Why Would a Seller Sell Today if They Didn’t Have to?

 Regular StreetWise reader, Jason Bartlein, suggest I address the question posed in the title of this piece. And it is a great question. Values are well off of their peaks, fundamentals are stressed, capital markets are erratic and participants generally feel that market conditions are difficult. Why would someone sell a property now, under these circumstances?

 The first thing I always tell a potential seller is that I guarantee that their property will be worth more at some point in the future. Worth more yes, but when, is the question. Is the seller willing to wait for that point in time when the property is worth more? And when it is worth more, how much more will it be worth? And how much more will alternative investments be worth? And what are the costs to wait until the value increases? The answers to these questions are all guesses (some more informed than others) and those guesses make the market.

There are always people who have little choice but to sell. The quintessential reasons for this forced selling include death, divorce, tax obligations, insolvency, partnership disputes and the like. These reasons exist in good times and in bad times with a clear propensity for the obvious ones during down markets.

We have seen some of this forced selling in this cycle but not nearly as much as we anticipated. Normally, discretionary sellers feed the supply chain of available properties. As market conditions become more difficult, discretionary sellers leave the market and the supply is normally fed by distressed sellers. During this cycle, we have not seen distressed sellers swoop in to fill the void.  For this reason, supply constraint rather than waning demand, the volume of sales has been miniscule ( I discussed this acute imbalance between supply and demand in last week’s column which is keeping values higher than economic fundamentals would dictate).

So why would a seller sell today if they didn’t have to? There are several reasons. Portfolio repositioning is a big one. If you wait to sell when prices are high, the properties purchased with the proceeds will be priced highly. If properties are sold when prices are low, replacement properties will be priced lower. From this perspective, the timing of a sale is all relative.

We have several clients using current conditions to realign their portfolios. Some are selling smaller properties and purchasing larger buildings. Others are selling non-core assets and acquiring additional core assets. We have clients selling properties so they can move from class c product to class A and B. Some are selling properties in the boroughs and using today’s market conditions to buy in Manhattan. This realignment is something that is often better done during a downturn than when things are booming. This is due to the fact that the price deviation between the high end and the low end is widest during the boom.

Another reason to sell today is to create a reserve of equity available to purchase opportunities which may arise. Sellers who have healthy equity cushions in some buildings may elect to sell in order to be ready for, what they perceive to be, better opportunities tomorrow.

Clearly, the distressed asset recycling and deleveraging process has not occurred to the extent that it must and when it does, excellent buying opportunities are likely to present themselves. Some sellers who believe prices will fall further are positioning themselves to take advantage of this.

A motivation closely associated with the one above, is that due to the economic uncertainty in the U.S. today, some people just want to sit on cash. We have several clients who are selling, paying the taxes, and sitting on the cash so they can sleep at night. All of the non-sense the country is going through today with runaway government spending, deficits, taxes, probable inflation, healthcare, etc, induced one client to sell his portfolio in order to move to another country to escape what he believes is a disastrous environment for those of means. He is actually becoming a citizen of his new country.

Some of our clients are looking at their portfolios and identifying properties which they feel have been “maxed-out”. These are properties which have gone through a value-added process and there remains little upside potential other than letting the value trend in tandem with the market. These assets are being sold in order to take advantage of the sell-low / buy-low dynamic as the seller looks for properties with imbedded upside potential which they can tap with some elbow grease.

Many clients are selling today to take advantage of the supply / demand imbalance that I mentioned earlier. Supply is currently very low and the demand side has seen extraordinary growth. High net-worth individuals and families have been the most active buyers in the past two years as institutional capital was sidelined when we tangibly started to feel the credit crunch in the summer of 2007. We have witnessed a resurgence of institutional capital recently as distressed buying funds have been formed and are actively seeking opportunities.

Additionally, foreign demand from high net-worth individuals has risen sharply to levels not seen since the mid-1980’s. All of this demand, in conjunction with little supply, has led to relatively strong prices. Some sellers are taking advantage of this condition as they believe supply could be increased greatly when distressed ostriches either decide to pull their heads out of the sand or are forced to. If supply were to increase greatly, it would exert significant downward pressure on prices.

Other discretionary sellers are concerned about interest rates. The inevitable inflationary pressures, which will result from the doubling of the money supply in the U.S., will push interest rates up. Also, when the Fed exits the market, it is likely that interest rates will increase. As rates increase, there will be significant pressure for banks to increase mortgage rates which will drive prices downward.

Expectations of increases in the capital gains tax rate is another reason why sellers may elect to sell today. The current federal rate is 15%. If the Bush tax cuts are allowed to sunset, the rate will go to 20%. If either of the House or Senate healthcare bills are passed, the rate would increase by another 5.4%. The administration has indicated that an additional 5% increase may be put on the table. In aggregate, this could result in a capital gains tax rate of around 30%.

There are no clear directions for any of these policies at the moment. Within the past two months, we have heard the Bush cuts will not sunset, they will sunset and that they will not sunset for some of us but will for others. Who knows what will actually happen? Those who think the rates will rise significantly (not a bad bet as capital gains are perceived to be only pertaining to the rich) may elect to sell at today’s historically low rates.  

The last reason a seller might decide to sell today is simply due to a lifestyle change. Some property owners spend all of their time dealing with the many issues that come with owning commercial real estate. Property management can be a time-intensive endeavor dealing with headache after headache. Years of headaches later, some owners decide they have had enough.

If retirement or a significant lifestyle change is contemplated within the next couple of years, an owner might decide to pull the trigger today. It is easy to surmise that things will not get appreciably better in the short term, as we will need substantial job creation over an extended period of time for our fundamentals to be sustainably enhanced. Most economists believe that the recovery will occur slowly and, likely, in a jobless manner. Sellers who are impatient may not be willing to wait.

Notwithstanding the seemingly poor market conditions today, there are many reasons why a seller may decide to sell today. Timing is such an important part of commercial real estate investment and sometimes there are externalities which create motivation to act. Given today’s lack of product, anything that would add to the supply of available properties for sale would be welcomed. We expect supply to grow as distressed sellers realize that working through their problems is inevitable and discretionary sellers may decide to sell for any of the reasons given above.  

 Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,050 properties in his career.

Are Investment Properties Selling for More Than They Should Sell For?

 

The title of this piece makes you wonder what is meant by “they should sell for”. What, after all, is value? Many people (particularly appraisers) feel that value is a very different thing than the price someone is willing to pay for a property. There are all types of qualifiers such as “an arms length transaction” between a “willing buyer and willing seller”, etc. As a broker who only represents sellers, I see value as the highest price that the most aggressive buyer will pay for a property. Whether the property is “worth it” or not is completely dependent upon the perspective of the buyer.

Arguments about value versus price versus worth can go on for quite a while. This column will not attempt to define the differences between these terms, but will merely look at the relative price levels investment properties are selling for today and try to figure out why.

One of the most evident trends in the investment sales market today is the acute imbalance between supply and demand. While I spend all of my time selling in the New York Metro area, it appears that these imbalances exit nationwide. Whenever I attend conferences across the country or speak with brokers working in major cities in the U.S., the story seems to be the same: Buyers are plentiful, there is a ton of capital on the sidelines and there is not much available for sale. Forget the infamous “bid / ask spread”. There is just not enough product on the market to meet existing demand.

In the New York City market, for example, the sales volume in 2009 was abysmal. We always view volume based upon the number of properties sold each year (as opposed to total dollar volume which can be skewed by a few mega-sales in excess of $1 billion). Using the Manhattan submarket as an example, we track a statistical sample of 27,649 properties south of 96^th Street on the eastside and south of 110^th Street on the Westside (north of these streets is considered the Northern Manhattan submarket).

Over a 25 year history, the average turnover rate within that sample has been 2.6%. The lowest turnover rate we had ever seen was 1.6% observed in 1992 and 2003. These were both years at the end of recessionary periods and were also years in which we hit peaks in cyclical unemployment.

We had always assumed that 1.6% was a baseline for turnover, below which the numbers could not reach. After all, in 1992 and 2003, the only people who were selling did so because they, essentially, had no choice. Death, divorce, taxes, insolvency, partnership disputes, what have you. Our baseline assumption was blown out of the water in 2009 as turnover hit, at least, a 26 year low of 1.17% (our statistics do not go back further than 1984 so we do not know whether this was a historic low or not).

To the causal observer, a lack of buying demand could explain the low activity level. However, if we look carefully at market dynamics, we see that the major contributor to the cobwebs which paralyzed the market was constrained supply.

Typically, the supply of properties for sale is fed by discretionary sellers. As these sellers pull back, as happens when values fall (on average in New York, prices per square foot have fallen in value by 32% from their peak in 2007), distressed sellers will normally step in to fill the void in the supply chain. Thus far in this cycle, those distressed sellers have not appeared in a meaningful way to normalize the available supply. Everything that has happened from a regulatory perspective has allowed the distress, for the most part, to stay camouflaged on lender’s balance sheets as a highly accommodative Fed monetary policy provides a recapitalization mechanism for the banking industry.

This has left brokers and buyers in need of magnifying glasses and Basset hounds to locate buildings for sale.

Simultaneously, the demand side has been strengthened and is growing. When we started to tangibly feel the effects of the credit crisis in mid-2007, institutional capital, which was a main inflator of the 2005-2007 bubble, evaporated from the market. From the summer of 2007 through the fall of 2009, the overwhelming majority of our properties were purchased by high-net-worth individuals and the old-line New York families which have been investing in the city for decades. Many of the institutions which were sidelined, had plenty of time to form distressed asset buying funds and began to reenter the market last fall joining the individuals and families in the battle for assets.

Additionally, we saw a substantial increase in the amount of capital emanating from overseas. This was mainly in the form of foreign high-net-worth individuals who, surprisingly, were not real estate investors back home. They had made money in other businesses and decided now was a good time to invest in a market where values have fallen sharply, the political climate was relatively stable and the U.S. dollar was relatively weak. We have not seen this level of foreign demand since the mid-1980s.

This has created a dynamic in which we have many frustrated buyers fighting over relatively few assets. Impatient investors are pressuring fund managers to whom they have given capital, to show some activity and the individuals do not want to miss an opportunity so they have been jumping in. Foreigners are transparently in the market and the confluence of all of this demand is causing bidding to be aggressive. Because of this imbalance, we actually saw prices per square foot increase in the second half of 2009 versus the first half of the year. There is no other explanation for this increase (other than excessive demand versus low supply) as our fundamentals continue to be under stress given continued elevated unemployment levels.

We believe prices are higher than economic fundamentals indicate they should be. This is particularly noticeable in our note sales. We are showing recovery rates of about 95% to 100% of collateral value (as opposed to par, from which discounts can be substantial) meaning that by the time the note buyer goes through the foreclosure process and obtains the deed, they will be into the asset for more than 100% of its value. This dynamic is not sustainable.

No, we do not believe the second half of 2009’s increase in values indicate that we have bottomed. We believe they will continue to slide until we have a tangible reversal in unemployment trends and that the upward trend in the second half of 2009 was only an upward bump on a downward trend toward a natural bottom. It is for this reason we have been encouraging sellers to act now to take advantage of these odd circumstances in which demand is extraordinarily greater than supply (this is a difficult thing for a broker to say without sounding completely self-serving). We believe this dynamic could change rapidly if something, probably a modification to bank regulations, changes the inertia in the distressed asset pipeline. Even without a regulatory or legislative change, we have already seen things begin to loosen up. Thus far, it has, unfortunately, only been a drop in the bucket compared to what exists in the market as we embark on the massive de-leveraging process that we must inevitably go through on the way to recovery.

Mr. Knakal is the Chairman of Massey Knakal Realty Services and has brokered the sale of over 1,050 properties in his career.

Is the Drop in Unemployment to 9.7% a Positive Sign for Commercial Real Estate?

As I sit here to write this week’s entry, I can’t help but think that my writing has had a pessimistic slant of late and that bothers me. As a broker, just like any of you other brokers out there (or anyone in the real estate business for that matter), I had optimism injected into my DNA when I was born. I remain an optimist but when it comes to the market, I have to call it how I see it. Things are not pretty. I don’t think I am being pessimistic, just realistic.

When I hear the government come out with “official” numbers, I am reminded of a famous quote from Mark Twain:  “There are three kinds of lies, lies, damn lies and statistics. ” Well, maybe they are not technically lies but certainly, upon further investigation,  it is easy to see how the figures presented can distort the truth and mislead the casual observer.

Last week, we looked at the 4Q09 GDP growth and came away with an understanding of what that growth consisted of and the ramifications on commercial real estate. This week we shall look at what really was behind last week’s official announcement that the U.S . unemployment rate dropped from 10% to 9.7% in January.

If you are a frequent reader of StreetWise you know my perspective on employment. It is the metric that has the most profound impact on real estate fundamentals. So the drop in the official rate should bode well for commercial real estate, right? Well, not so fast. Let’s take a closer look.

In January, the labor market shrunk by 20,000 jobs, yet the rate declined. How can this be? elementary math tells us that this is counterintuitive. There are two answers to understanding how this could occur.

The most common explanation is that, while the number of jobs shrank, what is called “the participation rate” declined. The official unemployment rate does not count those who are out of work and would like to be working but stop looking for more than 30 days because they are dejected. This can play havoc with the official rate.

If enough workers drop out of the search for a job, even with large reductions in the workforce, the rate can drop significantly (the participation rate declines). Conversely, with tangible job growth, the official rate can rise as encouraged unemployed citizens get back into the group of those who are actively searching for a job (the participation rate increases).

In addition to fluctuations in the participation rate, seasonal adjustments are made to the data. These seasonal adjustments represent what the government’s computers think ought to have happened during a particular season of the year. For instance, if we look at the Department of Labor’s data and, particularly, their “Employment Situation”, we see that in January “Men, 20 Years and Over” the non-seasonally adjusted figures showed a reduction of 914,000 jobs. After seasonal adjustments, this figure drops to a mere 1,000. The government data shows that, without the adjustments, the real unemployment rate was about 10.6% in January.

What all of this means is that the rate itself is not as important as the net number of jobs created. This is  especially important for our real estate fundamentals. Whether people are looking for work or not (the participation rate) doesn’t affect occupancy rates in commercial buildings and computer generated seasonal adjustments don’t get apartments rented. And with seasonal adjustments, the numbers have to “true up” within a year. This is why in January, a revision (the government loves revising data) was made to the 2009 data which indicated there were actually about 550,000 more jobs lost than the official date showed.

So each month, look at the net number of jobs gained or lost, forget about the official rate. In order for real estate fundamentals to improve, we need job growth and a lot of it. During this recession our economy has lost over 8 million jobs. These job losses have been punishing to our consumer spending levels  and our apartment houses, office buildings, retail properties and hotels.  

The government estimates that, in 2010,  our job market will grow by an average of 90,000 jobs per month. Something we must keep in mind is that our economy needs 100,000 (some estimates are as high as 130,000) jobs created per month just to keep up with population growth. In order to regain a good portion of those 8 million jobs lost within a reasonable period of time, how many new jobs do we need created each month? 200,000? 300,000? You can figure out how long it will take even at these rates.

Democrats say that at the end of 2008, our economy was shedding jobs at the rate of 600,000 to 700,000 per month and that today’s only modest monthly losses are an improvement. Republicans say that the administration wasted a year focusing on healthcare and cap-and-trade and just now is getting around to jobs. As Realestatarians, what we need to help our market achieve sustainable recovery are jobs.

When I write about the need for job creation, I receive many emails about what I think are the best methods to stimulate job creation. After all, “The president is not a miracle worker”, one reader conveyed with a defensive tone. While I am far from an economic strategist, here are a few ideas:

Tax Policy: One of the most commonly mentioned reasons why employers are not adding new workers is due to the uncertainty they are feeling about future  tax policy. The printing presses at the Treasury are smoking like a 40 year-old pickup truck chugging down a dirt road due to almost 24 hour operations to double our money supply in just one year. Inflation, higher interest rates and, of course, higher taxes are expected due to this reality. Discussing spending cuts here would only be a waste of keystrokes (as no politician from either party seems to have the intestinal fortitute to cut spending in a meaninful way) so the only option for a rational thinker to assume is higher taxes on everyone.

After a campaign vow of no tax increases for 95% of Americans, the president now says he is “agnostic” about tax increases. What does that mean exactly? I have heard six different interpretations of that rhetoric. More uncertainty is not what we need.

Does the administration really believe a “jobs program” featuring a payroll tax credit is going to create jobs? Would you go out and hire a $40,000 plus benefits employee because you were going to get a one time 5,000 tax credit (just ask Jimmy Carter how effective this mechanism was)? Not if consumer demand did not justify the position and especially not if you think your taxes are going to go up substantially in the near term.

The administration should set a tax policy which can be relied on for the next three years, or longer. Will they let the Bush tax cuts sunset? Some days the implication is yes, some days no, and some days maybe for some income levels and not for others. Markets hate nothing more than uncertainty. Simplify and confirm what tax obligations will be moving forward and employers can make decisions with more comfort.

Additionally, the recently released U.S. budget contains a set of proposals headed “Reform U.S. International Tax System”. If these proposals are enacted, over the next decade, multinational firms will face a $122.2 billion tax increase. The fundamental assumption behind these proposals is that U.S. multinationals expand overseas only to export jobs out of America. The thinking is that taxing their foreign operations more would boost tax revenue here and create desperately needed U.S. jobs. This is simply incorrect.

These tax increases would not create American jobs, they would destroy them. Many independent studies have consistently found that expansion abroad by U.S. multinationals tends to support jobs based at home. Moreover, these studies find that more investment and employment abroad is strongly associated with more investment and employment in American parent companies.

Setting tax policy that can be relied upon is critical.

Stimulate Consumers: Why take tax dollars from consumers, have the government sprinkle in some waste, fraud, abuse and corruption (both parties are experts in this area) , and send the dollars, less the afore mentioned seasoning, back to the consumers in the form of assistance, entitlements or bailouts? Why not just leave them with more after tax dollars? Then 100% of the money gets into the consumer’s hands. When you consider that 50% of U.S. taxpayers pay less than 1.5% of their income in taxes, you can see why the naysayers do not endorse tax cuts.

The case for tax cuts as deficit-fighting and consumer bolstering has never been more valid, since getting the tax base growing is the only way to escape an even bigger fiscal and monetary crisis. A swift and ideologically unembarrassed demonstration of bipartisan action to save the economy from untimely tax hikes would enhance the country’s confidence in the president and his approach to governing.

Trade Agreements:  The president said last week that if we can double our exports, our economy would grow by 2 million jobs. If he really believes this, why have three trade agreements been collecting dust on his desk since he took office? Negotiated trade agreements with Panama, Korea and Colombia are sitting in the president’s in-box and have been since he moved into the Oval Office. Several others are being negotiated with Malaysia, Thailand, the UAE and the SACU.

Free trade agreements help open markets and expand opportunities for American workers and businesses as they can enter and compete more easily in the global marketplace. Organized labor is clearly against these agreements and we have seen, first hand, how indebted the White House feels to these supporters based upon the gift wrapping placed on GM and Chrysler, their untouched pension plans, and the special deals they were getting in both the House and Senate versions of their healthcare bills. Don’t expect any action here until after the mid-term elections.

Infrastructure: A good percentage of unused stimulus money should be invested in an Infrastructure Bank. Infrastructure spending, in real dollars, is about the same now as it was in 1968 when our GDP was about one-third the size it is today. Is it a surprise that, in a 2009 report, the American Society of Civil Engineers gave our infrastructure a failing grade of D?

Over one-quarter of our nation’s bridges are structurally deficient or functionally obsolete and nearly 200 cities have “brownfield” contaminated waste sites in need of clean up and redevelopment. State and local governments, which account for about 75% of infrastructure spending, have terrible budget problems which have caused a growing backlog of economically viable projects that cannot be financed.

The writing is on the wall: our aging infrastructure will eventually constrain economic growth. The Infrastructure Bank could invest, in conjunction with private capital, in merit-based projects of national significance that encompass both traditional and technological infrastructure including roads, airports, bridges, high-speed rail, smart grids and broadband.

The bank could attract private funds to co-invest in projects that pass rigorous cost-benefit analysis to avoid proverbial and actual bridges to nowhere. These projects could generate revenues through user fees or guarantees from state and local governments. This investment/spending would create real jobs, especially in the construction industry, which accounted for about 1 in every 4 jobs lost last year.

Accelerated Depreciation:  Since the 1950’s, there has been a strong correlation between domestic job growth and business investment. To aid job creation, we need businesses to increase capital investment. This is particularly true for well-paying industrial jobs in capital-intensive industries. The best way to do that is to allow businesses to significantly accelerate depreciation of their capital purchases.

In a 2001 analysis, the Institute for Policy Innovation estimated that every $1 of tax cuts attributed to accelerated depreciation generates a whopping $9 of GDP Growth. Economists have rated this stimulus as one of the most productive of our time.

Last year, the president included a one-year extension of accelerated depreciation provisions in the American Reinvestment and Recovery Act. This doubled the amount of capital equipment purchases that small businesses can expense and allowed larger businesses to deduct 50% in the first year. The president recently asked for a one-year extension through 2010. This should be extended for two or three years.

Whatever Congress decides to do, one thing remains a fact: commercial real estate fundamentals need job growth more than anything else to find a tangible sustainable recovery. Let’s hope that, with regard to the administration’s new focus on job creation, we will be able to say, “better late than never”.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1.050 properties in his career.

How the 2009 Building Sales Market Finished and a Forecast for 2010

Anyway you look at it; the building sales market in 2009 was horrible, hideous, revolting, gruesome, cruel, beastly, awful and ghastly! Choose your own word, but it was really bad.  

I have spoken at real estate conferences across the country and hear the same thing that the results in the New York market tell me. Sales volume was abysmal and values continued their downward slides. But enough of the adjectives, if you are a frequent reader of StreetWise, you know that I like statistics, not words, to describe markets and issues so let’s take a look at the numbers:

In New York City, we saw 2009 dollar volume of sales come in at a mere $6.3 billion. This was down 75% from the $25.3 billion in 2008 and down 90% from the record $62.2 in 2007. Of this 2009 volume, about one-third consisted of office building sales and 20% were multi-family sales.

Because there are many large transactions that usually occur in New York that are well into the hundreds of millions or billions of dollars, we always like to look at the number of buildings sold as a clearer sign of sales volume.

In our market, we track a statistical sample of approximately 165,000 properties. If we analyze this sample going back to 1984 (the year I started in the business and the year we began tracking market data), we see an average turnover rate of 2.6% of this stock annually. This indicates that in an average year, about 4,300 properties sell. The lowest turnover rate we had ever seen was 1.6% recorded in 1992 and again in 2003. These were both years at the end of recessionary periods and both years in which we saw cyclical peaks in unemployment.

We had always assumed that this was a baseline of sales as the only sellers in those years were forced to sell. Death, divorce, taxes, insolvency, partnership disputes, what have you…. Our theory about 1.6% being a baseline of sales activity was shattered in 2009.

In 2007, 5,018 properties sold in New York City or about 3.04% of the total stock. In 2009, there were 1,439 properties sold representing a drop of 54% from the 3,144 sales in 2008 and a 71% drop from the 2007 total. The 1,439 sales in 2009 equates to a turnover rate of just 0.87%. As a broker relying on transaction volume, this is a sickening number. The percentage reduction seems to be in line with what my colleagues across the country are seeing.

An interesting thing to note about New York’s turnover rate is that the 25 year average of 2.6%, indicates an average holding period for an owner is about 40 years. In 2007, the 3.04% turnover would indicate a holding period of about 33 years and the 0.87% turnover in 2009 indicates a whopping 115 years!

Interestingly, while the dollar volume of sales was down 90% from the peak, the number of properties sold was “only” down 71%. This difference indicates a clear bias towards smaller transactions. This is due, in large part, to the conditions seen in the financing market. We have seen local community and regional banks continuing to lend, primarily on multi-family properties. These banks tend to have a comfort level on individual loans at about $30 million which, with today’s 60% average loan-to-value ratio, creates a pricing plateau at $50 million beneath which activity was clearly much better than above this level.

In fact, most of the transactions which occurred over $100 million (there were only 7 in 2009) utilized seller financing or assumable financing to get done.  Nine-figure loans proved very challenging to obtain.

The good news regarding volume of sales is that, while the turnover in 2009 was the lowest we have ever seen, volume did increase on a quarter over quarter basis throughout the year indicating that we are likely past the low point in sales activity. Pricing is, however, another matter.

On a price per square foot basis, average values in New York were down 38% from their peak. It is clearly difficult to read much into this figure without looking at specific locations and property types as the reductions vary widely.

The sector that held up the best was multi-family. This was not the case in the rest of the U.S. but in New York we have a rent regulation system which keeps rents artificially low and, therefore, downside risks are minimal provided debt is used wisely. Here values dropped only about 18%.

The office sector was hit hardest with reductions in value approaching 55%. Office properties with significant market exposure ie, those having huge vacancies or lease rollovers in the short term, saw values drop nearly 70%.

The average price of a property which sold in New York City in 2007 was $12.4 million. This price dropped 65% in 2009 to just $4.4 million. In Manhattan, the 2007 average price was $52.5 million and in 2009, the average was $12.9, a 75% reduction.

In 2009, cap rate expansion continued with increases, from the lows, ranging from 114 basis points in multi-family to 284 basis points in the office sector. Average cap rates in the multi-family sector have ranged from 6.12% for elevator properties to 6.92% for walk-up buildings (this distinction is common in the New York market). Average caps in mixed-use properties were 6.43%. Retail property caps averaged 7.12%. Cap rates in office buildings were difficult to calculate based upon the substantial vacancies in many of the properties that were sold.

We believe that values will continue to slide in 2010 until we see a reversal in unemployment trends. Last Friday’s reduction from 10% to 9.7% is not meaningful as we lost 20,000 jobs in January. The only reason the rate dropped is because many people stopped looking for work. We need positive job growth to enhance our real estate fundamentals. And we must remember that we need 130,000 jobs per month just to keep up with population growth so seeing a minimum of 250,000 jobs per month is necessary for sustainable recovery.

If we hit a bottom in value around the time unemployment peaks, the question becomes, where do we go from there? The answer is dependent upon a battle between several factors:

• The massive deleveraging process the market must go through (this exerts downward pressure on value).
• The impact of increased supply of properties for sale as lenders begin to loosen their grip on distressed assets (this exerts downward pressure on value).
• The impact of the Fed’s exit which will be negative on commercial real estate regardless of the method of exit chosen. Three of their four potential exit strategies will raise interest rates and the other will reduce the potential pool of capital from which real estate loans can be made (this exerts downward pressure on value).
• All of the capital sitting the sidelines waiting for opportunities (this exerts upward pressure on value).

Another reason we believe value will continue to slide is due to the imbalance between supply and demand in today’s market today. We see many buyers fighting over few available properties which has buildings selling for higher prices than current fundamentals would dictate. Activity in the note sales market clearly illustrates this dynamic. We have sold many notes at 95% to 100% of the value of the collateral (as compared to par). This means that by the time the buyer gets at the deed, they are into the asset for more than 100% of the property’s value. This is unsustainable.

We also saw prices per square foot increase in the second half of 2009 versus the first half. While one might say that this indicates a bottoming out in value, we do not believe this is the case. We believe that this value dynamic was created by severely distressed selling in the first half and generally better quality assets selling in the second half. Only time will tell if this is the case.

It will be interesting to see how 2010 plays out but it could be quite a while before tangible appreciation kicks in. The most distressed assets are those with 2006 and 2007 vintage loans which don’t mature until 2011 and 2012. We believe it could be 2013 before significant appreciation is seen. There are, of course, upside and downside risks to this forecast but we don’t expect 2010 to be much different from 2009. The good news is: It would be nearly impossible to be worse.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,050 properties in his career.