Manhattan Property Values and Capitalization Rates

By James R. MacCrate, MAI, CRE, ASA

Overview

In a previous post in 2008, What Has Happened to Manhattan Property Values?, the factors that would affect real property values in New York City were discussed. It was pointed out that real property values would decline because the gross potential income would fall, vacancies would increase along with rental concessions, property operating expenses and capitalization rates. We are sorry to say that prediction proved to be correct. If we analyze the national investor surveys published by several firms, one can isolate the various factors that are impacting real property values to the downside. For example, the following chart summarizes the average investor-expected changes in market rents and expenses reported by one of the national real estate investor surveys for office buildings. 

Year

Overall Cap Rate (OAR)

Market Rent Change Rate

Expense Change Rate

 

Average

Average

Average

2001

9.54%

2.33%

3.17%

2002

9.33%

0.92%

3.33%

2003

8.21%

0.93%

3.33%

2004

7.54%

1.36%

3.33%

2005

6.48%

2.14%

3.33%

2006

5.80%

6.71%

3.25%

2007

5.52%

6.91%

3.21%

2008

5.81%

3.03%

3.21%

2009

6.65%

-5.50%

2.75%

2010

6.65%

-3.75%

2.67%

Changes in Value Caused by Capitalization Rates

The following chart summarizes the effect on the indicated value as a result of changes in the expected overall capitalization rate and based on the assumption that the annual net operating income was $1,000,000. 

Year

Net Operating Income

Overall Cap Rate (OAR)

Indicated Value

Indicated Change in Value

2001

$1,000,000

9.54%

$10,482,180

 

2002

$1,000,000

9.33%

$10,718,114

2.25%

2003

$1,000,000

8.21%

$12,180,268

13.64%

2004

$1,000,000

7.54%

$13,262,599

8.89%

2005

$1,000,000

6.48%

$15,432,099

16.36%

2006

$1,000,000

5.80%

$17,241,379

11.72%

2007

$1,000,000

5.52%

$18,115,942

5.07%

2008

$1,000,000

5.81%

$17,211,704

-4.99%

2009

$1,000,000

6.65%

$15,037,594

-12.63%

2010

$1,000,000

6.65%

$15,037,594

0.00%

 It does appear that average office property values are beginning to stabilize based on the leveling off of overall capitalization rates.

Indicated Changes in Value Caused by a Limited Number of Factors

If one just analyzes the changes in the expected capitalization rates, market rent and expense growth rates, the impact on value can be clearly observed. 

Year

Adjusted Net Operating Income

Overall Cap Rate (OAR)

Indicated Value

Indicated Change in Value

Cumulative Change in Value from 2001 to 2010

2001

$1,000,000

9.54%

$10,482,180

   

2002

$988,474

9.33%

$10,594,577

1.07%

1.07%

2003

$976,339

8.21%

$11,892,077

12.25%

13.45%

2004

$971,529

7.54%

$12,884,995

8.35%

22.92%

2005

$981,029

6.48%

$15,139,329

17.50%

44.43%

2006

$1,080,777

5.80%

$18,634,093

23.08%

77.77%

2007

$1,192,913

5.52%

$21,610,742

15.97%

106.17%

2008

$1,227,178

5.81%

$21,121,818

-2.26%

101.50%

2009

$1,070,723

6.65%

$16,101,105

-23.77%

53.60%

2010

$959,441

6.65%

$14,427,685

-10.39%

37.64%

 
The preceding chart indicates that the peak in real property values occurred between 2006 and 2007, while overall capitalization rates continued to decline and market expectations peaked. It is interesting to note that the adjusted net operating income based on the average expected change in market rents and expenses has declined if  it is assumed that concessions, vacancy and credit loss remained level during this period of time. In fact, concessions and vacancy rates are higher now which would indicate that the loss in value is greater than indicated in the chart. Another interesting observation is that expenses have increased faster than the average growth in market rent over the last ten years.

Conclusions

The financial market participants have created a mess for commercial property owners.  Commercial property values have fallen more than 30% at stabilized occupancy.  Clearly, the situation is much worse when one factors increases in the vacancy rate and rental concessions. Now, what happens if interest rates are increased and financing is more difficult to obtain?  For further support visit Moodys/REAL Commercial Property Price Index (CPPI).

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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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2 Responses to Manhattan Property Values and Capitalization Rates

  1. Jim, this kind of basic analysis is so important. I draw several conclusions/observations. 1) the CARG is 3.25% over the ten years. That may be a sign that we are back to a normal long term trend in values and may be the markets have bottomed out, 2) if 2001 was a representative normal year, which is a question. 3) Since they didn’t listen to you when you said the markets were over primed, don’t be surprised when they don’t listen to you when you tell them that markets have bottomed. Fear and girly-man currently reign, and they will probably wrongly drive markets lower with higher interest, LTV, DSCR and risk rates and premiums, some of which is probably needed to get back to true sound due diligence and values, but will most likely go too negative.

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