When the nation’s finance and banking sector ended as the world
knew it last month, many in the New York City real estate community
were scratching their heads, wondering what this would mean for the
residential and commercial markets here and how deep the pain might be.
With institutions such as Lehman Brothers, Merrill Lynch,
Washington Mutual, Wachovia and the insurance giant AIG falling like
dominoes, there are the obvious questions about what sorts of investors
and lenders would fill the vacuum, and what would happen to any real
estate ventures financed by these defunct or hobbled companies.
In
New York City, the confusion was compounded by the fact that the
financial sector is not just an airy abstraction here, but an actual
economic engine providing jobs and tax revenues. In 2007, Wall Street
accounted for 5.8 percent of New York City’s private sector employment
and 23 percent of private sector wages.
First and foremost, prognosticators started with predicting the severity of the downturn.
At
the end of last month, as the stock market took its single biggest
daily hit ever (in terms of point drop), economists were having a hard
time determining exactly how bad the fallout from lost financial
services jobs would be in New York. Governor David Paterson said as
many as 40,000 Wall Street jobs might vanish.
Ken McCarthy, a
managing director of New York-area research at the commercial brokerage
Cushman & Wakefield, had the same estimate.
That’s still
mild by historical standards. In the recession that lasted from 1990 to
mid-1993, a total of 69,600 Wall Street jobs were lost, McCarthy said.
And New York City shed about 60,800 financial sector jobs from the end
of December 2000 to mid-2003, which marked the dotcom bust followed by
the World Trade Center attacks, he said.
So far, about 10,200
Wall Streeters have gotten pink slips since March 2008 — when the
credit crisis that started in the summer of 2007 claimed its first
finance sector victims.
The question now is: What kind of
ripple effect will the Wall Street downturn have on the city’s economy
and real estate market, which are inextricably linked?
Since every Wall Street job is said to create another two jobs, some experts suggested that the city might lose approximately 120,000 jobs in the wake of this financial meltdown.
That compares to a total of 350,000 jobs in the recession of the early 1990s and 250,000 jobs after the dotcom crash.
Even if the recession is shallower, economists anticipate Wall Street bonuses to be minimal to nonexistent this January.
Since
financial sector bonuses tend to be much bigger than salaries, many
have predicted that the worst is yet to come in the residential real
estate market, especially the upper end, which typically benefits
mightily when bonus checks go out. Experts said even the apartment
rental market will be significantly affected.
On the commercial
side, office leasing will take a hit, as failed or restructuring
financial institutions put space back on the market. And, of course,
difficulties obtaining financing will impinge on building sales.
Wall
Street job losses and concomitant economic woes should have
repercussions for all segments of the real estate industry, including
retail, hotels and industrial real estate. Here’s a breakdown of what to expect:
Residential reality sets in, as deals fail and prices drop
While
Manhattan had been more insulated than the rest of the country in the
past year, bolstered by the high end of the market, the numbers started
to slip before Wall Street’s implosion last month.
The average
apartment price in Manhattan was $1.7 million in the second quarter
this year, falling 3 percent from the first quarter, according to real
estate appraisal firm Miller Samuel.
Sales dropped 22 percent between the second quarter of 2007 and the same period in 2008.
And
the news appeared to get even worse after that. Manhattan’s average
condo and co-op prices were down 7 percent in the first two months of
the third quarter from the previous quarter, according to a New York
Times review of closing prices in July and August. Meanwhile, Manhattan
inventory grew about 14 percent from the last week of August to the
last week of September, leaping to more than 7,900 units from around
6,900, according to UrbanDigs.com.
Perhaps some of the growing
inventory numbers are due to scuttled deals. According to a recent
Federal Reserve survey of financial conditions, “a growing number of
deals are said to be falling through” in a weakening Manhattan condo
and co-op market “due to difficulty in getting financing — largely at
the middle of the market.”
Financing difficulties mean that what
should be a buyer’s market, with slowing sales, is actually shutting
out buyers. For brokers, that is not a favorable development.
Larry
Link, the managing director of Pari Passu Realty Corp., said the
residential market had sputtered to a halt, and prices might have to
drop at least 10 to 20 percent for the market to perk up. He predicted
that would happen in early spring 2009.
“When the job loss
numbers start to hit, and the bonus checks are nonexistent in January,
and people take a good, hard look at what’s going on around them, then
you’ll start to get a little more realism in pricing,” Link said.
“You’ll
see more and more incentives being offered,” he continued. “In
Brooklyn, they’ve tried to sell parking spaces and rooftop cabanas and
all that stuff. Those will be tossed in for free.”
Link said he didn’t anticipate any appreciation in residential real estate prices until 2010 or beyond.
But
without hard numbers for the Wall Street job losses, some residential
real estate brokers were adopting a more optimistic take, saying that
New York City wouldn’t take its lumps yet.
Phyllis Pezenik,
vice president for sales and leasing at DJK Residential, said she
doesn’t anticipate a huge influx of apartments flooding the market as a
result of the most recently announced layoffs.
“Those that are
losing their jobs are not going to be in a position where they’re going
to have to sell their properties immediately,” she said. “They’ll be
able to hold on for a while.”
Some brokers were holding out hope
that the government’s proposed bailout plan, which was in flux at press
time after being defeated in the House of Representatives, would help
infuse the credit markets with cash and alleviate some of the pain. But
Cushman & Wakefield’s McCarthy said he believes that even if a plan
passes, it will have little effect on the residential market.
Others noted that the necessity for larger down payments is torpedoing deals.
Darren
Sukenik, an executive vice president at Prudential Douglas Elliman,
said he was recently working with a Citibank employee who wanted to buy
a condo in Tribeca, but that the deal fell apart because the client’s
bank only offered 45 percent financing. Before the credit crunch,
financing for the apartment would have been between 70 and 80 percent,
Sukenik said (see Wall Street fear factor chills market).
High end to feel pain as Wall Street bonuses shrivel
At
the high end of the residential market — typically defined as the top
10 percent of sales (which in the second quarter of 2008 was all sales
priced at more than $3.15 million) — things do not look rosy.
Kirk
Henckels, the executive vice president and director of private
brokerage at Stribling & Associates, said diminished Wall Street
bonuses this year would slow down the market for apartments in the $5
to $15 million range. Late last month, the state comptroller estimated
that bonuses could drop by about 50 percent this year to about $16
billion from last year’s $33.2 billion (which was down from a record
$33.9 billion in 2006).
Meanwhile, according to the Wall Street
Journal, between Sept. 18 and 26, there were 200 price reductions on
Upper East Side and Upper West Side homes priced at under $10 million.
Corcoran broker Deanna Kory, who handles many properties priced between
$2 and $10 million, told the paper her showings were down in September
about 40 percent compared with the same time in 2007.
And the woes of the stock market should only add to that pain.
“The $15 million-and-up market is generally composed of hedge fund owners and private equity people,” Henckels said. “They’re going to be affected as well.”
Yet
some brokers who specialize in high-end apartments said they anticipate
the deals to continue — especially those involving cash — perhaps
because of layoffs.
“Some of the transactions that will happen
over these next, let’s say, two to eight weeks may very well be forced
sales,” said Stan Ponte, the president of Coldwell Banker Previews
International, the luxury marketing division for Coldwell Banker Hunt
Kennedy. “No one wants to think of that, as there’s a human behind it
… but there may be opportunities like that — and cash is king.”
Ponte
added that while middle-class Europeans are potential New York City
buyers who are now facing their own economic problems, “that
ultra-wealthy Muscovite, where there are more billionaires per mile
than anywhere else in the world, is still
very interested.”
For foreign buyers, of course, the strength or weakness of their currencies versus the dollar is a key factor.
But
another is inventory. Henckels argued that a general lack of quality
inventory could bolster the market, as opposed to previous economic
downturns. “We’re going into this well positioned,” he said.
Rental rebound or retreat as sales slow?
In Manhattan, rents have been down nearly across the board for the last year.
According
to the Real Estate Group New York brokerage, average rents for
Manhattan studios, one- and two-bedrooms dropped year over year from
September 2008 compared with September 2007. The biggest of those drops
was in doorman studios, where rents fell 7 percent to an average of
$2,584.
In the firm’s September report, the COO, Daniel Baum,
noted that the “summer upswing that we would normally expect to see was
absent.” But rents rebounded a bit last month, a fact that Baum
attributed to the sluggish sales market.
One broker told
<i>The Real Deal</i> that he was seeing fewer single
professionals with high-end monthly budgets in the $3,500 to $4,500
range because of the economy.
Pari Passu’s Link, whose
brokerage also handles apartment rentals, said late last month that the
market was starting to feel the preliminary effects of the Wall Street
turmoil. And he, too, said Wall Streeters who once didn’t think twice
about their high-price rentals would have to be more careful with
spending now.
“A lot of the guys who are big players in
investment banks are either losing their jobs, or they’re afraid of
losing their jobs,” he said. “They would have been fine renting an
apartment for $5,000 or $6,000 or $7,000 a month before, but now
they’re a bit gun-shy.”
Link said that landlords can be slow to face reality, but he predicted that at some point soon, they would drop rents further.
For
the last few months, landlords have been offering incentives — like a
free month’s rent and owner-paid commissions — to new tenants. Even in
high-end rental buildings, some landlords are already becoming more
open to out-of-state guarantors.
Now, some brokers have
predicted that landlords may start offering incentives to current
tenants to encourage them to renew leases as well.
Gary Malin, president of Citi Habitats, noted that any downward pressure on rents might be countered by an increase in the number of renters who can’t qualify for home mortgages with more demanding standards.
“With
the rules these days of banks wanting people with better credit scores
and more money upfront and more money in reserve, or you’re not going
to be able to buy — in Manhattan, what other options do you have other
than renting?” Malin asked.
He posited one possible silver
lining: If prices do adjust as a result of the Wall Street breakdown,
it could bring about movement in the rental market.
“You could
see people who wanted to live in Manhattan a year or two years ago, but
just felt [priced out], might find the time is good to move to
Manhattan, because the pricing makes sense to them,” he said.
Office leasing braces for further vacancy hikes, rent drops
In
the office leasing market, where anecdotes of rents dropping in August
and September by as much as 15 percent have been circulating,
uncertainties lay ahead.
Part of that is related to the consolidation of the financial industry.
As
part of its acquisition of Lehman Brothers, Barclays Capital took over
Lehman’s 1 million-square-foot headquarters at 745 Seventh Avenue. But
Lehman also leases space at a number of other buildings throughout the
city, and much of that space could hit the market when Barclays starts
laying off some of the 10,000 Lehman employees in the coming weeks and
months as it is expected to.
Meanwhile, in Lower Manhattan,
Merrill Lynch, which has about 2.6 million square feet in the World
Financial Center, was renegotiating its lease with Brookfield
Properties when Bank of America stepped in to purchase the floundering
financial institution. That absorption would most likely cut down on
the need for space for the old Merrill, which holds 1.6 million square
feet in addition to the World Financial Center space it occupies.
Considering
the shaky status of insurance giant AIG (which has about 3 million
square feet of office space in Lower Manhattan) and the financial firms
that are likely to shed space, some estimated that 10 million square
feet could be up for grabs. That’s about 2.2 percent of the total 450
million square feet of office space in Manhattan.
The financial
industry retrenchment leaves a building like 11 Times Square, an
as-yet-unleased 1.2 million-square-foot speculative tower built by SJP Properties, with a highly uncertain future.
Ditto for the
buildings being developed at the World Trade Center site by Silverstein
Properties and the Port Authority of New York and New Jersey.
In
August, the latest data available as of press time, the Manhattan
office vacancy rate was about 8.7 percent, according to Colliers ABR.
That’s a far cry from the 16 percent vacancy rate seen in the recession
of the early 1990s, but brokerages were predicting vacancy rates to hit
double digits by early next year.
Jones Lang LaSalle has predicted Manhattan’s Class A vacancy rate will rise to 11.3 percent by early 2009.
“When
sublease space comes back on the market, it does tend to put pressure
on landlords,” said Cushman & Wakefield’s McCarthy. “And sublease
space has started to come back to the market, so it wouldn’t surprise
us at all to see rental rates decline.”
Of course, critical to understanding what might happen in the office leasing world is pinning down how many jobs will be lost.
Every
financial services job creates two related jobs, but not all those jobs
use office space, McCarthy noted. Typically, every three Wall Street
jobs create one job that uses office space, he said.
Thus,
Cushman & Wakefield’s predicted loss of about 40,000 financial
sector jobs would imply a loss of another 13,300 related office jobs.
Since each office worker occupies roughly 300 feet of space, that could
mean nearly 16 million square feet of office space could return to
market.
However, some firms might warehouse space as opposed to
subleasing it. Cushman & Wakefield estimated that only 40 to 50
percent of the theoretical glut would return to market.
“However, even if half of it comes to market, it’s going to have an impact on the vacancy rate,” McCarthy said.
If
one uses numbers from Marisa Di Natale, senior economist with Moody’s
Economy.com, the possible increased inventory in the office leasing
market could be even greater. A loss of 65,000 financial sector jobs in
the 11-county greater metropolitan area would be compounded by the
disappearance of an additional 21,666 office jobs. At 300 square feet
per person, that might lead to as much as 26 million square feet of
space reappearing on the market (or 40 to 50 percent of that using
Cushman & Wakefield’s estimate).
However, Di Natale is
predicting a loss of only 70,000 jobs overall, because she said growth
in industries such as health care, education and government will offset
financial sector losses.
Marcus Rayner, a principal with
Cresa Partners, a commercial brokerage that represents tenants, said
his firm believes the end result of the Wall Street debacle will be
worse than what’s been forecast thus far.
“If the economists are
predicting something like 60,000 to 70,000 jobs lost overall, that’s a
fairly mild recession,” Rayner said. “It’s not very deep. We happen to
think it’s going to be worse than that … we don’t expect the real
estate markets to recover fully until the middle of 2010.”
Cresa’s
gloomier forecast takes into account sectors such as hedge funds, which
will most likely be hit by redemptions, Rayner said.
People could “start taking their money out of hedge funds, and if they do that, then you’ve got a sector in trouble,” he said.
And the hedge fund industry occupies the most expensive space in Midtown.
The
growing inventory in the office leasing market will be a boon to
tenants, who can expect to see rents drop at least 15 percent from
their levels in late September, Rayner said.
“What you’ve got to
watch for is refinancings,” he said. “Refinancings will be difficult,
and will probably require more equity.”
A landlord will want to
get his or her building fully leased to provide more refinancing
options. “That’s the opportunity for the tenant,” Rayner noted.
Already slowed building sales head for “suspended animation”
One
of the big unknowns swirling around Wall Street’s demise was whether
the proposed government bailout would pass in some new form, and if so,
whether it would kick-start building sales and prevent a portion of the
anticipated building failures in New York City over the next few years.
Building sales have already slowed dramatically since the
summer of 2007, when the credit crisis shrank pools of capital
available to potential buyers. Cushman & Wakefield data showed that
year to date through August, just $17.3 billion worth of sales of
Manhattan office properties valued at $10 million or more were closed
or under contract — a 58 percent decline from the comparable $40.3
billion for the same period last year.
Another report released
by Massey Knakal Realty Services reported that the number of sales of
commercial properties was 31 percent lower in the first half of 2008
in Manhattan, Brooklyn, Queens and the Bronx than in the same period
last year. The largest decline was seen in northern Manhattan, where
sales volume dropped by 63 percent.
Investment sales brokers
were predicting that asset fundamentals, like rents and vacancies,
would take a severe hit due to the Wall Street meltdown — and the
market might grind to a halt altogether.
According to Crain’s, the city’s largest private landlord, SL Green Realty, has already begun cutting rents in some of its buildings.
“Buyers
who bought at high numbers, particularly in 2006 and 2007, are
reluctant to sell at much lower numbers, so there is right now a sort
of mismatch between the bid and asks on properties,” McCarthy said.
“Those buyers and sellers need to get closer together — and then find
the capital.”
Philip “Tod” Waterman III, a managing member of
Waterman Interests, a company that owns office buildings, said the
building sales market would be in “complete suspended animation” until
the end of the year.
Waterman said he anticipates
tremendous investment activity in 2009 and 2010. “When I say investment
activity, I don’t just mean buildings trading,” he said. “It’s going to
be debt securities trading, and distressed debt trading, and those are
real estate assets.”
However, without extensive pools of credit, it may be difficult to get deals done.
For
instance, chatter has been rampant about AIG selling off some of its
extensive holdings — including three Manhattan buildings — to pay off
the $85 billion federal loan it got from the federal government last
month. But without financing available, it’s unclear who would step up
to buy them.
And a portion of the investment activity could be connected to other financial institutions getting rid of their real estate assets.
“Last
I checked, Lehman’s real estate book was $40 billion of assets, or
that’s what it’s marked at,” Waterman said. “All of that will hit the
market.”
Waterman said that for at least a period of time, real
estate transactions would be much simpler in their structure, and would
be done only by those firms that have access to large pools of equity
capital. Building values, he predicted, will drop.
“I think
the pendulum swung way too far in the direction of esoteric structure
and overleverage, and opaque leverage, and I think we’ll go back the
other way pretty quickly to a much simpler structure,” he said. “And
that will have a deflating effect on valuations in the short run.”
Large
real estate investment funds and real estate investment advisers will
continue to have the capital resources to make those purchases,
Waterman said.
Chilling effect for new projects, pre-sales a must now
The
pall that spread over the new development market after the credit
crisis of 2007 will continue to widen as the full effects of the Wall
Street calamity are felt, developers said.
“People will hold
back on projects that are not yet substantially in construction,” said
Francis Greenburger, CEO and chairman of the development company Time Equities.
“They’ll look to time them in a way that’s related to the recovery. I
think you’ll see a lot of projects that were proposed or conceived of,
or in predevelopment, that may be delayed or deferred.”
Greg
Belew, a co-founding partner of the development firm Fifth Square
Partners, said that obtaining construction financing is virtually
impossible, which is having a chilling effect on almost all new
development.
“Certainly, for-sale housing right now is just not
happening,” he said. “Maybe rental apartments or potentially preleased
office-type developments, but outside of that, I think it’s going to be
a while before you see the spigot turn back on.”
Belew said that developers are wondering who or what will replace former sources of capital that have disappeared.
“I
don’t know who’s going to step into that void where all the traditional
lending sources have been,” he said. “I don’t know if foreign banks, or
hedge funds, or who at some point is going to come in to get the wheels
turning again.”
For developers with residential projects under
construction that are not largely pre-sold, Belew said a worry is that
Wall Street layoffs could result in an influx of apartments on the
market that could compete with new development.
Greenburger, who
was pouring the foundation for one residential project and had two
others on the drawing table late last month, said he will be guided
more by presales in the current market than he would have in recent
years.
“Presales will be an important component of what we do, as well as what other people do,” he said.
As
for construction of new commercial properties — which are comparatively
few in number to begin with — that is expected to dry up as well. Large
commercial development projects such as the World Trade Center, Hudson
Yards and Atlantic Yards could be threatened if no major corporate
tenants emerge.
Retail and hotels to take lumps, industrial holding up
Troubles
on Wall Street — the actual street itself — will put a damper on a
high-end retail presence growing in the Financial District, predicted
Robert Futterman, president of Robert K. Futterman & Associates.
“The
luxury brands flocking to Wall Street will scratch their heads and
think twice before they pull the trigger to make sure there are people
that have jobs,” Futterman said.
In the past two years, luxury
stores such as Tiffany & Co., Thomas Pink and Hermès opened in
Lower Manhattan. More recently, Whole Foods and Barnes & Noble
opened just north of the World Trade Center site.
Meanwhile, reshuffling going on in the banking system, which recently led to JPMorgan
Chase’s purchase of Washington Mutual’s banking operations, and
Citigroup’s purchase of Wachovia, will mean bank branch closures.
The
industry is also probably due for a cyclical contraction. There are
about 660 bank branches in Manhattan, up from 446 bank branches in
1998. Along with the fallout from Wall Street job losses, those retail
closures will most likely push down retail rents in some parts of
Manhattan, Futterman said.
And while consumer confidence
should plummet as the jobless rate goes up, Futterman said he believes
consumers will shop close to home, and that the city will continue to
attract every class of retailer.
“New York is the greatest
opportunity for any brand — domestic or international — to do sales
volume,” he said. “You’re still going to have more people and more
shopping on the streets of New York than any other place in the U.S.”
As
for hotels, the city has one of the strongest hotel markets in the
world. Despite Wall Street angst, that will continue, said John Fox, a
senior vice president at PKF Consulting, which specializes in hotels.
He
said New York City has had an average daily rate of $295.98, up 7
percent over last year, and an occupancy rate just shy of 87 percent
for the first eight months of 2008. That’s more than 20 percentage
points over the national average.
As for a curtailment of
corporate travel due to the Wall Street imbroglio, “there’s a sense of
foreboding that we’re going to see a big impact, but we haven’t really
seen it yet,” Fox said.
While immediate cutbacks in business
travel may occur, also irksome for hotel owners late last month was
that September and October are the months when hotels negotiate daily
rates with the corporations that stay in them, he said.
Hotels may need to drop their rates a bit to capture corporate travelers.
“There’s
an expectation that it’s going to be a little tough negotiating this
year, and hotels may give way a little bit,” Fox said.
Since
hotels are facing the same constraints on capital as other real estate
sectors, Fox said that most likely some new hotel projects that had
been announced would be abandoned.
“And I don’t expect to see much in the way of new product announcements in the near term,” he said.
Of
the various sectors of the real estate business, the industrial real
estate market may be the most insulated from the Wall Street crisis.
While
the difficulties obtaining financing seen in all real estate sectors
are slowing down industrial building sales, leasing remained unaffected
late last month, said Kalmon Dolgin, co-president of Kalmon Dolgin
Affiliates.
“I do anticipate there will be some fallout from
the financial crisis,” Dolgin said. “How that’s resolved will determine
what jobs remain and what jobs are lost.”
Greenburger of Time
Equities is in the early stages on a few industrial redevelopment
projects. He said that there is such a shortage of industrial space in
the city, the market will hold up well despite job losses.
“Even
assuming there’s some fall-off in demand because of economic
conditions, probably the market is so tight, and there’s so little
supply, that those [industrial] projects will be affected less,” he
said.