Conventional wisdom suggests that the New York real estate investment market might be re-entering a bubble, especially within the ultra-hot submarkets like SoHo and Chelsea, and especially for today’s most favored asset types – retail driven properties, development sites, and elevator apartment buildings. We consider a bubble to be defined by pricing that doesn’t correspond to fundamentals; more precisely, bubbles are large volumes of trades that are not in keeping with intrinsic values. In the national economy, many fear we have entered a no-growth era reminiscent of Japan’s “lost decade,” and on the global front, the contagion prospect of a long-lasting European depression looms large. As pricing in Manhattan commercial real estate continues to eclipse pre-Lehman levels and we routinely see 4% cap rate deals, it is the volume component that most challenges the bubble concept in today’s market.
As any of my colleagues at Eastern Consolidated might tell you, there is simply not enough quality product in the marketplace today to begin to meet investor demand. I am constantly fielding calls from frustrated investors asking me why I am not bringing them better deals, why they haven’t been privy to the “diamond in the rough” offerings. These buyers are realistic regarding pricing and well-capitalized – but there just is not enough product that meets their expectations of quality.
Take a look at today’s transactional volume: In the 2nd Quarter of this year, commercial property sales volume totaled $6.1 billion, roughly the same as it was in the 1st Quarter. Contrast this with the 2nd Quarter of 2007, when commercial property sales volume reached just shy of $20 million.
Many recessions begin with a flight to quality. In New York, we flew there, planted a flag and set up camp. Despite that almost total retrenchment in volume experienced in 2009, investors have not decamped – the flight to quality remains the dominant paradigm. Our market is almost entirely characterized by opportunistic and value add capital that requires top quality locations, solid infrastructure and often repositioning potential. While cheap debt is available, investor equity is filling up a much larger portion of the capital stack and driving the bus toward opportunistic and value add strategies.
Globally in 2011, it was the closed-end real estate private equity funds that focused on major markets in North America that raised the most capital, raising $28.1 billion last year, more than three times what was raised for Europe or for Asia. Many of these funds are characterized by foreign capital with a major New York real estate strategy, and almost all of them have a value-add or an opportunistic mandate. With not enough product to meet the enormous influx of investor capital, the supply constraint creates upward pricing pressure that often ignores the underwriting limitations of in-place income. Does this alone amount to a present bubble?
Other arguments against the bubble concept: (1) while unemployment nationally appears stuck, hovering over 8.0% for 42 months, job growth in New York has been exceptionally strong in 2012, (2) truly, debt is staggeringly cheap, but over-levering is by far the exception not the rule, and finally (3) rents have largely rebounded in retail and especially in multi-family. Most residential firms currently report apartment vacancy rates to be roughly 1.0%.
I was talking with a friend over the weekend who runs the New York office of a European-based private equity firm. When he was graduating from college in Virginia fifteen years ago, he recalled being torn between competing job offers in Virginia and New York. In his calculus, the Virginia job paid far better in the near term after cost of living adjustments, but the New York job was more compelling in the long term. If he was willing to suffer through a few lean start-up years, the career trajectory would yield much better monetary results in New York than in other markets. Like the Manhattan apartment renter confronting 1% vacancy rates, investors clearly want to be here, and are willing to pay dearly for the privilege. Like the private equity manager, the investor willing to bet on New York’s long term growth must bring his or her own talents and deploy those talents into the right opportunities. In addition, they’ve got to have at least a little faith in the face of a never-ending stream of bleak headlines.
Marion T. Jones is a Director at Eastern Consolidated and works with Senior Director and Principal David Schechtman to service lenders, special servicers, owners and buyers alike.