about trying to prevent a collapse in the money supply. When the Fed buys assets, it creates deposits which, in turn, helps offset the reductions in available credit. If deleveraging and the credit contraction does last a couple of years, and if the Fed is interested in offsetting it, they will have to continue to buy assets through next year. Presently, they intend to stop the purchases well before that.

It appears clear that the economic recovery will not be as strong as history suggests it should be. We have a long way to go before we get back to above trend growth. The recovery in the commercial real estate market will come on the heals of the economic recovery as we generally lag behind the economy. As lenders put off dealing with the problems imbedded in their balance sheets,  the recovery simply slows down and credit markets remain soft. I certainly hope the recovery evolves more quickly and forcefully than it appears it will.  Our commercial real estate markets could use the help.

Distressed Asset Update

Two years ago, almost everyone was discussing, and looking forward to, a tsunami of distressed assets which would be coming to market based upon the sub-prime mortgage crisis and the stresses it would exert on the credit markets in general. In September of 2008, when Lehman failed and Wall Street as we knew it was structurally transformed from an investment banking platform to one of bank holding companies, the “almost everyone” mentioned above was changed to “everyone”. But the tsunami has not arrived, not even close.

The fact that only a few distressed assets have been put in play is not because they aren’t out there. The pipeline is chock full of them.

Let’s use the New York City marketplace as an example. In the 2005-2007 period, there were $109 billion of investment sales in New York City. Based upon reductions in revenue (rent levels) across all product types including residential, office, retail and industrial and cap rate expansion, values have declined by 32%, on average, year to date. If we eliminate multifamily properties from this analysis, values have fallen from peak levels approximately 48%. Based upon these reductions, we estimate that, of the $109 billion spent on investment properties, $80 billion of that was spent on properties which now are in a negative equity position. This relates to about 6,000 properties.

If we include properties which were refinanced during the 2005-2007 period, the number of properties having negative equity jumps to 15,000. We estimate that there is about $165 billion in debt on these properties and, based upon today’s underwriting standards, there should only be about $65 billion in debt on them. This means that in order to have a conservatively leveraged marketplace, we would need to extract $100 billion in debt.

Clearly, this will not happen. Many investors have the ability to feed their properties and, based upon a desire to own them on a long-term basis, will do so. Other transactions will be worked out utilizing any of our favorite terms which have become commonplace in today’s vernacular including, “extend and pretend”, “delay and pray”, “a rolling loan gathers no loss” or “kicking the can down the road”. We do believe, however, that $30 to $40 billion will ultimately be extracted from the market in the form of losses.

So where are those distressed assets now? Some have not come to the market because they aren’t even in default yet due to mortgages which are still in interest only periods or are operating on an interest reserve set up by the lender when the loan was originated. Others have loans floating over 30-day LIBOR which closed on friday at 23 basis points (3-month LIBOR is only at 26 basis points). At 150 over LIBOR, the rate being paid on those loans would only be 1.73% and they can cash flow at those levels of debt service. While some properties are fundamentally under water, they are not yet in default, but likely will be when these advantageous terms expire.

Other distressed assets haven’t come to market because everything that has happened legislatively has allowed lenders to hide bad assets on their balance sheets. The FASB mark-to-market accounting rules have been modified to allow loss avoidance. Similarly, bank regulators will now allow lenders to hold a loan on their balance sheet at 100 even if they know that the underlying collateral for that loan is only worth 60. Additionally, modifications to the REMIC regulations have made it easier for CMBS loans to be kicked down the street.

Any of these delaying tactics will only be beneficial if appreciation is anticipated in the short-run. Given the massive deleveraging the market must experience and unemployment rates which are anticipated to remain elevated for at least another year to 18 months, we do not see support for the short-run appreciation argument.

We really don’t understand the reluctance of lenders to deal with these problem properties. Many of those that are in default are currently in the foreclosure process. This is a frustrating process, especially in New York, as it can take years to get through the process and obtain the title to the collateral. Many borrowers further complicate things by going into bankruptcy, which, based upon backlogs in the bankruptcy courts, adds additional time to the process.

It is very difficult to say this without sounding completely self-serving ( After all, I do sell buildings and notes for a living) but, if a lender wants out of a bad deal, selling a note today is likely to lead to a better recovery than waiting a year or two.

We believe this because the lack of product on the market toady has created a dynamic in which many investors are fighting over relatively few opportunities. Because of this, particularly on our income producing properties for sale, we are generally receiving 25 to 35 offers for each. Furthermore, on each note we have sold this year, we have received over 50 offers. This is due to the fact that buyers today would rather purchase from a lender than a private seller, believing they will get a better deal. “Believing” is the key word in the last sentence.

Due to the excessive demand for distressed assets, buyers are currently paying aggressive prices for anything banks are selling.  In many cases this year, we have obtained prices for notes that, we believe, are at or very near the value of the underlying collateral.

Some lenders are taking advantage of these dynamics to rid their balance sheets of underwater loans and are using the proceeds to make good loans today. Consider that two years ago, bank spreads, based upon all of the competition to put money out, were as low as 30 or 40 basis points. Those spreads can be 300-400 over corresponding treasuries today. Additionally, today’s loans have less risk associated with them as, rather than a loan to value ratio of 75%-85%, LTVs today are generally in the 60%-65% range. These loans are also significantly less on a price per square foot basis than they were two years ago.

If your business was 10 times as profitable as it used to be and there was much less risk involved, wouldn’t you be trying to do as much business as you could?

“Out with the bad, in with the good”, should be the mantra of lenders today. Until now, this has been slow to develop. To illustrate this, consider the following very telling statistics: Massey Knakal is asked by potential sellers to provide opinion of value reports and provide an explanation of our marketing program and we exclusively list about 31% of the properties that we are asked to analyze. It is just like a batting average in baseball, if we are hitting .300, we feel pretty good. With lenders and special servicers we are working with, we have completed just over 1,000 valuations and have exclusively listed just 12 properties/notes. That is a batting average of just .012. Many of these opportunities have simply not come to the market in any form. Perhaps the lender/servicer is waiting to see what the future will bring; perhaps they are simply making deals with the borrowers.

We have, however, seen this freeze thawing slightly as 2009 comes to a close. We expect to be coming to market with several distressed notes from lenders and special servicers right after the holidays and remain optimistic that we will be able to continue to achieve pricing at levels where the recovery versus collateral value is significant. There are also some foreclosures which should be concluding shortly which will lead to some REO which should be placed on the market shortly thereafter.

Let’s hope that 2010 sees a significant rise in these opportunities coming to market. It appears that the year will, at least, start out that way.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

Will the U.S. Housing Market Double Dip?

I am often asked why I, a commercial building sales broker, pay attention to the residential housing market. It is because we landed in this recession due to stresses in the housing market and the roads leading out of the recession will run through the housing market as well. During the summer, that road seemed to be heading toward recovery.

Over the past few months, there have been some signs that the U.S. housing market had begun to stabilize. Some economists have even said that the market bottomed as early as the spring of this year. Let’s look at the reasons for the optimism.

Industry experts were cheering October’s new-home sales figures, which easily beat estimates by climbing 6.2%. Prices, which had been in free fall, dropped by the smallest margin in nearly a year. (The S & P Case-Schiller Index, which only tracks 20 markets suggests prices have been increasing for 5 months running). The National Association of Realtors reported last monday that sales of previously occupied homes in October jumped 10.1% from September to a seasonally adjusted annual rate of 6.1 million, the highest level since February 2007. The number of home listed for sale nationally was 3.57 million at the end of October, down 3.7% from a month earlier. Much of the sales activity was driven by buyers who rushed to claim the first-time home buyer’s tax credit before it was to expire on November 30th of this year. The number of homes for sale in September was 3.63 million, down 15% from a year earlier.

Mortgage rates have been at historically low levels. Mortgage backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae rose to their highest level of the year last week buoyed by strong investor demand. Risk premiums on the bonds, which measure their yield (moving inversely to the price), fell as low as 1.24 perceentage points above the yields of comparable Treasuries last Wednesday. The previous narrowest level was 1.29 in May. These dynamics have created an average rate on 30-year fixed rate mortgages at only 4.78%, which matches a record low from April. That rate was down from 4.83 the previous week and 5.97% a year ago.

If we look at the housing market dynamics more closely, however, it appears there is a good chance that government intervention may be creating a bubble of its own, artificially and unsustainably propping the market up.

Consider this: The average single family home price in the United States is $178,000. Most mortgages made today are guaranteed by the Federal Housing Administration which requires only a 3.5% downpayment (less in several circumstances) which is $6,230. With the $8,000 first-time home buyer’s tax credit, the government (the taxpayer) is paying people to buy houses (It has been estimated that 80% of the purchases that occurred using the credit would have occurred anyway so the “real cost” of the economic incentive to create a sale is $40,000, not $8,000). Buyers are utilizing artificially low interest rates as the Fed is buying a significant percentage of offered Treasuries to keep rates down. Without this quantitative easing, mortgage rates would be much higher. The Fed is also buying much of the residential mortgage-backed securities that are being sold. Between Fannie, Freddie and the FHA, the government( the taxpayer) presently guarantees 92% of all home mortgages in the country. To top it off, the government (the taxpayer) is also purchasing a substantial amount of these very mortgages that we, um – I mean the government, guarantees.  Does this sound vaguely familiar to you? Isn’t this type of shell game that got us into this mess in the first place?

We must not forget that the catalyst for most of the stress in the housing market was government policy aimed at increasing the homeownership rate through lowering mortgage lending standards. These policies began in 1977 with the Community Reinvestment Act (CRA) which targeted banks and encouraged them to increase lending in low- and moderate-income communities. From 1977 to 1991, $9 billion in CRA lending committments had been announced.

In 1992, congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, also known as the GSE Act (ironically, the name sounds so benign). The objective here was to force Fannie and Freddie to purchase loans that had been made by banks; loans that were made as part of the CRA. The GSEs had to do this to comply with the law’s “affordable housing” requirements. Since then, Fannie and Freddie have purchased over $6 trillion of these mortgages. The goal of community groups, of forcing Fannie and Freddie to loosen their underwriting standards in order to facilitate the purchase of loans made under the CRA, was achieved. Congress inserted language into the law encouraging the GSEs to accept downpayments as low as 5% or less, ignore impaired credit if the blotch was more than a year old, and otherwise loosen their lending guidelines.

The result of these loosened credit standards, and a mandate to make “affordable-housing” loans, created a massive pool of high risk lending that ultimately drowned the GSEs, overwhelmed the housing finance system, and caused an expected $1 trillion in mortgage loan losses by the GSEs, banks, and other investors and guarantors. Most tragically, there is an expectation that, at the end of this cycle, the U.S. will have seen 10 million or more home  foreclosures.

The refundable tax credit, available even if a family has no taxable income, will enable many more purchasers to buy a home, even if they are not qualified. But it could also bankrupt the FHA and, by doing so, would damage an already weak housing market.

This credit was initially available only to first-time buyers with a combined income of $150,000 or less ($75,000 for individuals). In 2009, about 40% of all first time buyers used the credit, so extending it was strongly supported by residential real estate brokers, home builders and their congressional allies. The recently passed extension (until April of 2010) makes the credit available, not only to first time buyers but, also to those who have owned a home for at least five years. In addition, it raises the maximum income for a qualified buyer to $225,000.

The first-time home buyers tax credit is expected to cost the Treasury about $15 billion in 2009, more than twice the projected cost when Congress approved the stimulus package (is it really hard to believe that the government could underestimate the cost of the programs it implements? – watch out healtcare reform!).

The problem here is that, as we discussed above, the FHA insures mortgages with such low downpayments that it can be funded completely by the refundable tax credit. Owners who don’t invest their own money into a house are much more likely to default on the mortgage. The FHA is already looking at a number of serious problems. Two weeks ago, the agency reported that its cash reserves, which are federally mandated to be no lower than 2% (down from 3% last fall) of its portfolio, had dropped to 0.53%.

The deteriorating quality of the FHA’s mortgage portfolio is a critical challenge to the housing market and the federal budget. A recent government audit concluded that the FHA would run out of money in 2011 and need a federal bailout if a recovery is not swift.

Presently, the percentage of U.S. homeowners who owe more on their mortgages than their properties are worth swelled to about 25% according to a report in the Wall Street Journal. Moody’s.com pegs this percentage at nearly 33%. Either way, this dynamic threatens prospects for a sustained housing recovery. These so-called underwater mortgages present a roadblock to a housing recovery as these properties are more likely to fall into foreclosure and get placed on the market, adding to an already bloated supply.

Over 40% of borrowers who took out a mortgage in 2006, when home prices peaked, are under water. In some parts of the country, home prices have dropped so much that borrowers who purchased homes five years ago now have negative equity. Even recent bargain hunters have been hit as 11% of borrowers who took out mortgages in 2009 already owe more than their homes are worth. Borrowers with negative equity are more likely to default and, today, about 7.5 million households are 30 days or more behind on their mortgage payments or are in foreclosure.

This level of negative equity has some economists projecting that housing won’t really bottom out until 2011. There are additional factors that lead to their conclusions.

The home sale statistics that are presented by the NAR and Commerce Department exaggerate activity as they double count some sales. If a foreclosure occurs and the bank sells the property to an investor at an auction who subsequently resells the house to someone who intends to live there, that counts as two sales. Additionally, “seasonally adjusted” numbers also will exaggerate the real level of activity.

Moreover, most of the sales activity is taking place in the areas which have been hit the hardest such as California, Southern Florida, Arizona and Las Vegas where we see the highest level of distress and very cheap condos, co-ops and single family residences.

Home prices are measured in three different ways: 1) median income to median sales price, 2) the cost of owning versus the cost of renting, and 3) the total housing stock value as a percentage of GDP. If we consider these three different methods of measuring home prices and affordability, it is possible to conclude that home prices have another 10% – 15% to adjust before the market actually hits its natural bottom.

All of the government intervention has prevented the market from hitting its natural bottom. No one wants to see people displaced but artificially propping the market up only makes things take longer to correct and simply delays the inevitable. The American consumer has had a long-held taboo against walking away from their home, but this crisis seems to be eroding that.

The Fannie and Freddie bailouts have already cost us $112 billion (and counting). How much will the FHA bailout cost? If housing values don’t recover, or the FHA cannot outrun its problems, the government audit suggests that FHA could ask for $1.6 billion by 2012. judging from history, that is probably a low-ball estimate.

Congress probably doesnt mind, however, because these liabilities are technically off budget, until they aren’t. i certainly hope the housing market recovers quickly but there appear to be many hurdles to overcome before this can happen.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

A Potential Catalyst to Stimulate 2010 Property Sales Activity

This recession has hit the U.S. very hard causing an unprecedented level of government intervention. Trillions of dollars have been committed in spending, bailouts, tax credits and guarantees.  Eventually we must  pay for these financial commitments and we pay for them in the form of higher long-term interest rates, increased taxes or, most likely, a combination of both.

Not only is the federal government running massive and record-setting deficits but most states are in the same position.  While the fed is presently committed to keeping interest rates low (we know they will have no choice but to tighten monetary policy at some point), the tax picture is another story. There is no doubt that taxes are going to increase and increase across the board.  Federal, State and local taxes are going to increase and everyone, even those who were promised no tax increases constantly in pre-election speech after speech after speech.

The Bush administration’s tax cuts sunset at the end of 2010 which will push the federal capital gains rate up from 15% to 20%. It is expected that the present administration will raise this rate also by only three to five percent. They can get away with what looks like a small increase because they are not responsible for the 5% increase already built into the system. So we could be looking at a 23% to 25% capital gains rate beginning in 2011. But wait, there is more….

The healthcare proposals that are going to be debated in congress have politicians scrambling to find ways to pay for the (at least) $1 trillion program. In order to achieve their objective of making this program appear deficit neutral, we are seeing some of the most creative accounting techniques used, most of which increase taxes and on, just about, everyone. Some of these techniques would even make Bernard Madoff blush. (For instance, under the healthcare proposal, we are theoretically deficit neutral because we count revenue over 10 years but spending over only 6. Revenue comes in beginning in 2010 but payments are not made until 2014. I wish we could account for profits this way in the private sector. ) But let’s get back to taxes.

For the first time in over 30 years, we may see the return of income tax bracket creep. Buried deep in the 2,000 page healthcare bill is a provision which will partially repeal tax indexing for inflation. What this provision means is that, as earnings rise over a lifetime, Americans can look forward to paying higher income tax rates even if their income gains are not “real”. Two main features of the current version of the plan are not indexed. The first is the $500,000 threshold for the 5.4% income tax surcharge (does the word “surcharge” really sound more benign than “tax”?). The second is the payroll level at which small businesses must pay a new 8% tax penalty for not offering employees health insurance.

Let’s take a look at the true impact of the surcharge. This tax is set to begin in 2011 on all income above $500,000 for single filers and above $1 million for those filing jointly. Assuming a 4% inflation rate over the next decade (not an aggressive assumption given our fiscal picture), the $500,000 threshold for an individual filer would impact families with the 5.4% surcharge at an inflation-adjusted equivalent of about $335,000. After 20 years without indexing, the surcharge threshold falls to about $250,000.  As the real inflation rate rises, these thresholds drop further.

This mechanism is a covert way for politicians to dig deeper into more worker’s pockets each year without having to legislate tax increases. The negatives of failing to index compound over time, producing a windfall for the government as the years go by hitting unsuspecting taxpayers.

This trick is nothing new and its impact is tangible. For example, in 1960, just 3% of tax filers paid a 30% or higher marginal tax rate. By 1980, the inflation of the 1970’s resulted in that share increasing to 33% of filers! These stealth tax increases, which forced more Americans to pay higher tax rates on phantom gains in income, were widely thought to be unfair. In response, in 1981, as part of the Reagan tax cuts, indexing the tax brackets for inflation was adopted by a bipartisan coalition.

Another example of the impact of this stealth, inflation-ruse, technique can be seen in the performance of the Alternative Minimum Tax. In 1969, when this tax was first passed, it was intended to only hit 1% of all Americans. In 1993, the Clinton administration increased the AMT tax rate. At neither of these times was the tax indexed for inflation. As a result, the number of families hit by this tax more than tripled over the next decade. Today, unless congress passes an annual “patch”, families with incomes as low as $75,000 can be affected.

Importantly for our real estate industry, the 5.4% surcharge has been creatively written to be applicable to modified adjusted gross income. This means it applies to capital gains taxes. Piled on top of the increase caused by the sunsetting of the Bush cuts, our 2011 federal capital gains tax rate would balloon to 25.4%, even without any additional increases imposed by the present administration. If congress acts as expected, the new rate could top 30%.

With such a dramatic increase in the capital gains rate, sellers, who are considering the sale of commercial real estate in the short-term, must seriously consider the implications of this increased cost. Logic would dictate that this dynamic should catalyze an increase in sales activity in 2010 as seller’s rush to take advantage of the low 15% rate.  This increase in sales volume would be welcomed as 2009 will be, by a wide margin, the year with the lowest turnover (in terms of number of buildings sold) of investment property sales since at least 1984 (we do not have records prior to 1984).

The creative accounting in Washington could have another silver lining for our industry. Similar to the way the “modified adjusted gross income” includes capital gains, it also includes dividends. Adding the 5.4% surcharge to the increase caused by the Bush cuts sunsetting, the tax rate on dividends will explode from 15% to 45% ( 5.4% plus the pre-Bush rate of 39.6%). This dramatic increase would shift massive amounts of capital away from equities into other forms of investments, including commercial real estate.

I always try to figure out how our industry is affected by what goes on in Washington. While there may be some positives for commercial real estate, the present shenanigans are troubling. The return of the days without inflation indexing is nothing more than stealth taxation. It would repeal a 30 year bipartisan consensus that it is unfair to tax unreal gains in income. The result will be that millions of middle-class Americans will be hit with new taxes over time with taxes advertised as only hitting “the rich”.

Mr. Knakal is the Chairman of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

Why Sellers Should Sell and Buyers Should Buy

Whose kidding whom? Sellers will only sell if they want or need to and buyers will only buy if they believe they see a good opportunity. Brokers can’t “sell” a client into acting but I wanted to discuss some reasons why sellers might want to sell today and buyers might want to buy today.

Clearly, there is tremendous uncertainty in today’s investment sales market. Values are far below their peak and are expected to continue dropping. The volume of sales is also far below its record peaks as activity has ground to a halt. As a broker who sells buildings, the level of sales activity is far more important than the direction of prices. The activity just has not been there in 2009.

I am asked several times each day by clients who would like to purchase properties if the time is right to buy. They think prices will continue to drop so the inevitable question is, “Why not wait until prices hit bottom?”. Potential sellers constantly ask when the optimal time to sell is ( I rarely suggest that sometime in 2006 or 2007 would have been optimal). “If I wait a few months will prices be better?” and “How long do I have to wait until my value will be higher?” are the most frequently asked questions from them. As uncertainty rules the day, how do I answer these difficult questions without sounding self-serving? 

Let’s take a look at current market conditions to set the stage for the discussion of perspectives relayed to buyers and sellers. I will discuss conditions in the New York City market as that is the only market I know. I assume most markets around the country are experiencing similar dynamics, to differing degrees perhaps, but still heading in the same direction.  

Using the Manhattan marketplace, for example, in the first three-quarters of 2009, there were 209 investment property sales having an aggregate sales value of $3.2 billion. The $3.2 billion in sales represents a 92% reduction from the activity in the peak three-quarters of 2007 in which there were $40 billion in sales. The 209 properties sold represents a reduction of 74% from the peak number of properties sold in the first three-quarters of 2007 which totaled 803.

The Manhattan market has a total of 27,649 investment properties (south of 96th Street on the eastside and south of 110th Street on the westside). Over the past 25 years, the average turnover of this stock has been 2.6% or approximately 719 sales. The lowest turnover we have ever seen was 1.6% in 1992 and 2003, both years were at the end of recessionary periods and both years experienced cyclical peaks in unemployment.

If we annualized the activity in the first three-quarters of 2009, turnover was running at 1.0%. (It is actually trending up as, in the first quarter, the volume was running at 0.7%, in the first half it was 0.9% and 1.0% for the first three-quarters). We believe turnover will finish the year at 1.1% to 1.2%, establishing a new low since we began tracking this data in 1984. 

In the Manhattan market, the average sales price in the first three-quarters of 2009 dropped an average of 32% from the peak prices achieved. In order to understand this reduction more clearly, we need to look at how different property types are performing. 

Multifamily properties have performed best with walk-up properties having lost only 16% from the peak with elevatored properties dropping 20%. Given the fact that consumer spending has been greatly reduced, retailers have had a difficult time which has resulted in large reductions in retail rents. It is, therefore, not surprising that mixed-use properties (those having at least 20% of their square footage occupied by retail tenants with apartments above) have lost 46% of value while retail properties have lost 49% of value from their cyclical peak.

Office buildings have lost 62% of their value from the peak. However, if we look at office properties which are well-leased on a long-term basis without market exposure, average values have dropped only 25%. Those with significant vacancy, or a large percentage of leases rolling in the short-term, have seen values fall by 70%.

We believe that value will continue to fall into 2010 as unemployment continues to rise. As unemployment rises, real estate fundamentals become stressed and as fundamentals become stressed, value falls. Economists expect unemployment to peak in the first half of 2010. It is at this point that fundamentals will be at their weakest and value will, presumably, be at its lowest.

Why should sellers sell today?

With values well below their peak and expected to fall a little more, why should a seller sell today? As counterintuitive as it may be, there are several reasons why a seller could benefit from selling today. This, of course, assumes that an owner is compelled to sell or has some external pressure motivating them to sell within the next year or two.

The first thing to consider is that the extremely low volume of sales has been caused by supply constraint not a lack of demand. The fact is that demand is significant. We have received dozens of offers on each of the income producing properties we are selling and have received over 50 offers on each of the notes we have sold this year.

Additionally, there is a massive amount of capital sitting on the sidelines waiting for an opportunity. We can refer to this patient capital as “shadow demand”. Much of this is from institutional distressed asset funds which are currently being pressured by their investors to show some activity. The lack of supply has created frustration for these funds and their appetite is currently very large.

Another reason to put a property on the market today is that the supply of properties available for sale is extraordinarily low. The massive demand that is chasing few assets is actually driving property prices above the level that fundamentals would dictate (notwithstanding the price reductions we have already seen). It is anticipated that distressed assets will be coming onto the market in significant numbers over the next couple of years which will provide more choice for investors, placing downward pressure on prices.

Potential sellers should also consider that prices have not yet hit bottom and they may be able to get out prior to the market hitting its bottom. Value will be lower in the future before it increases.

Financing, particularly for smaller multifamily properties, is plentiful from portfolio lenders for cash flowing properties. Community banks and small regional banks have remained very active and continue to look for additional opportunities.

Additionally, mortgage rates are very low by historical standards providing buyers with the ability to pay a relatively aggressive price. Given how much the Fed has increased the money supply and has increased spending, there is nowhere for rates to go but up. We will have to pay for these policies in the form of higher long-term interest rates , higher taxes or, most likely, a combination of both. As mortgage rates increase, values will face additional downward pressure.

Today’s market also provides an opportunity for portfolio reallocation. Several clients are looking to sell “maxed out” properties or smaller, non-core assets in order to take advantage of the more reasonable pricing of core assets.

Why should buyers buy today?

So, with value expected to drop further, why should buyers look to purchase now. The first reason is that it is nearly impossible to time the exact bottom of the market. Value has fallen so much already that it is expected to bottom out in the short-term, only falling another 10% or so. If this is the case, and a buyer has a long-term investment strategy, buying today may not be such a bad move.

The supply of available properties in New York is always very low. If you consider that the average turnover rate during a 25 year period has been 2.6% of the total stock, this means the average holding period is 40 years. Yes, some properties like the GM building have traded several times within the past 15 years but properties like that are offset by properties which have been owned for over 100 years by the same family. For these reasons, when an asset becomes available, if an investor wants to own that asset, they should move on it because is will likely not be for sale when the buyer decides the market has hit bottom. (We will only really know we have hit bottom after we have emerged from it.)

If a buyer believes that the government’s reaction to the recession will lead to inflation, hard assets are great things to own in an inflationary environment. Commercial investment properties are excellent hard assets. Investors would want to ride the upswing in inflation but with inflation comes Fed tightening and higher interest rates. However, if properties are purchased now, locking in today’s low rates on a long-term, fixed-rate basis, they will be sitting pretty when inflation hits.

After the market hits bottom, we expect value to just bounce along the bottom for 2 or 3 years as the market goes through deleveraging. Whether, and to what extent, properties appreciate will be dependent upon a fight between upward pricing pressure created by excessive buying demand and downward pressure created by the massive deleveraging that will be necessary as 2006 and 2007 vintage loans mature in 2011 and 2012.

Regardless of the incentives created by the dynamics mentioned above, we still believe the volume of sales in New York City will be lower than the 1.6% level in 2010. We hope that we are wrong but the congestion in the distressed pipeline is not expected to loosen up until the later half of the year.

So, should sellers sell and should buyers buy? The answers to these questions will be decided by participants in the market and the timing of these decisions will determine who the winners will be coming out of this downturn. One thing is clear, a significant transfer of wealth will occur over the next few years and the results for each individual (other than those who are forced out of positions by lenders or note buyers foreclosing on them) will be based upon how they answer those two questions and the timing of the decisions they make.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

10.2% Unemployment and the Impact on Commercial Real Estate

I know what you’re thinking: Why is Knakal addressing unemployment yet again? Simply, it is because last week’s announcement that the official rate has climbed to more than double digits further illustrates that the administration is incorrectly focused on things other than job growth.

As I have always stated, our commercial real estate markets need employment more than anything else to enhance our fundamentals and turn our outlook around. As unemployment increases, our fundamentals degrade and as our fundamentals degrade, our values drop. Until the trend in unemployment reverses, it will be nearly impossible to see tangible health return to any segment of commercial real estate. Our rising unemployment rate begs the question: How did job creation get put on the back burner?

In October 2008 in Toledo, Ohio, a major economic speech was delivered by then candidate Barack Obama. Let’s take a close look at what he said:

“Right now, we face an immediate economic emergency, and that requires urgent action. We can’t wait to help workers and families….who don’t know if their jobs……will be there tomorrow. … We need to pass an economic rescue plan for the middle-class, and we need to do it not five years from now, not next year, we need to do it right now. It’s a plan that begins with one word thats on everybody’s mind, and its easy to spell: J-O-B-S.”

That sounds pretty good and is pretty powerful. That sounds like focus. Mr. Obama gave the impression that job creation would be his top priority and that his action would be swift.

Gandhi once said that, “Action expresses priorities”. If this is true, job creation has, clearly, not been one of the president’s priorities. Recently, the administration has begun talking about job creation but this provides little comfort as this recession began two years ago.

The results of the off-year elections in Virginia and New Jersey have demonstrated that Americans are increasingly believing that the administration should not be prioritizing health-care, climate change, and financial regulation while hundreds of thousands of people continue to lose jobs each month. Nearly 90% of those voting in these gubernatorial races said they were worried about the direction of the economy and the majority of those who held that view voted for the Republican candidate. Are we looking at another 1994 (a year in which we saw a dynamic shift in political power) in 2010? If jobs do not become the priority, we just may be.

Could it be any more obvious that the objective on Pennsylvania Avenue is to push an entire agenda through before power is potentially lost in the midterm elections? This could be a tragic policy flaw which could lead to relinquished majorities in the fall of 2010.

This lack of focus on jobs has resulted in an official unemployment rate of 10.2% (the highest since 1983) and an underemployment rate of 17.5%. The latter takes into consideration those who are out of work and have stopped looking for work and those who are employed part-time who are seeking full-time employment.

Clearly, job creation has dropped from a top priority to just one of many, and President Obama has been remanded to pandering for patience and offering excuses. On one hand he argues that there is some good news in the awful numbers as things are indeed getting worse but at a slower pace. On the other, he constantly reminds us that he inherited this mess. How long can he continue to do this? Fair or not, finger-pointing is not effective policy.

The administration now claims that the stimulus has “created or saved” one million jobs. Does anyone really believe that?  (Maybe if Congress spends another $787 billion, it can get the jobless rate up to 12%). The data upon which this claim is based is of extraordinarily low quality and are not reliable indicators of job creation or the even vaguer notion of job retention. There are two major problems with the data. The first is a strong reporting bias. Those providing data are those who have received stimulus funds. If they are creating or saving jobs, they are likely to get more free money, hence, a strong incentive to inflate reality.

The second is that the government is using what is referred to as “gains-only” reporting.  When the government reports this figure, it wants us to believe that the new hires came from the pool of the unemployed and that they are net additions to the stock of employed workers. The data do not speak to the number of workers who left their current jobs to fill government sponsored jobs.  Because these data do not tell us where the workers come from and what happens to the positions they left, the numbers cannot answer the ultimate question: How many net jobs were created? The government is reporting the gross positive figures, not the relevant net figures.

On a monthly basis, the Department of Labor reports activity from the Job Openings and Labor Turnover Survey (Jolts). The Jolts data show that, in August of 2009, about 4 million workers were hired. Unlike the administration’s new jobs-created-or-saved data, the Jolts data also lets us know that about 4.3 million workers lost their jobs. How difficult is it to figure out what the relevant numbers are?

It is difficult to imagine a more complete repudiation of Keynesian stimulus than the recent evidence in our job market. Only 11% of the stimulus money is actually stimulative (spent on infrastructure) with significant percentages being spent on pork projects and non-stimulative transfer payments such as Medicaid and jobless benefits. The net effect is that net job creation has been negative. The much ballyhooed Keynesian multiplier that every dollar of government spending yields 1.5 times that in economic growth has, once again, been exposed as false. Few people remember that Keynes developed his theory when government spending only represented about 2% of GDP, a far cry from where it is today.

The policy lesson here is for both political parties (if you are  a frequent reader of StreetWise, you know that I try to critique both parties equally and, I believe, fairly). In 2008, President Bush caved-in and initiated the first “stimulus”, a $160 billion program that was ill-conceived and not very stimulative. Mr. Bush lost policy bearings during his last year and forgot that in order for a tax cut to be stimulating it must be immediate, permanent and at the margin of the next dollar. Instead, for the past two years, the U.S. and most of the rest of the world have been pouring trillions into a Keynesian black hole. Let’s not forget that this spending must be paid for at some point. Tax increases are inevitable and this expectation continues to stifle consumer spending.

If the administration is serious about wanting to create jobs (a by-product of which would be to help our commercial real estate markets) the best policy action would be to ask themselves and Congress, Why?…..

Why create so much investment uncertainty and additional barriers to businesses hiring new employees?

Why raise the costs of doing business by making it easier to unionize workers via “card check”?

Why raise energy costs for businesses with a cap-and-trade (“cap-and-tax”) bill?

Why add to an already inflated budget deficit and future tax burden with a 12% increase (proposed in the draft budget) in domestic spending in 2010?

Why force through Congress, on a partisan vote, a health-care bill that imposes a 5.4% income tax “surcharge” on anyone making more than $500,000? The Joint Tax Committee reports that about one-third of this $460.5 billion tax increase will be paid by small business job creators who file their taxes under the individual income tax code.

Perhaps someone should read Mr. Obama a transcript of his Toledo speech. Then maybe he will be reminded that he cannot wait for next year, he needs to act now and, very simply, it’s all about J-O-B-S.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

How Green are the Economy’s Green Shoots?

This past Thursday, the government announced that our Gross Domestic Product – a broad measure of the economy that sums up all the goods and services produced in the U.S. – increased at a rate of 3.5% during the third quarter of 2009. The Dow Jones Industrial Average has been hovering around 10,000 and housing market indexes have been positive for months. These statistics might lead you to think that our economy was starting to briskly emerge from the recession, however,  let’s take a closer look at each of these green shoots.

During the third quarter of 2009, GDP did, indeed, expand after shrinking for four consecutive quarters, indicating an apparent end to the worst recession since World War II. The expansion was 3.5%, however, a majority of the increase was related to vehicle purchases and residential construction, both stimulated by government support. 2.2% of the increase was due to these two sectors and an additional 0.6% was attributed to government spending.

Additionally, inventories had been stripped to the bone and are now being rebuilt. In the third quarter, companies dumped inventory, though less aggressively than during the previous three months. By the math of GDP accounting, merely slowing down inventory liquidation will boost growth.

The most surprising result was the pace of consumer spending growth, although a significant portion of this appears to have been borrowed from the future. Consumers provided nearly two-thirds of the GDP growth with auto sales and parts alone adding 1% to the total. The cash-for-clunkers program stimulated significant increases in July and August sales but activity crashed in September after the program expired as demand was accelerated from future months.

The first time homebuyer’s credit has prompted residential investment to increase handsomely. Private residential investment, of which home building is a large component, surged 23.4%, the first increase in 14 quarters. This accounted for half a percentage point of GDP growth. We will look at this credit in more depth when we discuss the housing market.

Much of the growth relies on government spending or incentive programs which are either expired or expiring. Therefore, it is unclear if consumers and businesses have regained the strength to propel the economy on their own. Businesses remain cautious and American households are still burdened by mountains of debt, two factors that have economists predicting growth will slow considerably in the coming months.

The Dow Jones Industrial Average has closed near 10,000 for a couple of weeks as a healthy majority of firms have exceeded earnings expectations recently. Unfortunately, these earnings are the result of companies cutting jobs and working hours and squeezing costs mercilessly.

While 73% of firms beat earnings expectations, 58% had worse than expected revenue. High unemployment has created significant slack in the economy with tremendous excess capacity. Productivity has increased at a rate of 6.4% as employers are squeezing more work out of exisitng workers.  It is very typical to see productivity increases as an economy emerges from recession as firms wait until the last possible moment to begin rehiring.

These favorable earnings are, unfortunately,  not sustainable without revenue growth as there is only so much overhead that companies can eliminate.

With regard to the positive news coming out of the housing sector, most in the media point to the S & P Case Shiller Index. This index has seen strong gains for five months running. Unfortunately, many economists discount the accuracy of the index as it only tracks 20 markets, representing only approximately 38% of all homes in the U.S.  It is thought that this index overshoots reality both on the upside and the downside.

While the housing numbers appear positive, economists warn not to make too much of them because low prices and low mortgage rates, along with the tax credit, have spurred a home buying bonanza, at least in the low end of the market. Roughly one-third of home resales are foreclosures or short sales, where the mortgage exceeds the sales price.

The $8,000 first time homebuyer credit has catalyzed much of the activity in the sector and there is good reason for this. The average home price in the U.S. is $178,400. Given FHA’s 3.5% downpayment requirement (which amounts to $6,244 for the average home) the government is, essentially, paying people to buy a home.

This program has been ripe with fraud as is often the case with government run programs, particularly those with “refundable” credits that guarantee that claimants will get cash back even if they paid no taxes. A lack of documentation requirements make this program a layup for scammers ( You really couldn’t even make this stuff up!).

The Treasury tax-oversight office said at least 19,000 filers who hadn’t purchased homes claimed $139 million in tax credits and were reimbursed. Officials have found an additional 74,000 tax credit claims, valued at $500 million, where evidence of previous homeownership could make their claims invalid. More than 500 people under the age of 18, including a 4-year-old child, also had their names on applications for the credit which has no minimum age requirement. Most of the claims involving children were made by parents who purchased homes but would not qualify for the credit because their incomes were too high.

These problems show the dangers in creating refundable tax credits that give money to filers even if they don’t owe any taxes. The Internal Revenue Service and Justice Department are investigating more than 100 suspected criminal schemes involving the credit. The IRS is conducting more than 100,000 examinations that could require filers to give back the credit and pay civil penalties.

This program was set to expire at the end of November, so naturally given its record of abuse, Congress has extended and expanded the program. Not only is the program extended into 2010 but now existing homeowners, who have owned their present home for at least 5 years, can qualify for a $6,500 credit in the event of a new purchase.

So let’s recap the housing situation: 1) the government is providing tax credits to buyers through which buyers are “paid” to purchase a house; 2) there are no documentation requirements for the reciepients of the credit; 3) the government guarantees 92% of all single family mortages through Fannie, Freddie or FHA; 4) the government purchases most of those mortgages. Does everyone on Capitol Hill have amnesia?

While the credit seems to have boosted home sales, many of those sales would have happened anyway and have merely been stolen from the future. Meanwhile, the credit continues to distort the housing market and delays the process of home prices achieving a natural bottom which would serve as the basis for a fundamentally sound recovery.

There has only been modest growth in business investment which reveals how wary companies are about taking new risks or committing to expensive projects or new job creation in the current political and economic climate. The fiscal stimulus has pounded the federal balance sheet. With a deficit of $1.4 trillion in 2009, and $9 trillion more predicted over the next decade, every investor and business in America can see a gigantic tax bill coming right at them. The House health-care bill, which was released last week, takes another major wack at the job creators who own small businesses. The uncertainty of the Washington policy outlook is, no doubt, putting a significant crimp on future investment plans.

The simple truth is that without a recovery in the job market, consumers will not be able to carry the expansion for long and real growth is just an illusion. I guess it was heartening when, last week, after the recession has been with us for 22 months, Nancy Pelosi finally said the the focus has to be on job creation. Washington’s current policy makers are growing increasingly concerned about the jobless rate and the looming mid-term elections in 2010. They should, however, remember that the best way to nurture an expansion isn’t to feed it recklessly with easy money and more stimulus in order to meet an election timetable. Let the economy’s natural animal spirits revive at their own pace.

We are certainly in a better place than we were one year ago, but we still have a long way to go and should not be misled by data that inaccurately reflects reality.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

Is a Weak Dollar a Good Thing?

So often I hear people in our industry say that the weak dollar is encouraging foreign investment in U.S. real estate. This is something that only makes sense in two ways: the first is if the foreign investor is purchasing a residential property for his or her own use and it is simply “cheap” to them because of the exchange rate. Think of the opportunity to buy a mansion on the water in the south of France for $10,000US. If this location is of interest to you, you might just buy that property because it is so cheap that you figure, why not?

The second reason a foreign investor might buy based upon the weak dollar is if they are looking for a currency arbitrage ie, they believe that the U.S. dollar will increase in value at a greater rate than their currency will increase.

Other than these reasons, the weak dollar is not a motivator. Consider this: if an investor purchases an income producing property because of a weak dollar, their gross revenue will be in that weak dollar, they will pay expenses in that weak dollar, they will collect net operating income and cash flow in that weak dollar and if they sell the asset, they receive the sale proceeds in that same weak dollar. That doesnt sound like great motivation to me.

Why is the dollar weakening as much as it has lately? Look no farther than the weak jobs numbers that come out month after month. With unemployment at 9.8% and climbing, it convinces markets that monetary policy will remain loose regardless of dollar weakness.

The dollar’s weakness also partly reflects fears that the economic recovery will take a lot longer than most economists anticipate. Besides being a deterrent to buying into America’s future, this sets up a classic deflationary mindset: Why buy now if the dollar may be even weaker in a few months?

You have to believe that the Obama administration wants the dollar to remain weak regardless of what they say publicly. The greenback has lost 11.9% of its value against a basket of currencies since the President took office. Treasury Secretary Geithner constantly says, “It’s very important to the United States that we continue to have a strong dollar…We’re going to do everything necessary to make sure we sustain confidence.” Unfortunately, the U.S. is willing to talk about a strong dollar but is unwilling to do anything about it.

With the amount of dollars that are being printed, it is no wonder that the dollar is increasingly perceived as the default mechanism for out-of-control government spending and, with this condition, its role as a reliable standard of value is destined to fade. Excess government spending leads to inflation, and inflation plays dollar savers for fools at home and abroad.

For now, the weak dollar helps our exports, by making them cheaper abroad, a welcome development at a moment of domestic economic weakness. Cheaper U.S. goods overseas could help achieve the long-sought rebalancing of the global economy in which the U.S. exports more, and others, including China, import more.

Public officials have been saying that the United States needs to become less dependent on domestic consumption which now makes up 70% of our GDP. Although politicians won’t say this means we need a weaker dollar, many economists take this as a given if rebalancing is to be achieved. This is one reason why all of the “strong dollar” talk coming out of Washington is not taken seriously.

One of the ways a country gets out from under its debt burden is to devalue its currency. On the surface a weak dollar may not look so bad to those on Wall Street. Gold, oil, the euro and equities are all rising as the dollar declines.

Some weak-dollar advocates believe that American workers will eventually become cheap enough, in foreign currency terms, to win manufacturing jobs back. In actuality, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create.

The unfortunate fact for the weak-dollar advocates is that no countries have ever devalued their way into prosperity.

If money is a moral contract between a government and its citizens, we are in a vulnerable position while the rest of the world simply wants to avoid having the wool pulled over their eyes. This is why China and Russia, the two largest holders of dollars, are advocating for a new kind of global currency for denominating reserve assets. It is also why OPEC is growing increasingly anxious about whether to continue pricing oil in depreciated dollars and why central banks around the world are turning their backs on dollars in favor of alternative currencies. This reduced global demand exacerbates the dollar’s decline.

If the President and Congress are serious about wanting a strong dollar, they need to show a genuine commitment to private-sector economic growth. The solution includes some key ingredients such as a strong U.S. jobs program, a flatter more competitive tax structure, significant reductions in future spending and common sense bank regulation so small business lending can restart.

In the short run, the weak dollar may bring international travelers to our cities and help our hotel industry but, if we are interested in real growth and long term prosperity, we need a stronger U.S. dollar.

Low Volume of Investment Sales Caused by Supply Constraint; Demand Still Strong

The volume of investment sales recently has been extraordinarily weak whether you look at aggregate sales price or number of transactions. In fact, we are on pace to see sales volume hit the lowest level we have seen in the 26 years we have been tracking these statistics.

Our recently completed analysis of the Manhattan property sales market, through the first three quarters of 2009, shows only $3.2 billion in volume; a remarkable reduction in the aggregate sales price of 82% from the first three quarters of 2008 and 92% from this cycle’s peak in the first three quarters of 2007. For those of you familiar with the Manhattan market, our study analyzes sales which occurred south of 96th Street on the eastside and south of 110th Street on the westside.

In the first three quarters of 2009, there have been 209 Manhattan sales. This number of transactions is down by 60% from 2008 and 75% from 2007.

The above data would lead one to believe that people are just not interested in purchasing investment properties in New York. Nothing could be farther from the truth. We have noticed trends in the marketplace and have been saying that the market is in a severe supply constrained dynamic since the middle of 2008. This is now manifesting itself in a very low volume of sales activity.

Average property value has falled in New York by 32% from its peak levels. Clearly, this percentage variesdepending on product type and building classification. Multi-family properties have been performing best, having lost only 16% of value while office buildings with significant expoure to the marketplace have been the most negatively affected, seeing a reduction in value of about 70%.

These reduced values have peaked the interest from the buying community as investors are looking for core assets at greatly reduced prices. Conversely, discretionary sellers are seeing these pricing trends as a tangible reason not to place properties on the market at the present time. The difficulties in the financing market have been a major contributing factor to the reduction in value. With banks underwriting more conservatively, additional equity is required and , therefore, prices buyers can pay have been going down. We are all aware that equity costs a lot more than debt does.

This supply constrained enviromnent is illustrated in the listings portfolio of my firm, Massey Knakal. At the height of the market in the first half of 2007, we had, at one point, 836 exclusive listings. Today, we have just 513 and have been below 600 for the entire year ( I am only using Massey Knakal data because this exclusive listing data is not readily available from any of the research firms as brokerage companies are not required to pubically divulge their exclusive listings ).

These dynamics have not, however, reduced demand for New York City investment properties. For the transactions that we have marketed and sold thus far in 2009, we’ve been pleasantly surprised by the number of bids we have received. For stable cash flowing properties,  we have received dozens of offers on each listing. Properties which are vacant or have a value-added component have also seen above trend numbers of offers.

Most interestingly, for the notes that we have sold for lenders thus far in 2009, we have had in excess of 50 offers for each of them. Where is this demand coming from?

Institutional capital was a significant driver of the increase in values in the 2005-2007 period. When the credit crisis tangibly took hold in the summer of 2007, this institutional capital all but evaporated. Fron the summer of 2007 until recently, nearly all of our properties have been sold to high net worth individuals and old-line New York families that have been investing in the city for decades. These buyers remain very active today and continue to seek opportunities to buy well located assets at today’s reduced values.

Additionally, we have seen tremendous interest from high net worth foreign based purchasers. Remarkably, these foreign purchasers are typically not real estate professionals in their countries of origin. They have made money in other industries such as technology, manufacturing or financial services. They are choosing to deploy theri capital into the U.S. which is perceived to be at the very low pint in the value cycle. We have not seen the influx of foreign capital that we have seen recently since the mid-1980s.

In addition, on the demand side, we have seen resurgence, within the past month or two, of institutional capital. As I mentioned earlier, this capital all but evaporated from the marketplace in the summer of 2007 and many of these institutional real estate players have formed distressed asset funds looking to buy properties. These funds are now in the market actively bidding on opportunities.

This all leads to an extremely healthy demand side for New York investment properties.

We remain hopeful that the supply side of the equation will get better as distressed assets appear to be coming to the market in slightly better numbers than we have seen thus far in the cycle. There have been a number of legislative changes that have created tremendous inertia within the distressed asset marketplace but, notwithstanding these modifications, we believe that fundamentally troubled properties will ultimately come to the market, in one form or another, before too long adding to our supply. This would certainly be a welcome happening for the brokerage community and all of the purchasers waiting for opportunities.