What Has Happened To Manhattan Property Values?

What Has Happened To Manhattan Property Values?

 

By James R. MacCrate, MAI, CRE, ASA

Real estate appraisers have to be wondering what property values are doing in Manhattan and elsewhere.  Clearly, the real estate market is being hit by numerous factors that are affecting property values.  The following chart indicates how Manhattan apartment values have changed in comparison to changes in the nationwide apartment value index, CPI index and applying capitalization rates to the projected changes in income to develop indexes based on the average and median long term (20 plus years) capitalization rates.  From 1998 through 2003, apartment value trends followed the CPI very closely.

82008-miller-blog

The nationwide apartment value index followed a similar pattern to New York’s until 2003.  If the long term average or median capitalization rate is applied to the projected net operating income, apartment values in Manhattan would not have kept pace with inflation in New York.

Impact of Financing 

Other factors drove the increase in apartment values.  The following chart indicates the path the apartment capitalization rates took for the last eight years or so.  Optimism, lower interest rates, huge capital inflows (beginning in the latter part of 2003) and tax free exchanges drove apartment prices into a bubble that is waiting to collapse.

82008-miller-blog2

If it is true that over the long term real estate values keep pace with inflation and returns regress toward the mean, Manhattan apartment values are in for a rough ride.  If rates of return do regress toward the mean as interest rates increase, a large drop in value is indicated or values will remain stable waiting for the CPI to catch up.  During the 1970’s and early 1990’s, apartment values declined and, then, stabilized for several years.

But Wait…….

 Not only are interest rates and debt coverage ratios increasing, all operating costs are increasing quite rapidly in the New York area.  The NYC RGB forecasted the following expected increases in operating expenses from April 2007 through April 2008 for all apartment projects as follows:

Taxes                             0.3%
Labor Costs                   4.0%
Fuel                              37.4%
Utilities                          8.9%
Contractor Services      4.6%
Administrative Costs     5.3%
Insurance Costs              2.3%
Parts and Supplies          2.3%
Replacement Costs         4.0%
All Costs                            7.8%

During the first six months of 2008, fuel costs have already reportedly increased 20% annually.  Real estate taxes will have to be increased more than expected to cover the shortfall in city revenues from other sources.  All other costs will probably follow the inflationary spiral that has begun.  Increases in rental income generally lag expense increases.

What will hurt apartment values will be increasing capitalization rates, operating costs and switching from interest only loans to amortizing loans.  It would not be surprising to see an increase in delinquencies within the next six months or so.  Lenders will be forced to modify loans or foreclose.

In addition, the New York City Comptroller’s Office issued a report stating “the real estate sector accounted for nearly $200 billion of the New York metropolitan area’s gross product in 2005, showing a location quotient of 1.3, or 30 percent higher than the national average.”   That sector is contracting along with the financial services sector which accounts for 13.6 percent of the regional economy.  Job growth is slowing and unemployment is rising.

So, The Question Is Not If But When? 

The following chart provides a summary of the estimated apartment capitalization rates over time.

 

 

 

 

Estimated NYC

 

Ten Year Bond BAA Bond 30 YR Mortgage

Apartment Cap Rates

 

 

 

 

 

Long Term Average (Twenty Years)

 

 

Average

5.99%

8.05%

7.62%

7.89%

Median

5.86%

8.02%

7.43%

8.51%

 

 

 

 

 

Ten Year Moving Average

 

 

Average

6.49%

8.35%

7.97%

8.65%

Median

6.49%

8.35%

7.98%

8.66%

 

 

 

 

 

Five Year Moving Average

 

 

Average

5.59%

7.71%

7.22%

8.15%

Median

5.69%

7.84%

7.42%

8.55%

 

 

 

 

 

10 Year Average

4.82%

7.13%

6.61%

7.38%

5 Year Average

4.38%

6.45%

6.10%

6.15%

 

 

 

 

 

Source: Korpacz Real Estate Investor Survey, Real Capital Analytics, MacCrate Associates LLC.

With capitalization rates falling below 6.00% during the mid-2000, it is only a matter of time for the rates to regress back to the mean and let the air out of the balloon.  The events unfolding were predictable and the general historical patterns are similar.  Financial regulation and sound underwriting policies disappeared during this time period of “irrational exuberance.”

For current information, see Apartment Glut Deepens in 2009.

Originally posted on Soapbox.

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About Jim MacCrate

Real estate appraiser and valuation consultant for more than 30 years specializing in reviewing real estate appraisals, risk management and quality control.
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