From the September issue: Researchers at the Brookings Institution and Financial Times declared this spring that “after numerous fits and false starts,” the global economic recovery has finally become “broad-based and stable.” Other observers have since echoed that, and with the collapse of Lehman Brothers nine years in the rearview, most projections are onward and upward.
But the global commercial real estate market may have already hit a ceiling. The total amount of investment sales around the world topped out at $722 billion in late 2015, about 6 percent shy of the pre-crisis record in 2007, according to JLL.
After a tumultuous past year that brought the surprise election of Donald Trump, a clampdown on Chinese capital flows and the early phases of Brexit, what comes next is anyone’s guess.
Global investment sales have ticked up slightly in 2017, after sliding to $661 billion last year, replacing “extra innings” with “late-stage momentum” as the industry buzz phrase du jour. Meanwhile, the world’s two largest commercial real estate markets — New York City and London — are trending in very different directions.
Across the Atlantic, the Big Smoke appears to have weathered the United Kingdom’s great existential Brexit crisis. The city’s central business district saw investment sales climb 18 percent year over year in the first half of 2017 to $11.25 billion, per Cushman & Wakefield. And in another sign of confidence, London scored two exceptional deals this year when a pair of Hong Kong buyers snapped up trophy office towers at record prices.
Manhattan, on the other hand, is heading toward a different kind of record. Sales of commercial properties in the Big Apple continue to slide and are on track to end the year at $19.8 billion — the exact same number recorded in 2008, the year Lehman went under.
“From a cyclical standpoint, some people are concerned that New York is in a later stage than other markets,” said Spencer Levy, the head of research for the Americas at CBRE. “Europe took longer to bounce back, and that’s where some of the growth expectations [for London] might be coming from.”
Tale of two cities
New York and London followed similar patterns as they emerged from the global recession early. Both started to see investment activity pick up in 2010, as commercial buyers who viewed the markets as safe havens were eager to partake in their rebounds.
Then, as real estate prices hit record highs in the following years, investors became increasingly wary of overpaying, and transaction volumes in New York and London both took a turn. But that’s where their paths diverged.
Britain’s vote to leave the European Union introduced several unknowns. It sent the value of the pound into free fall, giving most foreign buyers more bang for their buck. It also created a feeling of instability in the city’s office market as banks and other large financial firms began making plans to move out of London and set up shop in the eurozone. The day after the U.K. referendum in June 2016, the pound sterling dropped 10 percent, global stocks lost $2.1 trillion in value, and investors dumped their stakes in the country’s real estate investment trusts.
That opened the door for a new wave of buyers, many from East Asia and Germany, according to industry sources. “Investors are jumping in who think that maybe after Brexit there’s an opportunity to get into London at prices they’ve never been able to,” said Real Capital Analytics research boss Jim Costello.
In Manhattan and the greater New York market, there’s been no such disruption to break the stalemate between buyers and sellers. Instead, the real estate industry is grappling with a hangover that began in late 2015.
“New York is at a place now where we haven’t seen a collapse in prices as much as a sharp decline in dollar volumes,” said Adam Kamins, a senior economist at Moody’s Analytics.
In fact, out of the world’s 30 most active commercial real estate markets tracked by RCA, only two — Paris and Denver — saw transaction volumes fall further than the New York metropolitan area during the first half of the year.
Out of the top five global markets, New York’s metro area saw investment sales volumes plummet 40 percent year over year to $20.2 billion in 2017’s first half, according to RCA. The other four metro areas — Los Angeles, London, San Francisco and Hong Kong — all remained within a few percentage points of where they were in the first half of last year. Frankfurt and the Rhine-Ruhr region in Germany, Madrid, Singapore and Shanghai, meanwhile, saw investment sales volumes grow 40 to 80 percent in that time.
Of course, no one is likening the condition of New York’s real estate market to where it was during the height of the financial crisis, and there’s little indication of another great systemic shock.
But as NYC looks to rebound and London continues to build momentum, the two leading cities face global competition like they never have before.
JLL identified a group of 40 midsized world cities that are seeing steady growth in commercial real estate investment — from Oslo, Norway, to the Silicon Valley region.
Over the past decade, those 40 markets combined have grown to account for 23 percent of global commercial real estate investment. That’s more than the combined total of New York, London, Paris, Tokyo, Hong Kong and Singapore, according to the global real estate services firm.
In Silicon Valley, much of the investment growth has come with the rising tide of e-commerce and tech firms, from industry leaders like Microsoft, Apple, Amazon and Facebook to smaller companies like Twitter and Groupon.
“Looking long-term, what does that mean for [the] shifting of business worldwide? I don’t think it’s any prophecy of doom,” said Byron Carlock, head of the U.S. real estate practice at PricewaterhouseCoopers. “But think about the importance of Detroit and Cleveland from 1920 to 1970. You can’t deny these shifts … that in the last 10 years the five largest companies in the world are not in New York and London.”
Taking shape
Only a handle of Manhattan buildings are named for their shapes, including the Lipstick Building in Midtown and the Durst Organization’s Far West Side apartment building that many call the Pyramid.
Londoners are much more enthusiastic about giving their office towers colorful monikers. And two of those properties have helped drive the city’s rebound this year. In March, the Leadenhall Building, locally nicknamed the Cheesegrater, traded for the highest price per square foot ever seen in London when Hong Kong’s CC Land Holdings bought the tower for £1.14 billion ($1.48 billion, which works out to a record $2,241 per foot).
And just four months later, LKK Health Products Group, a Hong Kong-based company best known for its oyster sauces, bought the Raphael Viñoly-designed “Walkie Talkie” skyscraper for £1.3 billion ($1.7 billion) — a record price for a single property in London.
Those deals, along with Central London’s recent investment sales boost, have given many reason to believe the city is bouncing back from its Brexit fears. Central London is on track to record £17.6 billion ($22.2 billion) in commercial property trades this year, up 30 percent from 2016, according to Cushman. While that’s still about 25 percent off from where the market was two years ago, industry players forecast further growth ahead.
“I can just remember the headlines,” said David Steinbach, chief investment officer at the global real estate firm Hines. “They were afraid the U.K. was headed straight into a recession … but the capital markets there have been resilient.”
While many point to the weaker pound as an incentive for foreign buyers to snap up properties in London, the currency game has played out very differently in New York.
After the U.S. dollar hit a 14-year high in December 2016, it fell 10 percent to a 15-month low this summer. That should spark a surge in foreign investment, according to conventional thinking. But CBRE’s Levy said all bets are off as investors worry that rising interest rates and tighter monetary policy will limit the upside for core properties.
If interest rates go up and cap rates expand even modestly from their record-low levels, trophy office towers in New York could suffer the greatest falloff in demand, he noted.
“When the U.S. dollar gets weaker, which it has this year, the logic would suggest you would see more capital flows than less,’” Levy explained. “[It would suggest] the U.S. is ‘on sale.’ We’re actually seeing the opposite.”
And while the realities of Brexit become seemingly clearer, New York faces greater ambiguity under the current atmosphere in Washington. Trump’s proposed travel ban and broader immigration policies, among other factors, could take a major toll on the city, which relies on immigrant workers and students in addition to wealthy foreign investors.
“People who have been trying to get in might not be as apt to try to find jobs here,” said RCA’s Costello. “And I think it’s going to be an issue with the universities being able to attract top talent. I don’t think it’s going to be immediate, but longer-term.”
Sudden withdrawal
When Manhattan investment sales started to decline in 2016, market cheerleaders pointed to the fact that 2015 was a remarkable year with total sales hitting a record high — one that Cushman pegged at $59.9 billion, up 14 percent from 2007. Since 2016’s numbers were on par with those from 2014, many framed it as a return to normal.
But the same can’t be said of 2017. Investment sales in the borough are projected to fall nearly 67 percent from two years ago, according to Cushman. Doug Harmon, a chairman in the brokerage’s capital markets division, called the slide the inevitable result of “transaction volume climbing straight up hill.”
“Because of the relatively lengthy recovery, some weakening fundamentals are nerve-wracking to certain investors who worry that a value correction could be around the next corner,” he said.
The average price per square foot for Manhattan commercial properties in the first half of 2017, on the other hand, was $1,483 — up 11 percent from 2015.
When prices continue to rise as transaction volumes fall, it often a signals a disconnect between what buyers are willing to pay and what sellers are willing to accept for a property. That disconnect can be seen in the recent dearth of blockbuster deals that typically drive the market.
Last year, Manhattan clocked seven investment sales with a price tag of $1 billion or more. In 2017, the borough has only seen two such deals: Singaporean sovereign wealth fund GIC’s purchase of a 95 percent stake in 60 Wall Street for $1.04 billion and HNA Group’s $2.2 billion acquisition of 245 Park Avenue.
And that may be all that gets recorded this year. Kathy Sloane, a broker at Brown Harris Stevens who works with both residential and commercial clients, said deals of that size often take months to close due to the complex negotiations involved. As of late August, the sound of crickets dominated the megadeal front.
“You can pretty much say that if the [next round of big] sales are not in contract, they probably won’t close this calendar year,” Sloane noted. “If this year is not already substantially ahead of 2016, it probably won’t be.”
Adding to the sales drought, New York stands to take a major hit from capital controls in China aimed at curtailing outbound investment, as The Real Deal reported in May. Chinese firms accounted for 43 percent of foreign buyers on commercial property transactions in the U.S. last year, compared to just 5 percent in the U.K.
In the first eight months of 2017, investment from mainland Chinese and Hong Kong-based buyers in Manhattan has dropped nearly 40 percent to $3.8 billion, according to RCA, down from $6.3 billion during the same period last year. An August report from Morgan Stanley forecast that outbound real estate investment from China across the board could plunge 84 percent this year and another 14 percent in 2018.
The country’s banking regulatory commission recently launched an investigation into five big Chinese firms that include HNA, Dalian Wanda and Anbang Insurance Group, which owns the Waldorf Astoria.
“No one seems to know if this is the end of the tunnel or the beginning, or if it will spill over into other potential regulatory-control issues,” said Wendy Cai-Lee, founder of the debt and equity fund Oenus Capital and a former executive at East West Bank.
Borrowed time?
It’s not just big Chinese firms that are missing from the equation this year.
U.S.-based buyers such as Citigroup, RXR Realty, CalPERS and Commonwealth Partners were all doing big deals in New York this time last year. But many of those leading investors have sat on the sidelines in 2017.
While prospective buyers may be waiting for prices to drop as they gauge the health of the city’s real estate market, a growing number of potential sellers have decided to change course this year — many opting to refinance instead.
“People have this [idea of what a building’s] value should be in their head,” said RXR chief Scott Rechler. “If they’re well-capitalized and can borrow cheap, there’s no real incentive to sell.”
This year, the Chicago-based Private Equity Firm Walton Street Capital abandoned plans to sell a 49 percent stake in 237 Park Avenue, and instead refinanced the 21-story office tower with an $850 million loan in June. And New York’s BCB Property Management recently did the same with a six-building multifamily portfolio on the Upper West Side. The owner had been looking to sell the properties for $125 million but decided to pull them off the market and refinance instead with $72 million in debt.
Will Silverman, an investment sales agent at the commercial brokerage Hodges Ward Elliott, said that because Manhattan acquisitions were financed conservatively in the years following the financial crisis, owners now feel less pressure to sell when their loans mature.
“One could argue that transaction volumes have become the victim of responsible underwriting from the last cycle,” he said.
