After the credit crunch, where to invest

With the smoke clearing from around the subprime mortgage collapse, it’s clear that some real estate sectors will be hurt worse than others. Against a national backdrop where home foreclosures have hit record levels and office rents appear to be halting their upward climb, which sectors in the New York real estate market will perform well going forward?

Real estate experts interviewed were optimistic overall about the city’s market in both the short and long term. Foreign investment encouraged by an increasingly weak dollar and tight inventory across all sectors make New York’s real estate market well-insulated from disaster, said David Lichtenstein, CEO and founder of the Lightstone Group, a big owner of shopping centers, office buildings and apartments.

“New York is not the United States — it is an international city, and it stands on its own legs,” he said. “New York will be the most mildly hit of any region in the country. And the shakeout nationally will be much less severe than anticipated. The Fed is being so aggressive it’s giving people a lot of confidence, and New York in particular seems to be best sheltered.”

That said, industry soothsayers have their recommendations for which sectors will be in best — and worst — shape to withstand any bumps resulting from the subprime shakeout.

Lichtenstein said he would bet on the residential rental market, pointing out that any downturn in the condo market will be a boon for the rental sector.

Paul Fried, principal of AFC Realty Capital, said that in the long-term, the New York rental market may be the only viable real estate sector since office, condo, hotel and industrial could all suffer from the trickle down of the recent credit crunch. “My concern is that the subprime issue is indicative of a greater problem,” Fried said. “When the economy is led by the consumer — and the consumer is leading by their home purchases — when the home purchases dry up, so do all other purchases.”

A slowdown could tighten consumer spending in retail, restaurants and entertainment, which could be detrimental to real estate. “One area that could see a benefit from this is the rental market,” Fried noted.

Jon McMillan, Rockrose Development’s director of planning, echoed Fried’s confidence in the residential rental market above all others. In addition, he said investors should be wary of new condo developments in some areas outside Manhattan. High-end condos targeted at younger buyers — such as those in Williamsburg and Jersey City — could see these less-capitalized consumers unable to qualify for sufficient mortgages in the new climate. McMillan said new construction overall will be challenged, since not only will the city’s 421-a tax exemption for new developments be phased out in 2008, but also there will be a challenge to the market from rising construction costs. “At some point that has to fall apart a little bit,” he said.

In the short term, Fried is bullish on condo and hotel properties able to draw foreign buyers, as New York’s unique attractiveness to foreign investment and its strong position as an international tourism and business destination make it resilient in the face of domestic economic turmoil.

On the whole, Fried said he favors residential over office properties, which he feels are more susceptible to economy-induced challenges businesses may face.

“There have been lofty numbers for office properties in recent years on the basis of occupancy and rate projections, and they now have overhang on them,” Fried said, adding that all eyes are on developer Harry Macklowe, whose highly leveraged $7 billion purchase of a Manhattan office building portfolio earlier this year may land him in trouble and cause him to lose some of his properties (see What’s coming next for Harry).

These recommendations, Fried noted, are the same ones he would have made 12 months ago.

On the other hand, Steven Kohn, president of real estate investment firm Cushman & Wakefield Sonnenblick Goldman, said retail and office markets are a safer investment bet for the time being, because their long-term leases lock in revenue streams. “In a rapidly rising market, the longer-term leases associated with retail and office can be a negative if rents are below market, but in a downward market it can be a positive to have those leases in place,” Kohn said. “Hotels, followed by the residential market, most closely represent the current state of the market.”

In other words, hotels, with their daily price fluctuations and residential rentals, with their one- and two-year contracts, are riskier investments in rocky economic climates, he said.