01/08/09

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Bringing the bull to his knees

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.