I was on CNBC a couple of weeks ago with my friend Brian Sullivan, and I mentioned that I thought we were heading into the “biggest transfer of ownership in the history of New York City.” This caused a flood of questions, texts, emails and DMs asking for details.
Here goes.
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The investment sales market in New York City is in unprecedented circumstances. During each of the past major corrections — savings & loan crisis in the early 1990s, the recession in the early 2000s, the Global Financial Crisis of 2008-2009 and the “long slide” from 2016 through 2021 — every product type was losing value, just to varying degrees.
In this correction, which was precipitated by the Fed’s misguided interest rate policy, which started in March of 2022 but didn’t take hold until September of 2022, we now have a circumstance where different product sectors are performing differently. That means externalities — other than interest rate policy, but in addition to them — are impacting asset performance.
I would argue that the retail sector is currently improving. Retail was adversely impacted well before other sectors, and it is generally agreed that retail rents have finally stopped falling. Leasing activity is picking up and we have been getting investor calls looking for retail assets, something that began about five months ago for the first time in many years.
The hotel market is also on the upswing. Of our stock of about 120,000 hotel rooms, 30,000 are no longer hotel rooms. Some 14,000 have been converted to other uses, like student housing and residential apartments, and 16,000 are occupied by migrants. In addition, the city has cracked down on Airbnb, and a combination of that and the reduction in supply has led to significant upward pressure on average daily hotel rates and occupancies.
The land market is starting to turn positive also. The better-quality, well-located sites are starting to see values rise. Interestingly, lesser-quality sites are still seeing downward pressure exerted on values, but this dynamic is typical as the land market emerges from a downturn.
The two sectors that will lead this historic selloff will be multifamily and Class B and C office.
The multifamily sector, which represents the overwhelming majority of New York City’s building stock, continues to face tremendous political headwinds. Even prior to interest rate movements, the rent regulation changes state lawmakers made in June 2019 delivered a body blow to the industry and virtually eliminated the ability to extract upside potential from these buildings, which was the bedrock of the sector for decades. Layering interest rate increases on top of the policy changes was a one-two punch that has profoundly changed the sector.
Virtually every refinance today requires a cash infusion and, given the continued political headwinds, many investors are reluctant to throw good money after bad. We are presently consulting with 28 families that would sell their entire portfolios “if the price was right.” Many of these folks will have to sell at least a portion of their portfolios — even if the price is wrong.
In the B and C office sector, there appears to be a tough road ahead. A property that was purchased for $750 per square foot years ago may have $400 per square foot in debt. The competing property across the street is selling for $300 per square foot or less. The landlord of the newly acquired property can undercut by a wide margin the minimum rent the holder of the $400 debt must charge. As more and more of these lower-priced assets sell, the more opportunities tenants will have to find a much cheaper rent.
And will owners put in fresh capital to effectuate a refinance? In a real-life example, a Midtown West asset was purchased for $110 million many years ago with $50 million in debt. The debt was at 3.5 percent and matured a year ago. The lender kicked the can for one year. They won’t do it again, and offered the borrower $35 million at 7.5 percent. The owner has the $15 million, but will he put it into the asset, which may be worth only $60 million today?
The calculus: Put in $15 million (which you need a return on) and see your mortgage payment go up by $875,000 per annum. With a 6 percent return required on the additional equity, the rent has to go up by 42 percent for the owner to break even. He is going to sell. Others facing the same circumstances, many of whom don’t have the $15 million, will also sell.
To offer some perspective: Of the 27,649 investment properties south of 96th Street in Manhattan, the average turnover rate over 40 years has been 2.6 percent. Its lowest point was 1.2 percent in 2009 and the highest it has ever been was 4.3 percent in 2012 as sellers were rushing to beat the 3.8 percent capital gains tax increases kicking in for 2013.
We anticipate, then, two or three years in a row with 5 percent to 6 percent turnover as owners struggle with current market conditions. Put your space helmets on, it’s going to be a wild ride!
Robert Knakal is founder, chairman and CEO of BK Real Estate Advisors.