If recent activity in New York City’s financial services sector offers any insight, the economic outlook for 2008 may not be so bright. Financial heavyweights Merrill Lynch and Citigroup both announced multi-billion-dollar fourth-quarter losses last month. And a recent report revealed that consumer spending has been declining even at top-shelf retailers like Tiffany & Co. and Nordstrom—which until now have been largely insulated from the country’s fiscal woes.
To get a better sense of what might be in store for the city’s economy, The Real Deal spoke to Dr. Sam Chandan, chief economist at Reis Inc., in a recent Webcast interview. He talked about how the recent perfect storm of events will impact the city’s residential and commercial real estate market, which has long helped fuel the robust economy New Yorkers have grown accustomed to.
The Real Deal: There were reports recently that bonuses were down at many financial firms. How will that impact the residential real estate market?
Sam Chandan: New York is a very unique environment in that we have a large financial services sector in which bonuses are a significant driver of consumer spending. But we have noticed that many people are stepping away from the homeownership market right now and thinking about renting as an alternative.
TRD: Why is that?
SC: Would-be homeowners are concerned about the possibility of home values plummeting.
TRD: Do you see prices coming down in New York City?
SC: I think there’s growing concern that prices will fall here. Our expectation is that prices will drop. New York is beginning to show some clearer signs of vulnerability.
TRD: How much has transaction activity slowed recently?
SC: We’ve seen transaction volume fall significantly. But we have enough supply on the market, so at the current rate it would take well over a year to unload. We have to remember that the user cost of buying is not only driven by the price of the asset but by how much it costs to finance that purchase. What distinguishes a place like New York from some of the largest markets in the country is that no matter what asset you’re going to buy—in Manhattan, in Brooklyn, as well as in some of the other boroughs—you’re going to have to get a jumbo mortgage.
TRD: Many retailers reported dismal sales in December 2007. Does that mean we should expect more reasonable retail rents in the city after seeing year-over-year increases over the last five years?
SC: What we’ve seen over the last few years is that retail spending and consumer activity in the market have been a very strong product of the wealth effect. Consumers feel wealthier because their home and condo values are going up and also because they’ve had access to that equity through home equity lines of credit and second mortgages.
TRD: So consumer spending will remain healthy, and retailers shouldn’t be concerned?
SC: Consumers have been able to access their stores of wealth and have been engaging in spending at a very high rate. Now, we find ourselves in a situation where the willingness to draw from our savings has diminished because we’re all very concerned about the performance of the economy and job growth. That is putting stress on retailers.
TRD: Can we expect to see retail rents in New York City come down?
SC: I think it’s fair to say that if the vacancy rate for retail space in New York begins to show a larger number of empty storefronts, landlords will have to be more competitive to draw in new tenants.
TRD: Do you think we will see more vacant storefronts dotting our neighborhoods?
SC: I think we will over the next couple of years, but not necessarily at pharmacies or the neighborhood convenience store. At the end of the day, consumers will need to fill their prescriptions, and they will need to buy bread and milk. Those aren’t the types of businesses that are going to be affected during a slowdown in consumer spending. We have to be a little bit more concerned about the repercussions of some of the bonuses we talked about coming off the table. How are some of the locations that depend on the discretionary dollar going to perform?
TRD: What is your forecast for the city’s office market?
SC: One thing we saw in New York City last year – particularly in the office sector – was that rents accelerated tremendously, and the market remained strong. It may hit a rough patch, but we will see a modest increase in the vacancy rate compared to what we’ve seen in previous downturns. The real concern is not over fundamentals, rents and vacancies; in general, they will remain fairly stable. We need to think about whether there will be enough investors buying assets and holding the very strong pricing that we’ve been seeing in the market.
TRD: Give me a market outlook for the next four quarters in New York City.
SC: That’s a good question. The most significant issue for us right now is that demand for space is softening. What does that mean for us? Over the next few quarters, we will have a lot of space coming online, and we have to be a little concerned about how much of that new space will lease up.
TRD: Is New York City no longer insulated from the downturn that has plagued the rest of the country?
SC: New York may have been insulated for a long time from what has been going on in other parts of the county, but the recent surge in write-downs and adjustments indicates that the insulation may be fading. Over the next few quarters, we should see more pressure on the asset market for commercial space. And there will be fewer people looking seriously to buy a condo, given the great deal of uncertainty in the market right now.