2007 Outlook for Real Estate

This week I went to a panel discussion organized by the ULI on the Economic outlook and trends in the Real Estate Industry for 2007. Both panelists, Mark Zandi, Chief Economist of Moody's Economy.com and Robert White, President of Real Capital Analytics, gave utterly and totally amazing presentations, Zandi on the residential market and White on the commercial market. The following are my notes from the event, with particularly interesting things bolded for emphasis. My comments will follow at the end.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

Mark Zandi, Chief Economist, Moody's Economy.com

GDP growth was about 2% this past year, which was below potential, as we need 3% GDP growth to sustain a stable rate of unemployment.

Housing construction was off 30% with housing price declines of about 14% nationally.

This slowdown in housing has shaved 1% off of GDP growth, so the housing sector is then really pulling the economy down.

There have been measurable housing price declines in: Boston and DC because of affordability issues, Michigan, Ohio and Indiana due to a rather bad economy in these areas, Florida because investors are leaving the luxury condo market and Denver, Phoenix and San Diego, most likely because of overbuilding.

The Metro NYC area (defined as: the 5 Boroughs, Bergen, Passaic, Westchester and Putnam counties) sees an economy that is better now than it was in the late '90s/early '00s.

Fed tightening of interest rates is less likely.

On affordability - housing affordability is beginning to improve as prices soften, set to improve so that 1st time buyers can get in - HOWEVER, lenders are getting tighter, so people may be less likely to get loans.

Real estate flippers are exiting the market.

On overbuilding - some 500,000 - 750,000 new houses need to be absorbed by the market before housing construction can continue. Still, supply is less than demand, so housing starts are likely to keep declining.

Housing construction will be lighter in NYC.

Wall Street accounts for 12% of jobs and some 25% of income in the NYC area.


Risks
-----

Bond market trends (an inversion of the yield curve) portend recession (bond markets predict recession by 1 year). Before every recession since WWII, there has been an inverted yield curve.

A housing market correction could be more substantive than initially thought - spillover could be substantive in the rest of the economy.

BUT...the stock market isn't concerned (so far) with these risks. The stock market usually falls prior to recessions, so according to the stock market there is no more recession but stock markets predict recessions by 6 months.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

Bob White, President, Real Capital Analytics

The correction in housing markets is not really affecting commercial real estate markets.

The average price of a hotel in Manhattan is $650,000 per sq. ft. per key.

Real estate prices in NYC are some 3 - 4 times the national average (apartments are getting into $1000 per sq. ft.)

Prices are being driven nationally (by stock market speculation, financing).

Sales volume is very strong in the office (both Central Business District and suburban) and retail (but not so much regional malls).

Trend towards increasing deal size (Peter Cooper Village/Stuyvesant Town deal and the Mall of America deals, for instance). Mall of America deal 2nd largest deal in the country.

The table below lists the largest real estate transactions of 2006.


click on the image to enlarge

2006 saw $43 billion in activity, mostly in the office sector. Manhattan saw 72% of sales volume in NYC Metro area. Outer boroughs saw huge increase in activity ($3.7 billion or 8% of the market). The smart money is going into the outer boroughs. .

The NYC market has twice the sales volume of the LA Metro Market, the 2nd largest in the country.

Cap rates have generally been in decline since 2003, mortgage rates have increased during 2006 (more of an impact outside the NYC area). All property prices are up in inverse proportion to cap rates, equilibrium between the two earlyish in 2005.

There have been rising construction costs over the last couple of years. Also huge surges in land prices (~ $366 per buildable sq. ft.).

Continued inflow of capital into NYC Metro area also driving up commercial real estate prices. 2006 Market consisted of:

34% private in-state buyers
23% institutional buyers
12% fund buyers
11% foreign capital
11% REIT/Public buyers

The NYC Metro market sees a lot of volume, with people both buying and selling buildings

Investors smelling opportunities in the San Francisco metro area.

3 million sq. ft. of Manhattan office space was converted to residential space last year.

Average cap rate in NYC Metro area ~4.6%

Are prices in Manhattan too high? Yes, but not as much as we think - still less than replacement costs. Capital still floods into Manhattan commercial real estate market despite price increases.

Very bullish on Manhattan and NYC Metro area. Get used to higher prices in NYC.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

From Q&A Session

Smartest money in the outer boroughs. The Bronx, especially the South Bronx, is the best deal. Best bet is mixed use near transportation.

Increase in self-employed/small business growth - not as easily captured by economic data - look at tax revenue fir data on self-employment and small business growth.

[The self-employed and small businesses could drive further demand for low-cost office space]
___________________________________________________________________

My Comments

When Bob White said the smart money was in the Bronx, especially the South Bronx, I gasped with shock right there at my table. How long have I been saying this? How many times have I bounced the idea of building low-cost office space for small businesses in the South Bronx, everyone was so skeptical, saying that there's too much of a stigma, not enough services, too far from the center, etc., etc., etc. That this man said this in front of some big players in the industry in New York City, means that things might very well definitely be on the upswing in the Bronx. There is already a lot of housing construction in the Bronx and on my ride home on the Bruckner nearish Hunt's Point I counted THREE construction cranes within an area that is probably only a few square blocks. Then there are the recently finished projects and a project I heard about when a local green developer did a presentation during one of our last REAP classes.

After the panel discussion I spoke to this Bob White briefly and told him I have had similar ideas for some time. He said that the whole borough is actually a good investment, not just the South Bronx. He specifically mentioned the eastern flank of the Bronx as well (a lot of waterfront space there. I have heard that luxury high rises are going up in Throggs Neck, for instance).

This has emboldened me to look into this development project again. As I have bounced the ides off of some people I have gotten tips on where to get funding.

Moreover, since the passing of my father in October, I have received a small (very small, but significant enough, at least to me - under $100,000) inheritance that enables me to contribute a small amount of equity.

I just need to get myself around some people who can provide me with some support, both moral, financial and operational.

Through the interviewing I have done over the last 6 months I have learned a lot about different players in the industry and now know of a couple small consulting firms I could contact for help on things that scared me away from this idea beforehand - like zoning, construction, architecture and financing issues.

I will still continue my search for opportunities as well as some further study at the NYU Real Estate Institute.

A lawyer I know socially who practices in regulatory enforcement (or something like that) and works with a lot of investment banking firms said that an idea for equity that will be less risky to me is to find a company willing to be an anchor tenant and then find and develop the space for them with me contributing my little bit of money and sweat equity. He really likes my idea.

AAREPNY (African American Real Estate Professionals of New York) had a similar event two days later sponsored by a major pension fund. I approached one of their people (whom I had met a couple years ago at a National Black MBA event) who mentioned that they are starting a socially responsible investing group whose sole purpose is to take in new real estate investment deal ideas.

Socially responsible real estate investment in the Bronx is a great thing and it's good to see the business community play its part in the revitalization of distressed areas not just as charity but as a core part of their business.