Archive for July, 2010

Get Ready for the Investment Sales Surge

In the first half of 2010, we have seen a significant increase in the number of investment property sales in New York City. I understand, from speaking with many of you across the country, that this trend is being seen elsewhere and, while perhaps it is not as sharp and increase as in New York, the trends are positive nonetheless.

In all of 2009, 1436 properties were sold in the Big Apple and, in the first half of 2010 (1H10), there were 818 buildings sold. The dollar volume of sales also increased significantly, going from $6.26 billion in all of 2009 to $6.49 billion in 1H10.

The projected annualized increase in the number of buildings sold is 14% while the annualized dollar volume increase is projected to be 131%. These figures illustrate two very tangible dynamics. The first, and most obvious, is that activity is picking up significantly and, the second is that the average sale price of transactions is increasing sharply.  The average sales price of a New York City transaction in 1H10 reached $7.9 million, up from $4.4 million last year.

We believe that, although we have seen very significant volume increases thus far in 2010 from 2009 levels, the activity will pick up even more dramatically during the second half of the year as several important factors come into play.

The first of these factors involves distressed assets. We are seeing distressed properties and notes coming to market in much greater frequency as lenders and special servicers look to take advantage of current market conditions. As I have written about frequently on StreetWise, current demand substantially outweighs supply leading to achievable pricing that is surprising (to the upside) many market participants. Lenders and servicers have been noticing the recovery possible on these sales which is proving to be compelling.

Additionally, the Fed’s highly accommodative monetary policy has allowed for a massive recapitalization of the banking industry over the past two years. The profitability these banks have enjoyed is affording them the ability to absorb losses incurred due to the disposition of distressed assets. Many have indicated a desire and/or a need to clean up balance sheet problems by the end of 2010. We believe that we will see increasing activity with respect to REO and note sales as this balance sheet cleanup occurs and the necessary deleveraging process occurs.

The second factor revolves around the interest rate environment. Rates hover around record lows as the Fed is keeping them there to help stimulate the economy. Trouble in Europe has created a flight to safety and quality which has exerted significant downward pressure on Treasury rates. The 5-year has been well below 2% for weeks and the 10-year has been below three for a good part of that period. This is keeping commercial lending rates down, which, in turn, is keeping capitalization rates down and prices up. As economic indicators are weak and not responding they way anyone would like them to, it would appear that the Fed will keep rates low in the short to medium term, unless of course, indicators dramatically improve. This low interest rate/high value dynamic is luring both distressed and discretionary sellers alike.

The third factor involves tax policy. We are seeing significant activity from discretionary sellers who are concerned that capital gains tax increases in 2011 will create a disadvantageous selling environment. We have received dozens of exclusive listings over the past few months from discretionary sellers who are desirous of beating the capital gains tax increase.

If you do not believe that tax policy impacts private sector decision making, look no further than the dreaded New York State capital gains tax (the “Cuomo Tax”) increase implemented in the Empire State in the 1980’s. This tax was an additional 10% tax on top of the existing capital gains tax on any property sale over $1,000,000. Then Governor, Mario Cuomo, felt that this tax on “rich real estate investors” would raise needed revenue for the state. Transaction volume slowed to a crawl during this period. Ironically, when the tax was eliminated, the tax dollars collected actually increased as transaction volume exploded.

If we examine history, it is not surprising that we are seeing this activity in anticipation of a tax increase. In 1981, when Ronald Reagan announced tax cuts, which would become effective in 1983, economic activity ground to a halt in anticipation of a more tax-friendly environment. Today, the reverse is true and, as they anticipate a less friendly tax environment next year, investors will be rushing to get transactions done this year.

These factors will increase the supply of properties for sale which will increase transaction volume across the board. Demand exceeds supply to such an extent that this additional supply should not impact value in a negative way… least for the rest of 2010.  We, therefore, believe that we will see significant sales volume increases in the third, and particularly the fourth quarters of 2010.

The balance of this year should be very strong for the investment sales business. How things proceed from there will be dependent upon many things. I will keep you posted.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has sold over 1,075 properties in his career having a market value in excess of $6.5 billion.


Employment and Pending Tax Increases

If you are a regular reader of this StreetWise column, you know the importance that I believe the employment picture has on our commercial real estate markets. In fact, there is no other metric that more profoundly impacts the fundamentals of both residential and commercial real estate.


This is why last Friday’s jobs report was particularly troubling. In June, U.S. payrolls lost 125,000 jobs, the first monthly loss of 2010. These losses were due, mainly, to the elimination of 225,000 temporary government census workers. Just as 441,000 new census temporary jobs skewed the numbers higher months ago (and the administration seemed downright giddy over this “job growth”), June’s job eliminations have skewed the numbers to the downside.


The official unemployment rate, interestingly, dropped from 9.7 percent in May to 9.5 percent even though the market lost 125,000 jobs. You may ask how this can happen as elementary school mathematics would indicate this is an impossibility. The fact is that something called the “participation rate” impacts the official unemployment rate calculation. While the market lost 125,000 jobs, simultaneously, 652,000 discouraged Americans stopped looking for work. After their job search has ceased for more than 30 days, these unemployed workers are no longer technically considered unemployed. This quirk in the official rate calculation caused the reduction seen in June.


However, if these discouraged workers are counted and those who work part-time wishing to be employed full-time are included, the unemployment rates balloons to 16.5 percent. Equally troubling is the fact that the median duration of unemployment rose to 25.5 weeks in June from 23.2 in May.


The most important thing to extract from the jobs report is that the private sector created only 83,000 jobs in June. This comes after an equally disappointing private sector job creation number, in May, of only 33,000 private sector jobs.


During this recession, our economy has lost 8.4 million jobs. It is important to note that, depending upon which analysis you read, our economy needs between 100,000 and 150,000 jobs created per month just to keep up with population growth. Therefore, even with monthly job creation on the order of 300,000 or 400,000, it will take many years to regain the jobs that have been lost.


Additionally, in June, employers cut the average the work week of existing employees. The average work week fell to 34.1 hours after rising for the previous 3 months. Average hourly earnings also slipped in June down to $22.53 from $22.55.  


So, why isn’t the private sector creating jobs at the typical rate seen at this point in a recovery?  Economic growth shifted positively almost one year ago. In typical recoveries job creation becomes self sustaining. Jobs are created, more people have disposable income, and this creates demand, which creates profits, which leads to more new jobs. This process normally works very nicely.


Unfortunately, we are presently seeing an employment picture that is merely muddling along. The fact is that private sector employers are in a holding pattern. Hiring decision are being delayed as employers wait to see how much more politicians are going to increase their costs of doing business. Job creation and new investment have suffered from the destructive impact of trade restrictions, additional regulation and, most importantly, higher taxes.


Even before any new taxes are proposed to address budget deficits, Americans are bracing for the biggest federal tax increase in America’s 234 year history, which is expected in six months. Naturally, Washington will portray this tax increase as a “restoration” of old taxes, not new taxes.


 In 2001 and 2003, Congress enacted tax relief that spurred economic growth and development. These cuts will expire on January 1, 2011. Income tax brackets will shift significantly. The top income tax rate will rise from 35 percent to 39.6 percent. The lowest bracket will increase from 10 percent to 15 percent and all other brackets will increase by 3 percent annually.


Additionally, itemized deductions and personal exemptions will phase out which effectively create even higher marginal tax rates.


On top of these tax hikes, the marriage penalty will return and will be applicable to every dollar of income. The child tax credit will be cut in half and dependant care and adoption tax credits will be cut. The estate tax will increase to 55 percent on estates over $1 million.


Important to our real estate markets, capital gains rates will increase from 15 percent to 20 percent in 2011. The dividend tax rate will rise from 15 percent this year to 39.6 percent next year. Additionally, the new healthcare bill will increase both of these rates by 3.8 percent beginning in 2013. This increase will bring capital gains rate to 23.8 percent or 60 percent higher than its present level. Dividends will be significantly impacted as the top dividend rate will escalate to 43.4 percent or nearly three times today’s rate. The healthcare bill includes 20 new or higher taxes, several of which become effective January 1, 2011. In the face of these increasing costs, is it any wonder why private sector job growth is moving like a glacier?


For the sake of the commercial real estate market let’s hope policy makers realize the importance of job growth and that they understand what the real drivers of private sector job creation are. A clarity with regard to future costs, particularly taxes, and elimination of much of the uncertainty, which presently exists, would induce private sector employers to begin hiring again. Our economy needs this and so do our commercial real estate markets.          

 Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,075 properties having a market value in excess of $6.4 billion.