Wave Theory

The next time you are at the beach, watch the waves rolling in and out. Each one rises to an apex and then crashes down. Then the next comes, rising and then crashing. This same ebb and flow is a good representation of the real estate market in New York City.  We began with a wave of tsunami proportions in 2008. The wave crashed down, then slowly receded, taking a portion of the sand back to the ocean with the force of the undertow. Then a smaller wave rose and it too fell. Now another is beginning to appear as the preceding one finishes receding.

The surge of business activity, which ended in the summer of 2008, was America’s economic tsunami. The real estate market dropped 75% from is peak level of activity and prices dropped by 25% to 35 % in Manhattan. This enormous wave receded in the first quarter of 2009 taking a substantial amount of wealth with it.

Another surge crested in June, when business activity rose to its highest level in a year and a half. In July the wave came down and now, in August, it is again receding. Business activity in July dropped a third from what it had been in June and dropped another third in August. As we enter the latter part of August we are seeing another wave appear. Open houses are showing increased activity. This wave will appear in its fullest in September and October and will again recede in November and December.  These waves will continue unless something of unexpected dimension occurs which disrupts this trend.

What Causes this Wave Pattern?

Consider the nature of the supply and demand between buyers and sellers. An increase in the size of the inventory represents a weakening of the seller’s position.  The resistance of buyers to prices demanded by sellers leads to market inactivity and inventory buildup. Some sellers eventually acquiesce to demands by buyers to lower prices, leading to a cascade of falling prices as other sellers follow suit.  Lower prices bring more sales. As product is absorbed by the increased level of transactions, inventory declines. Lower inventory causes sellers to firm up their positions and prices to rise.  As prices rise, buyers stop buying and the level of activity again recedes. Accordingly, inventory again rises and the cycle repeats.

Let me give you a more concrete scenario. Last year, the West Side activity was at a low level relative to our other neighborhood offices. Prices on the West Side were relatively high when compared to other neighborhoods. The East Side, in turn, was showing greater activity because its prices were relatively lower. A sudden a shift occurred in May. Prices on the West Side dropped, activity shot up and the level of transactions on the East Side quickly receded.

Take the experience of Mrs. Smith, who owned a Classic Six on the West Side. She believed her apartment was worth $2,000,000. It had been for sale on the market for over a year. There were three other apartments in the building like hers and they, too, had been on the market for some time. One day, the seller of one of the other apartments decided to reduce his asking price to $1,800,000 to stimulate buyer interest. After hearing this, Mrs. Smith realized that she, too, needed to reduce her price to be competitive. In short order, everyone selling an apartment in the building was forced to reduce their prices. Finally there was a sale at $1,600,000. Even though Mrs. Smith was not happy about it, she really wanted to sell her home, so she accepted that this was the new benchmark for the apartment’s value.

Now look at Mr. Gold, who has a two bedroom on the East Side. He wants to sell the apartment for $1,800,000. There were other two bedroom apartments in the building that recently sold at a similar price so he was confident that he could also achieve this figure. Offers came in at $1,600,000 and he turned them down since he still believed that the higher price he placed on his home was justified. Sales activity in the building all but ceased. After a few months of inactivity he decided to accept a previous bid of $1,600,000 to move the apartment. He called the broker, who told him that the potential buyer already purchased a two bedroom on the West Side for $1,600,000. Mr. Gold decided to drop his price officially to $1,600,000 to find another buyer.

Surfing the Wave

These waves of activity and inactivity are happening in the general market and in various neighborhoods. The key is to look at the inventory in the category you are seeking to buy or sell. Are there a lot of choices at the present time?  If the inventory is high, the wave is against the seller.

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September 2009

Neil’s Musings…

Wave Theory

The next time you are at the beach, watch the waves rolling in and out. Each one rises to an apex and then crashes down. Then the next comes, rising and then crashing. This same ebb and flow is a good representation of the real estate market in New York City.  We began with a wave of tsunami proportions in 2008. The wave crashed down, then slowly receded, taking a portion of the sand back to the ocean with the force of the undertow. Then a smaller wave rose and it too fell. Now another is beginning to appear as the preceding one finishes receding.

The surge of business activity, which ended in the summer of 2008, was America’s economic tsunami. The real estate market dropped 75% from is peak level of activity and prices dropped by 25% to 35 % in Manhattan. This enormous wave receded in the first quarter of 2009 taking a substantial amount of wealth with it.

Another surge crested in June, when business activity rose to its highest level in a year and a half. In July the wave came down and now, in August, it is again receding. Business activity in July dropped a third from what it had been in June and dropped another third in August. As we enter the latter part of August we are seeing another wave appear. Open houses are showing increased activity. This wave will appear in its fullest in September and October and will again recede in November and December.  These waves will continue unless something of unexpected dimension occurs which disrupts this trend.

What Causes this Wave Pattern?

Consider the nature of the supply and demand between buyers and sellers. An increase in the size of the inventory represents a weakening of the seller’s position.  The resistance of buyers to prices demanded by sellers leads to market inactivity and inventory buildup. Some sellers eventually acquiesce to demands by buyers to lower prices, leading to a cascade of falling prices as other sellers follow suit.  Lower prices bring more sales. As product is absorbed by the increased level of transactions, inventory declines. Lower inventory causes sellers to firm up their positions and prices to rise.  As prices rise, buyers stop buying and the level of activity again recedes. Accordingly, inventory again rises and the cycle repeats.

Let me give you a more concrete scenario. Last year, the West Side activity was at a low level relative to our other neighborhood offices. Prices on the West Side were relatively high when compared to other neighborhoods. The East Side, in turn, was showing greater activity because its prices were relatively lower. A sudden a shift occurred in May. Prices on the West Side dropped, activity shot up and the level of transactions on the East Side quickly receded.

Take the experience of Mrs. Smith, who owned a Classic Six on the West Side. She believed her apartment was worth $2,000,000. It had been for sale on the market for over a year. There were three other apartments in the building like hers and they, too, had been on the market for some time. One day, the seller of one of the other apartments decided to reduce his asking price to $1,800,000 to stimulate buyer interest. After hearing this, Mrs. Smith realized that she, too, needed to reduce her price to be competitive. In short order, everyone selling an apartment in the building was forced to reduce their prices. Finally there was a sale at $1,600,000. Even though Mrs. Smith was not happy about it, she really wanted to sell her home, so she accepted that this was the new benchmark for the apartment’s value.

Now look at Mr. Gold, who has a two bedroom on the East Side. He wants to sell the apartment for $1,800,000. There were other two bedroom apartments in the building that recently sold at a similar price so he was confident that he could also achieve this figure. Offers came in at $1,600,000 and he turned them down since he still believed that the higher price he placed on his home was justified. Sales activity in the building all but ceased. After a few months of inactivity he decided to accept a previous bid of $1,600,000 to move the apartment. He called the broker, who told him that the potential buyer already purchased a two bedroom on the West Side for $1,600,000. Mr. Gold decided to drop his price officially to $1,600,000 to find another buyer.

Surfing the Wave

These waves of activity and inactivity are happening in the general market and in various neighborhoods. The key is to look at the inventory in the category you are seeking to buy or sell. Are there a lot of choices at the present time?  If the inventory is high, the wave is against the seller.

State of the Market

You wrote a month ago that the recession is over. Do you still believe that?

Two months ago the reported inventory of active listings for sale as reported on www.bellmarc.com was 12,100. Today this inventory is 10,800. That’s a 10% decrease in one month! However, there has also been a significant decline in prices. In large measure I believe this is due to the fact that sellers have reconciled themselves to the current state in the market and are no longer expecting appreciation. This, plus the awareness that summer months are normally a slower period have caused many sellers to bite the bullet and accept the price reductions required to make a deal.

 Going forward, we still see a resurgence of buyer activity.  Buyers are hearing about the heated level of business and recognize that their best opportunities are now. The recession is over and the trend is a continuation of higher levels of business activity.

What do you think is the state of new construction in Manhattan? 

Historically, new construction sold at a 30% premium over resales. This premium surged to 60% as a result of the enormous interest by foreigners and investors in new construction condominiums. As this segment of the buyer market declined substantially, developers were left with considerable inventories. News reports about buyers of new condominium projects seeking to back out of their deals also have not helped developers support their current price structures. 

Some developers are having serious financial difficulties, while others are shaving back prices to respond to market realities. There is also considerable activity in bulk sales, where developers off-load large numbers of apartments in a single transaction to a vulture fund or opportunistic investor. A significant number of these apartments are being rented as a last resort.

My forecast is that the number of new projects will dramatically decline. The glut in inventory, the elimination of tax laws that favored residential construction and the pressure on banks to cut back on big lending has made the environment unfavorable. The only projects that will be going in the ground are those where prior commitments have been made and the developers have deep pockets to provide significant equity to the projects.

What do you think of the rental market?

The bad economy has eliminated much of the upside potential for rental properties. Many developers are finding it slow going to fill their properties and landlords have resorted to paying commissions where, for years, commissions were paid by the tenant.  We are seeing owners offering free months’ rent in addition to lowering monthly charges. I view the rental market has a soft component for some time until the economy shows a lower level of uncertainty. There are too many properties available to support any strengthening in prices of these properties.           

Where do you see mortgage rates going – up or down?

For years mortgages rates were a function of the tradable values of mortgage-backed securities on Wall Street. Since there were enormous sums of money going into this market, interest rates remained historically low. This has substantially changed. 

The U.S. government’s takeover of Fannie Mae and the government’s significant influence over the entire banking industry has cause interest rates to become part of political policy. The current low level in interest rates is very much a function of the federal government’s intention to keep the mortgage markets open and affordable regardless of market conditions. I don’t think this is likely to change in the foreseeable future. Interest rates will sell within a limited band of 1 or 2 percent with a target rate of 5 to 5.5%. We will also see a substantial reduction of adjustable rate mortgages that are under 5 years. The government is looking to create stability and variable rate mortgages are a large threat to that goal. 

When will Manhattan housing prices go back up?

There are two factors that need to be resolved before substantial price appreciation will appear.

The first is confidence. The typical buyer must feel secure enough with the economy and their employment status that the challenge of buying a more expensive home is an opportunity worth taking.

The second is inventory. A further reduction of inventory is needed to support a more favorable position for sellers relative to buyers.

There are many people who believe that, as a result of the enormous amount of lending incurred by the government, inflation is pending and that real estate is a good hedge in this kind of environment. Many economists are unsure that inflation is clearly in the winds since the money supply available in the market at any given time is being controlled by the Fed.  Therefore, I am unclear if the possibility of inflation will really appear and what affect it will have in the marketplace.

The New Economic Climb

I recently received a shareholder’s report from a company in which I own shares.  I think the first paragraph of the letter provided by the President of the company is very interesting reading, so I have decided to pass it along:

“Dear Shareholders,

2008 brought all sorts of challenges to investors. Throughout the year, the financial sector was plagued with failures in banking, insurance and brokerage firms. By year’s end, after a meltdown in the credit markets, historically high levels of volatility in the stock market, and the resulting turmoil to the overall economy, the Dow’s total return was -31.92% (as of 12/31/08). In fact, 2008 was the Dow Jones Industrial Average’s third worst calendar year since its inception in 1896. For the year, the negative total return performance of the Dow was surpassed only by 1931 and 1907, two years in which the U.S. was also enduring a major banking crisis. Of the thirty stocks in the Dow, only two were up in 2008. For the first four months of 2009, however, the market has shown positive signs. In fact, many economists believe the recession that began in December 2007 ended in March 2009.”

The recession is over. Buyers are looking and buying. Sellers are accepting that a new era has begun and they have reset their prices to reflect a reduction of 25% to 35%.

This is the beginning of our new economic climb. It will not be a straight upward road; however, the trough is past and the best buying opportunity in the last 10 years is upon us.

The Recession is Over

            Most of you who have been reading the press and have seen numerous articles portraying the decline in the market values throughout the country. The most recent of these articles that I have seen state that prices have declined almost 20%. I suggest to you that these figures are not really reflective of the current market environment since they relate to transaction closings where the offer and acceptance normally occurred three months prior. The true decline in prices has been dramatically greater. At the present time, I am easily seeing 25% declines and in some areas the declines are 35%.

            As real estate brokers, we focus on the trend. An upward trend puts pressure on buyers to accommodate the seller and in a declining market this is reversed—buyer reticence puts pressure on the seller to accept less. Transaction activity intensifies as both parties become more aware of this trend – what we call the bandwagon effect. Let me give you Bellmarc’s activity portray over the last six months. I use January 2008 as the benchmark for an “average month”:

• December 2008 – 25% 
• January 2009 – 35%
• February – 35%
•  March – 30%
• April – 40%
• May – 55%.

            As you can see, activity levels were lumbering along and suddenly in April a glimmer of activity showed after a decline in production in March. In May activity became the strongest it has been in six months and it appears to be further intensifying.

While this increase in activity is apparent to us all, it is also interesting that the increase in activity is coupled with a much greater decline in prices in a short period of time. It seems that people are getting it. Sellers are beginning to recognize that in order to sell their property they have to face the buyer’s demands rather than insist on numbers that are just not achievable in the current environment.

            My prediction is that inventory will continue to decline. We have finally dropped below 12,000 apartments for sale for the first time in six months. We are seeing strong attendance at open houses and managers are reporting strong buyer interest generally. We are also registering increased numbers of transactions.  These are all good omens that portray the beginning of a very strong real estate market. Hold on to your seat ladies and gentlemen. Three months from now you’ll read it in the newspapers: the recession has come to an end.

Lunch With Senator Shelby

             I had the pleasure of having lunch with Senator Richard Shelby from Alabama, who is the ranking Republican member of the Banking, Housing and Urban Affairs Committee and the Appropriations Committee. There were six of us at the lunch so I was able to ask him some pertinent questions relating to our business. I also found that some of the questions from the other parties were very useful.

            We started talking about the automobile industry. Senator Shelby believes that things are not good. He expects that General Motors will enter into bankruptcy. He also believes that the bondholders and the unions are not making the concessions necessary to create a viable plan and that bankruptcy is the only way that these issues can be seriously addressed. According to Senator Shelby, “Now that Wagoner is gone and they know we mean business, maybe they’ll wake up, but I don’t think so.” He also said that Chrysler has no choice, “They either find a partner or they’ll go into bankruptcy too.”

            I then asked him about the bank financing problems we’ve been having. I told him that the banks are creating ridiculous rules and that getting a contact signed on a real estate deal should be the hard part-not getting the loan. He smiled and said, “The banks have a lot of money. Unfortunately, they don’t want to use it. I don’t have the ability to make them use I,t only to give it to them.” 

            I mentioned that Fannie Mae rules are being complied with to the letter and that many of these rules are ridiculous.  Senator Shelby answered that he had heard this before and that he realizes that things have gone to the other extreme, “I truly believe that everyone is being overly careful,” he said. “Remember, Fannie Mae is now under government control. That means an additional bureaucrat is looking over those documents. I believe things will work out over time but not immediately.”

            Senator Shelby also talked about the future of real estate. “We have put trillions into the banks. To be honest with you, no one knows what they are doing-they are just throwing money at the problem in the hope that it helps. Even Federal Reserve Chairman Bernanke is saying that he is uncertain what to do.”

            I asked him what a buyer should do in the current situation. According to the Senator, “If he has gold plated credit he should buy. It’s a great time to buy because in six months there’s going to be inflation. So much money is going into the economy that there is no other possibility. Owning real estate is the best hedge there is in an inflationary period. I also believe it makes sense to reduce your leverage. Too much borrowing can be particularly dangerous at this time.”

            Discussion then focused on current legislation in Congress entitled “Hope for Homeowners,” which permits the government to force a reduction in payment on a first mortgage for a period of years and also calls for a reduction in the loan value in certain circumstances where there is a bankruptcy (referred to as the Cram Down provision). There was considerable unhappiness among some of the luncheon guests, who expressed concern that this was intruding on a valid contract and impairing the value of an existing loan. Senator Shelby is sympathetic to their position and feels that the proposed law is not a good means of dealing with the current situation. However, he noted, “This is a populist bill. It helps people struggling with their payments and ignores property rights and contract rights. I also feel there are real constitutional issues present. Nevertheless, I believe the bill will be attached to a budget resolution that requires only 51 Senators to approve. I see a good likelihood it will pass even though I’m not in favor of it.”

            At the latter part of the luncheon, the Senator made an overall evaluation. “We are dealing with big political issues. Everyone is on a train racing as fast as they can to address serious problems without taking any time out to think about it. I think this is a mistake. We need to pull over onto a side track. We need to slow down and take a closer look at what we are doing.” 

(ED NOTE:  All quotations are paraphrased.)

Bank Evaluation and Projection

           It’s All About Money.

            On Friday, March 20, 2009, an article appeared in the Money and Investing section of the Wall Street Journal that has great significance. The article, entitled, “Best Check on Inflation: Broken Banks,” didn’t seem to give away awesome information on its face but I assure you that it did – I will explain why.

             There is a well respected school of economics referred to as Monetarists. They are best known through their leader (who is now dead): Milton Friedman. Monetarists believe that the key to maintaining control over inflation is a function of the money supply. To the extent that the money supply grows significantly, there is more money chasing a given level of products and services naturally leading to an increase in prices. In turn, if there is a decline in the money supply there is a natural tendency for deflation. However, in additional to the actual supply, there is also an issue of the velocity of money. That is, how many time money turns over in the economy. Thus, even if the money supply grows, if the level of velocity in the use of money declines the net effect is that the “supply” is dampened by the reduction in use.

            This article reveals that the most commonly used measure of money supply, referred to as “M2″ as reported by the Federal Reserves has grown 10% in the last year-an increase of $767 billion. This is a dramatic increase that would imply that there is inflationary pressure. However, the velocity, the speed of its being used, fell in the fourth quarter of 2008 to its lowest level since 1991 and based on the expected decline in the first quarter of 2009, the velocity measure is expected to be at its lowest level since 1987.  According to other measures used by experts,  the velocity level is at an all time low.

            If there is such an increase in money and it isn’t being spent,  then where is it going? A lot of it is sitting in banks. They have parked mountains of cash in their reserves. In August of last year bank reserves were $45 billion and at last count they are now at $657 billion. Thus, almost the entire amount of the increase in money supply is just sitting asleep in banks. 

            When is this money going to go to work? Now they are keeping this money to protect themselves against defaults and other prospective losses, but they are paying interest on it, so eventually they have to figure out how to make it earn income. When  the economy shows a bit of stability, this money is going to be blowing out their windows as they desperately seek to earn enough income to show a profit for the year 2009. Historical records confirm this position– it has taken two to three quarters after the build up massive reserves for banks to start putting money in the hands of consumers and businesses. I predict that the third quarter of 2009 is going to be when the market heats up and everyone starts realizing that its time to start taking advantage of investment opportunities.

            The article has some caveats reciting the continuing lingering effect of loan losses. I say,  not so; the government will be buying up toxic loans like crazy (many of which are not toxic by the way and having been paying debt service without interruption every month) and with increased business activity the pressure on every segment of the economy is going to be dramatic.

 

The Market Outlook

President Obama spoke to the country and inspired us to take a positive view of events to come. My projection for the Manhattan market is optimistic. I see the following events to come:

1. Wall Street will change. Many big hitters with the major banks will go off on their own setting up investment houses with their client bases in order to make the big profits that the government will not permit the banks to give them as bonuses.

2. Investment incentives for real estate will be restored. Paricularly conversions from commercial property to residential.  This makes much more economic sense than building enormous new projects like the hudson yards and will get construction going rather quickly.

3. Large blocks of new constructed properties will be sold to investors in order to take developers out of a difficult situation and will then be rented. Rents will continue to be soft for years to come.

4. Money is readily available for mortgages but the the amount of equity required by banks will be 65% to 70%. This will increase the tendency for seller second mortgage financing for 5 to 15% in order to accomodate buyers demand for leverage and help sellers get a top level price.

5. While prices are down between 10% to 30% depending on the relative supply of that type of property, there is an increase in buyer interest in open houses and transactions have improved 50% from December. The trough is past and the market is showing definite firming.

February Musings

While every firm will acknowledge that these are difficult times, I for one am seeing a number of signs that point to a positive market in the near future. These are my reasons:

1. The Stock Market: The Dow Jones index, which six months ago exceeded 12,000 is now hovering around 8,000. The index had fallen as low as 7,500 and seems to have gained traction in the 8,000 range. Most financial analyst believe that the market has already absorbed not only the bad news that has occurred but also the bad news yet to be reported in the next few months.
2. The Government Stimulus: It appears that the $900 billion government stimulus plan is about to be approved by Congress and sent to the President for signing. While there is still some negotiation going on with the Senate to alter the bill to afford more tax cuts rather than direct government direct spending, it is all but assured that this major infusion of capital into the economy will occur. This will create renewed activity in certain sectors and create a positive trend in economic activity.
3. Toxic Mortgages: Over the last six months, the government has spent billions to cover the effect of declining values of mortgages held by banks. It appears that the worst of this is behind us. In large measure many of these mortgages are now guaranteed by the government against losses and the banks are now positioning themselves to recuperate from this disaster. The only downside is that banks need to replenish their reserves and are being conservative in their lending policies. However, the government is strongly encouraging banks to lend and the level of lending should improve in the next six months.

I also hear that buyer attendance at open houses is increasing and the number of transactions has somewhat improved. What do you think?

Welcome to our new blog site!

Bellmarc is pleased to introduce our new effort to keep you in the information loop on residential real estate in New York City.  This blog will be a source of continuous information about the market and can be used to post your questions and comments so that we may serve you in the best way possible.   I hope it meets your needs and thank you for logging in —rock and roll!

Neil Binder