The building sales market continues to bounce along the bottom as the volume of sales trends and value trends fail to show consistent performance.
With regard to sales volume, we had seen 6 consecutive quarters of volume increases in the New York market through the second quarter of 2010. While our 3Q10 statistics are not completed yet, it appears that this trend will not continue.
Generally, in New York City, volume trends have been positive. Beginning at the start of 2009, we saw the volume of sales, both in terms of number of properties sold and the dollar volume, increasing. The Manhattan and Northern Manhattan markets led the way, turning positive prior to the outer boroughs. In 2Q10, we finally saw Queens and Brooklyn turn positive and we had been expecting the Bronx to turn in 3Q10. The 3Q10 numbers thus far appear that they may show these positive trends have taken a step backwards.
Given the relative strength of markets like New York and Washington D.C., if we are seeing volume trends like this here, it is easy to surmise that volume is squishy across the nation.
Value trends have not experienced the same consistency, over the past 6 quarters, as we have seen in volume. After we hit what appeared to be a bottom, approximately 32% below the peak, value appears to be bouncing along the bottom as for some product types in some sub-markets values are up slightly, and for some product types in other sub-markets values continue to slide. This volatility is representative of a market which is trying to find its natural bottom.
As we move forward, we expect continued volatility in both of these important market metrics. On the volume side, we have seen the supply of available properties pick up as distressed sellers continue to put assets on the market with greater frequency. We are seeing banks and special servicers move aggressively to clean up balance sheets by monetizing sub-performing assets. These sellers are being joined by discretionary sellers who have been sitting on the sidelines for too long, creating pent up selling demand, and those who wish to sell in order to take advantage of this year’s advantageous capital gains rates. Most market participants believe that capital gains rates will be higher next year. If the existing tax rates are allowed to sunset, the gains rate will go from 15% to at least 20% on a federal level. Many participants also believe local capital gains taxes will increase as well as municipalities struggle to bridge budget gaps.
The sellers who are trying to beat the gains tax increase will accelerate some transaction volume, effectively “stealing” activity from 2011. We saw this same dynamic with the cash-for-clunkers program and the first-time-home-buyers tax credit which accelerated volume in the auto and home sales markets. After these programs expired, volume dropped like a stone. For these reasons, we believe transaction volume will be higher than usual in the second half of 2010 (particularly in 4Q10) with a drop in volume as we enter 2011.
Total volume in 2011 will be dependent upon several factors. Increased capital gains taxes will exert downward pressure on volume while continued pace in the distressed asset market should exert upward pressure. The majority of submerged assets (properties where the debt amount is higher than the value – “under water”) have debt which was placed in 2006 and 2007 when values and loan-to-value ratios were their highest. Most of this debt is maturing in 2011 and 2012 and, due to extremely advantageous mortgage terms, many of these loans are still performing although they possess significant negative equity positions. As these loans mature, these assets will have to be recycled as refinancing will not be possible unless the owner has the ability, and is willing, to inject additional equity into the property.
An additional factor to consider is that the inheritance tax is scheduled to go to 55% in 2011. Surprisingly, an overwhelming percentage of real estate investors are not well diversified as most of their wealth is in real estate investments. As these investors pass away, estates may find no option other than being forced to sell properties in order to pay these taxes. This dynamic should exert upward pressure on sales volume.
This data demonstrates that we have not seen a clear trend and that our real estate recovery has a lot more work to do before we can all feel comfortable that things are tangibly better and that a recovery can be sustained.
Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of nearly 1,100 properties having a market value in excess of $6.8 billion.