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« previous: How are disclosures different for co-ops and condos?   |  next: State of the Mortgage Market »

Monday, September 3, 2007

Facing the Fall? Seasons change in NYC real estate

"It may just turn out that co-op boards provided exactly the kind of greater oversight that was needed, and mitigated the risks better, than the gate keepers in the banking industry"

fall_ripples.jpgopinionAs the post Labor Day summer turns into Fall, will we see a fall in the NYC housing market too? I returned from vacation in mid-August to stories of impending doom in the housing market because of a spreading crisis in the sub-prime lending market. That very same week the New York Times ran The Manhattan Real Estate Slump That Wasn’t, which told a story I knew to be true. During the first half of the year, Manhattan was selling strongly. Any real effect of the credit crisis has been unobserved, it's all perception so far. Is the glass that seemed half full at the beginning of summer, suddenly looking half empty now? Can Manhattan continue to be insulated from the market forces affecting the nation?

People planning to move may need to take a second look at their spending power. There are some customers on the edge of qualifying for mortgages using interest only, or stated income (undocumented asset) loans, who suddenly find themselves facing a much bigger hurdle than before. They may need to re-evaluate their plans as tightened underwriting standards qualify them for lower mortgage amounts, or push them out of the market entirely. Climbing interest rates due to the recent volatility in stocks may not lead to many foreclosures in Manhattan, but will erode the available pool of buyers for any particular property. The effect has the possibility of translating into greater negotiability, or even downward pricing pressure. Larger down payments and stable income sources will win the day for home buyers.

In 2006, as the press carried stories of a national housing crisis; market demand cooled a little too. The Manhattan effect was that people thought a buying opportunity might exist. As soon as it became apparent that there would be no crash, they rushed in to fill the gap. They drove prices up, and inventory down. That's the demand side of the equation reacting to the actual local market— not the perceptions of a larger, but less relevant condition. Cash rich bargain hunters and bottom feeders just keep getting disappointed by the NYC real estate market. It all runs counter to the experience of the rest of the country, which is indeed seeing a price correction.

have those pesky co-op boards saved New York?

New York City is overwhelmingly an owner occupied market, with 80% of our housing market being cooperative apartment buildings. Primary residency is required to buy into a co-op, so speculation is effectively outlawed by house rules. A co-op's Board of Directors has a mandate to protect existing shareholders values by avoiding risk. It may just turn out that co-op boards provided exactly the kind of greater oversight that was needed, and mitigated the risks better, than the gate keepers in the banking industry. Any transaction deemed too edgy for the collective interests of the owners, will be rejected. A Board has the unique ability to turn down a prospective buyer if housing expenses and total debt to income ratios are out of line with what they consider comfortable— it doesn't matter if a buyer has a lineup of lenders ready to finance the transaction.

Unlike the practices which have triggered the credit crunch, co-ops require potential purchasers to submit an elaborate Board package; with full disclosure and documentation of assets, higher down payments, and greater personal liquidity required. There are no undocumented assets in co-op sales, (except possibly in the rare instance of a sale by sponsor) in Manhattan. Some co-op Boards simply won't permit 'interest only' and other exotic mortgage products.

In Manhattan, it may just turn out that co-op boards provided exactly the kind of greater oversight that was needed, and mitigated the risks better, than the gate keepers in the banking industry. My guess is that there is little increased risk to foreclosures in the Manhattan co-op marketplace, as a result of the national credit crisis. Its higher barrier to entry, requires an excellent financial profile to buy in. That leaves an inherently smaller pool of customers competing for these properties to begin with, and therefore the possibility for overheated demand and inflated values, is diminished. These properties are in short supply, and are likely to hold their values.

as for the condo market...

About 50% of recent sales in NYC have been condos. As a category, these have more exposure than co-ops to interest rate adjustments, speculative purchasers, and exotic mortgage products. How much exposure is anyone's guess, but these represent about 20% of the city's owned housing stock, and is overwhelmingly newer development. This is the arena where the doors were most open to risk, which in my opinion will turn out to involve over-extended speculators, more so than owner/occupants. Most of our condos too are lived in by their owners. Not that a couple of foreclosure properties in one's building wouldn't have a spillover, negative effect on value; but the damage would be largely localized. I'd even venture to say that demand is so strong for these homes that almost none would ever make it into foreclosure. Properly brokered, an owner could put them up for sale at a competitive price, and get market value for their property.

demand is still strong

Growing demand for housing here is not going away soon, we have a growing population. New York has always been a magnet for the successful, and lately for well-heeled retirees, whom are choosing places like Manhattan for the access to culture, services and medical facilities which retirement communities tend to be softer on. We are lucky to have growing demand from a pool of well qualified individuals. The market for condos and investment properties in Manhattan is also being buoyed by a strong international appetite for them. The weak dollar has created opportunities for European and Asian buyers, who suddenly are getting a lot more for their money. It's a market force you won't likely find playing out in many other parts of the country, and is contributing to the recent robustness of the market.

As a matter of fact, the only fall I can actually point to as of right now is not that of prices, but of inventory which is down by 31.5% from a year ago according to appraisal firm Miller Samuel. That's a huge drop and a trend that would indicate values still on the rise.

the Wall Street ripple

This is not to say that the ripples of the credit crisis won't touch the Manhattan market, but in my estimation, its not a tidal wave. We may see more modest adjustments of supply and demand at work, rather than a crisis of confidence in New York City, or a glut of foreclosure properties. The effects, if any, will be from a shrinking pool of buyers. These could be caused by an up tick in interest rates (still at very favorable levels historically) making a purchase more expensive, or Wall Street employees having a bad year. It remains to be seen if it will be enough to put any downward pressure on asking prices.

“Defaults are on the rise in most parts of the country, but it should be recognized that it is not always the case of a homeowner losing his or her home but is often the case of an investor gambling on a continued increase in home values and losing that gamble”

In other parts of the country, speculative buyers who placed the wrong bets, may get hurt as pointed the quote above from an Associated Press piece in Friday's NY Times. While there is some speculation happening in NYC, it is far less than in other places. The national housing slump is not just limited to speculators, there is plenty of pain to go around. Nationally, many people are in trouble, and an increasing amount of delinquencies today, will lead to increasing foreclosures over the next year. Underwriting standards have tightened greatly as a result of the crisis. A mortgage may be harder to get moving forward; But borrowers with good credit and lower debt, should still be able to make deals.

The jittery stock market we've experienced in recent weeks is due to the fact that the exposure to sub-prime laced Mortgage-Backed Securities (MBS) and Collateralized Debt Obligations (CDO). Complex financial derivative products and investments by private hedge funds add to the opacity of the problem. That's why the market is volatile. The cost of sub-prime risk was underestimated, and spread so widely, that it seems to reach globally and into many pockets. It's hard to know how much of that credit will default and where the exposure is. At the end of the day, diluting the risk of the sub-prime paper was not the same as eliminating the risk. Garbage in— garbage out.

How all this volatility translates into profits for financial firms is an open question this year. The possibility that Wall Street salaries and bonuses may be less robust, is another factor that may impact our residential market. Those bonuses are often larger than base salaries, and a good deal of them traditionally go toward property purchases in the first quarter of the year. If they are significantly reduced it will be a direct result of the sub-prime meltdown, and have a direct influence on the 2008 NYC marketplace. it's not doom and gloom, but your stock broker may have to delay gratification, and pine for that trophy penthouse for a little while longer.

Updated 09.24.2007

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