Archive for April, 2010

First Quarter NYC Sales Activity Flat but Horizon is Sunny

Normally, the content in StreetWise is very macro in nature as I try to make the topics of interest and germane to a national audience. This week, I will divert from this practice to share with you what we are seeing in the New York City building sales market and, perhaps, those of you operating in other markets across the country can chime in with what you are seeing in your markets.

In the first quarter of 2010 (1Q10), we did not see the increase in sales activity that we had anticipated based upon the positive psychology many participants in the market are exhibiting. In terms of dollar volume of sales citywide, there were $2.03 billion of closed transactions, a 0.7% reduction from the $2.05 billion transacted in 1Q09. Interestingly, we saw better results in Manhattan than in the outer boroughs where activity levels continue to drop from the remarkably low 2009 levels.

On the island of Manhattan, we segment the market into two distinct regions: “Manhattan” which is the market south of 96th Street on the Eastside and south of 110th Street on the Westside and “Northern Manhattan”, which is north of those boundaries. In 1Q10, Manhattan sales activity remained relatively unchanged from 1Q09 as we had $1.539 billion in closed transactions versus $1.536 a year earlier. While this total represented an increase of just 0.2% from 1Q09, the 1Q10 activity was up 51% from the $1.01 billion in 4Q09. Northern Manhattan performed much better as sales activity hit $116.9 billion, up 197 percent from the $39.3 billion in 1Q10. It is not surprising to see Northern Manhattan performing as well as it was the submarket most adversely affected during this downturn.

Surprisingly, sales activity in the boroughs continued to drop. In the Bronx, sales volume was down 13% from the $79.7 million in 1Q09. In Queens, volume dropped to $143.4 million in 1Q10, a 20.9% drop from a year earlier. Brooklyn was the weakest performer with $161.9 million in sales, a 23% drop from 1Q09.

1Q10 performance versus 1Q09 performance was relative unchanged on the whole; however, 1Q09 was not the low point in activity last year. In fact, activity levels dropped from 1Q09 showing that the low point in activity was in 2Q09 or 3Q09 depending on market segment. Therefore, if we annualize 1Q10 activity, the yearly total for 2010 would exceed 2009 by about 30%, something that bodes well for this year.

Manhattan is always the last submarket to fall and the first to rebound so the 1Q10 activity is a clear indication that the market is bottoming out and recovery is on the way.

While the dollar volume of sales tells us something about market activity, at Massey Knakal we focus much more on the number of buildings sold as a few large transactions can skew the dollar volume total significantly. In fact, in 1Q10 to top 6 sales represented nearly half (48%) of the total dollar volume of sales.

In New York City, we track a statistical sample of approximately 165,000 properties. In 1Q10, there were 373 properties sold. This represents a 2.8% increase over the 363 sales in 1Q09. If we annualize the 373 sales, we are on pace to see 1,492 buildings sold in New York City in 2010. This represents a turnover rate of 0.9 percent of the total stock of properties and is up slightly from the 0.87 percent turnover in 2009. To provide some perspective on this projection, in 2006 and 2007, we saw turnover ratios of 2.96 and 3.04 respectively.

With regard to the number of properties sold, once again, Manhattan and Northern Manhattan showed positive gains in 1Q10 while the boroughs continued to drop.

1Q10 sales activity was nothing to write home about, however, there are clearly reasons to be optimistic. We have seen a significant increase in the supply of distressed assets coming to market as banks and special servicers are either close to completing foreclosures or are growing tired of the protracted foreclosure process here and are deciding to sell paper as opposed to waiting to obtain title. The discounts necessary to sell notes is not large enough to dissuade sellers from moving this paper. We are also seeing a substantial increase in supply from discretionary sellers as they see more opportunities coming to market and want to either reposition their portfolios or have some extra dry powder to take advantage of new opportunities as they present themselves.

Even more positive is the fact that these new offerings are being met with tremendous demand. The activity on almost all of our exclusive listings (502 as of today) is very strong as we are seeing buyers move off the sidelines and onto the playing field. Based upon the number of contracts we have signed in 1Q10 (an increase of 87% over 1Q09), we expect activity to pick up significantly in the balance of 2010.

We are projecting a citywide volume of sales turnover to exceed 1.2% this year, about a 40% increase over last year. In Manhattan, we expect turnover to climb to 1.6% to 1.7%, a 40% to 45% increase over last year. While these projections would still result in historical lows (not counting 2009 levels), this level of activity would be a welcomed increase for those of us who rely on transaction volume for our livelihood.

Just as Manhattan is leading New York City out of this cycle, we expect New York and Washington (which has already seen positive shifts in fundamentals) to lead the U.S. out of this downturn. We remain firm in our conviction that the worst of this cycle is over and, while there are still some landmines out there, better times lie ahead of us.

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 having an aggregate market value in excess of $6.2 billion.


Distressed Asset Update – Here They Come

We have all been surprised by the relative lack of distressed assets in the marketplace thus far in this cycle. Two years ago, we were anticipating a significant amount of distressed assets coming to market. This was described in many ways, most notably as a potential tsunami or an avalanche of properties and notes that could be scooped up for pennies on the dollar. However, this condition has yet to occur.

The reasons for this are numerous. Essentially, everything that has happened from a regulatory perspective is allowing lenders and special servicers to not have to deal with their problem assets. Whether it is mark-to-market accounting rule changes, modifications to the REMIC guidelines or bank regulators leniency, distressed assets have not been coming to market in the numbers that we all know exist.

Bank regulators, for instance have essentially said to banks that if they have bad loans on their books at par and they know the collateral is only worth 60 percent of par, they can leave asset values as they are without incurring any write-downs.

The Fed’s highly accommodative monetary policy is allowing banks to borrow at close to zero and, if they are lending, they are making whopping spreads of 500 to 700 basis points depending upon the loan type. To the extent they don’t even lend, they can simply buy Treasuries and make nearly 400 basis points today. Just a couple of short years ago, spreads were as narrow as 30 or 40 basis points on some loans as the competition to put debt on the street was fierce.

Today’s massive spreads are allowing the banking industry to recapitalize itself, which was, after all, the Fed’s intention. Tremendous profits are being generated which can be used to write down bad loans incrementally. From the bank’s perspective, they are able to wait, make large quarterly profits, write-down bad loans and wait until the write-downs reduce book value close to market value. Once this occurs, distressed assets can be disposed of without incurring losses. For this reason the distressed asset flow has not been nearly what was anticipated.

Notwithstanding this fact, we have seen a significant increase in the amount of distressed assets that have been coming to market recently. During this cycle, Massey Knakal’s Special Assets Group has completed over 1,100 valuations for lenders and special servicers, giving them valuations for the underlying collateral of their loans. From September of 2008 through September of 2009, these efforts resulted in only12 exclusive listings. From October 1 of 2009 through the present, we have received 66 exclusive listings from banks and special servicers and we anticipate this flow of distressed assets to continue.

Although the flow has increased, it remains a drop in the, proverbial, bucket compared to what actually exists in the market. But the flow has tangibly increased which is a welcome occurrence for the brokerage community. A major reason for this is the cumbersome foreclosure process that exists in New York. Foreclosure can take two, or three, or even four years to complete in this state. Many holders of distressed notes do not want to go through that protracted process. This is particularly true given the relatively high recovery rates on note sales relative to collateral value. Therefore,  selling distressed paper has become a much more viable option.

As interest rates start to increase, as evidenced by the recent rise in the 10-year T-Bill based up on the Fed’s halting their asset buying program, these increases will put additional stress on distressed assets and could be a motivating factor for potential sellers to act quickly. If interest rates continue to rise, it will create more pressure on holders of distressed assets to sell as the opportunity cost of not doing so becomes greater and greater.

Adding to the increase flow of distressed assets is the fact that advantageous mortgage terms are beginning to expire. On an increasing basis, we have seen interest-only periods provided on 2006 and 2007 vintage loans start to evaporate. Interest reserves, which have carried many properties which have been fundamentally under water for quite a while, begin to burn off and floating rate loans originated in 2005 and 2006 are either at or nearing maturity. If these loans were floating over LIBOR, debt service rates may only be 2 or 3 percent today and, clearly, there are no lenders that will renew or extend a loan at these extraordinarily low interest rates.

We, therefore, expect the flow of distressed assets to continue to increase as we move farther into 2010 and into 2011 and, perhaps, 2012. Time will tell, but this recent trend is a very encouraging sign for those of us in the transaction business.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty in New York City and has brokered the sale of over 1,050 properties in his career having an aggregate market value in excess of $6.2 billion.

The Bulls Versus the Bears (Part 4)

This week, we conclude our discussion of the divergent perspectives of the optimists and the pessimists.

11) Cap Rates: Going into this down-cycle, it was expected that cap rates would rise significantly as significant levels of distress were evident in the marketplace. Cap rates had risen anywhere from a low on some product types of 50 to 75 basis points, up to as much as 250 to 300 basis points on others. It appears that, given the constrained supply of available assets and the significant demand chasing those assets, there is presently downward pressure on cap rates as they have not risen nearly as much as had been expected. Is this a temporary phenomenon or does this mark the beginning of a recovery? As usual, it depends upon your perspective.

The Bulls: The bulls believe that we have passed the bottom in terms of a high cap rate environment and that cap rates will continue to stay, essentially, where they are or go down slightly as the significant amounts of capital on the sidelines rush in to create significant demand for properties. They believe that the recovery is upon us and that value is rising. They point to the lack of suitable alternative investments and the low yields available on cash and cash like assets which provides motivation to own real estate yielding modest (by historical standards) returns.

The Bears: The bears believe that, while they have appeared to have plateaued, cap rates have only done so because of the acute supply / demand imbalance that the market is currently experiencing. They believe that when distressed assets come to the marketplace in the numbers that actually exist, the supply will be increased significantly, placing significant upward pressure on cap rates. The bears believe that with interest rates rising, cap rates will rise accordingly and that, if history repeats itself, a period of positive leverage will return to the market.

12) Supply and Demand: We have frequently referenced the significant imbalance between supply and demand in today’s investment sales market. The supply of available properties for sale is normally fed by discretionary sellers who decide that, for whatever reason, now is the time to sell their property. As value falls, as we have seen during this downturn, discretionary sellers withdraw from the market. The supply of available properties then typical gets fed by distressed sellers.

Everything that has happened from a regulatory perspective has allowed many distressed sellers the ability to not have to address their problems. Changes in mark-to-market accounting rules, bank regulators allowing loans to be held on balance sheets at par even though the lenders know the collateral is worth less and modifications to the REMIC guidelines, which address how CMBS loans are dealt with, have allowed lenders and servicers to kick, the proverbial, can down the street.

This has led to a sharply constrained supply and, with significant demand in the marketplace, there are far more buyers than there are properties available for sale. Demand has been seen from many sectors. These include: 1) high net worth individuals, 2) families that have been investing in various markets for decades, 3) institutional capital which was sidelined after the credit crisis started to be felt in the summer in 2007 is now back with distressed asset buying funds and opportunity funds and, 4) foreign investors have come into the marketplace in numbers not seen since the mid 1980’s.

The Bulls: The bulls believe that demand is so significant that it has the ability to absorb even a significant increase in the supply of available properties for sale. They believe that we are past the bottom and that upward pressure on pricing significantly exceeds downward pressure. They feel that the downward pressure on cap rates and the resulting upward pressure on values is not based simply on a supply / demand imbalance at a relatively short period in time, but a fundamental shift in investor perspective. While they believe this imbalance has exacerbated market conditions, they believe the imbalance is given too much credit for present conditions.

The Bears: The bears believe that the supply of distressed assets will eventually create an abundance of properties for sale which will drive prices lower as investors have significantly more options and competition for existing availabilities gets diffused.  They believe the supply / demand imbalance is the primary cause of today’s value levels and that supply can only rise from here. They point to tremendous pent-up demand on the sell side as many discretionary sellers who may have wanted to sell have delayed these decisions based upon soft market conditions. As time goes on, these sellers will decide they no longer will delay their action and many of these properties will come to market. Additionally, the number of distressed assets hitting the market have been minuscule compared to those that exist in the market and this condition will change. As supply increases, downward pressure will be exerted on value.       

 13) The Recovery:  The question here is whether the economic recovery is tangible and sustainable or has unprecedented levels of government intervention propped up the market resulting in seemingly unnatural bottoms being achieved.

The Bulls:  The bulls believe that the worst is behind us, inflation is not a concern, employment will begin to pick up and bank balance sheets are not in as much trouble as everyone thought. The bulls see fundamentals getting healthier. They believe that the stock market is a proxy for this recovery and that there is nothing but blue skies ahead.

The Bears: The bears believe that we are sitting in the eye of a hurricane. They believe all is calm which is providing a false sense of security about our being out of the tough times. They are quick to point out the massive need for refinancing and the still nowhere-to-be-found CMBS market. The bears are very concerned about rising interest rates and what they may do to the market moving forward.

Many of you have sent me emails stating that the issue is not really about the bulls and the bears but rather about the realists and those who cannot see things clearly. While I agree that realism is important, interpretation of statistics is based upon one’s psychology and one’s perspective. Whether a glass is half-full or half-empty is dependent upon perspective and interpretation.

As far as the bulls versus the bears go, time will tell who is correct. Until then, all we can do is take things one day at a time and do the best we can.

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 having a market value in excess of $6.2 billion.

The Bulls Versus the Bears (Part 3)

For the past two weeks, we have taken a close look at several factors which impact commercial real estate values and how optimist’s (the Bulls) perspectives differ from those of pessimists (the Bears). We continue this discussion below:

8 ) Corporate earnings: Corporate earnings are important as the more profitable companies are; the more likely it is that they will hire employees to grow their businesses. Growing business need more office space and growing retailers absorb vacant storefronts. The more employees that are hired, the better for our economy as output will grow and, most importantly, consumers will have more disposable income and, presumably, they will spend most of it. The recent stock market rally portents a more positive perspective on future earnings. Why the rally has been so strong is due to different factors depending upon whom you ask; the bulls or the bears.  

The Bulls: The bulls believe that corporate earnings have performed well above expectations at this point in the cycle and that this is reflected in a rallying stock market. They believe that these earnings are sustainable and will lead to new hiring initiatives. These earnings will lead to corporate growth which will enhance real estate fundamentals, leading to a substantial and sustainable  recovery.   

The Bears: The bears believe that much of the corporate earnings which have exceeded expectations were due, mainly, to massive cost cutting and that top-line revenue growth has not resumed to levels which are needed to promote substantial new hiring. The bears want to see top-line revenue growth continue for a quarter or two before they believe corporate earnings are solid. The rallying stock market, they claim, is based simply on future expectations, not solid earnings today which would precipitate job creation.

9) Capital on the sidelines: We have heard, and continue to hear, about the massive amount of capital that is sitting on the sidelines seeking opportunities to purchase distressed assets and core commercial real estate properties which need to be sold. Each day we hear about another fund or another investor that has entered the market and is looking to buy. At this point in the cycle, it appears the demand drivers are substantial, but, is this perception reality?  

The Bulls: The bulls believe that everyone who says they have $5 million, or $50 million, or $500 million to invest in real estate, have it. And they believe it is mostly from unique  sources indicating that there really are billions and billions of dollars sitting on the sidelines waiting for an opportunity to buy. Clearly, the demand is out there in the marketplace as we see a significant number of bidders on each of the properties being sold today. On our income producing properties dozens of offers are obtained and on the notes we have sold, which were collateralized by New York City properties, we have received over 50 offers on every one. A combination of high net worth individuals, families, institutional capital and foreign investors have created demand unlike anything we have seen in recent times. The bulls believe that this overwhelming demand, which exerts upward pressure on value, will dominate the factors in the market which exert downward pressure on value.

The Bears: The bears believe that, of the people claiming to have capital waiting to invest in commercial real estate, many are representing the same pools of equity. Many of the funds have not been raised with cash sitting in accounts. They merely have verbal representations that money is available “for the right deal”. It is very likely that equity sources have many “scouts” in the market claiming to represent the same pools of equity. If this is the case, the bears believe that the amounts of capital claimed to be looking for opportunities is grossly overstated.  They also believe that, while there may be a lot of capital available for “good deals”,  the expectations of what a good deal is, is unrealistic and, therefore, this demand is artificial.

10) Financing: Clearly, debt availability is a significant driver in our investment sales marketplace. Community and regional banks across the country have invested much of their risk based capital in construction and development projects and the result of this is that 124 banks failed in 2009 and is why today there are 720 banks on the FDIC’s watch list of potentially troubled institutions. Fortunately, for those of us in New York, our community and regional banks have invested primarily in cash-flowing properties and they have maintained very healthy portfolios. Because of this, they have continued to lend throughout this crisis. The commercial and money center banks have, however, for the most part, withdrawn from the real estate lending scene. Moreover, construction financing is extraordinarily challenging to find today. This is true particularly for any asset class other than residential rental properties. Even for residential rental construction financing, low loan-to-value ratios exist and recourse is generally included for, at least, part of the indebtedness.

The Bulls: The bulls believe the financing picture is thawing significantly and expectations are that the commercial and money center banks will be back in the game shortly, if they have not already begun to make loans. The bulls say that the CMBS market is on the road to recovery as evidenced by the recent transactions which began late last year. They believe that, although loan-to-values are low and recourse is required, construction financing is available and that there are lenders which are looking for strategic opportunities. If this level of availability existed, it would be extremely positive for the commercial real estate market.

The Bears: The bears see the lending environment as still very limited. Capital availability is low and most real estate loans are being made on only the most conservative terms. The bears also view the CMBS market as still in a relative state of inertia.  They point out that CMBS transactions which have occurred thus far in the cycle have helped only a very narrow slice of the marketplace as loan-to-values are around 50 percent ( one transaction was closed at 75% LTV) and loans that are being made are more in the form of personal loans based on the strength of the borrower as opposed to the viability of the real estate project. This is not only true for CMBS loans but also for traditional loans made by portfolio lenders. The bears believe it will be many years before construction financing comes back anywhere close to what its normal trend has been.

Next week, we conclude this discussion of the divergence of perspectives between the bulls and the bears. We will conclude with the topics of cap rates, supply / demand dynamics and the economic recovery.  Until then……

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 having an aggregate market value in excess of $6.2 billion.