Supply and Demand
Last, we will look at good old-fashioned supply and demand. In order to try to determine in which direction the market is headed, we must look at trends within the supply of available properties and must also consider what the demand side of the equation looks like.
In 2007, we had $63 billion worth of investment-sales transactions in the New York City marketplace. This amount dwindled to just $6.2 billion in 2009. Many people blame this 90 percent reduction in transaction volume on either a lack of buyers in the marketplace or the oft-mentioned bid/ask spread.
The first of these reasons is clearly not appropriate, as throughout the worst points during the recession, there was still significant buyer interest in New York City investment properties. As to the second reason, there may have been a slight bid/ask spread dynamic; however, supply constraint had much more to do with the reduction in volume than anything else.
The supply constraint condition is easy to understand when we look at the market from a macro perspective. The supply of available properties for sale is normally fed by discretionary sellers. When value drops, as it started to in 2008, discretionary sellers withdraw from the marketplace, as they could have sold their properties for higher prices previously. As discretionary sellers withdraw, distressed sellers normally swoop in to fill the void.
However, during this recession everything that has happened from a regulatory perspective has allowed distressed sellers to delay facing their problems. Whether they were changes in FASB mark-to-market accounting rules; bank regulators allowing lenders to hold loans on their books at par, even though the collateral is worth substantially less; or changes to REMIC guidelines for dealing with securitized loans, each of these have provided distressed sellers with cover not to take action.
We are now seeing distressed assets come to market with greater frequency as lenders and special servicers seek to clean up balance sheets. We’re also seeing discretionary sellers come to market with assets, as there has been significant pent-up selling demand. Discretionary sellers are also reacting to the anticipated increase in capital gains rates, adding properties to the available supply for sale.
Thus far, this added supply has not exerted significant downward pressure on value. A regulatory change impacting how banks handle their loan portfolios could have a significant impact on supply. We do not believe that this will occur, however, as it could have devastating repercussions for hundreds of banks across the country.
On the demand side, we’ve seen significant buying interest from all segments of the marketplace. In the summer of 2007, when we first started to tangibly feel the impact of the credit crisis, the institutional capital that inflated the asset bubble in the 2005 to 2007 period evaporated from the marketplace. Most of our transactions since that point in time were acquired by high-net-worth individuals and New York families who have been active purchasing properties here for decades. Recently, we have seen a reemergence of institutional capital, which is back in the marketplace with distressed asset buying funds and opportunity funds. They are joined by foreign high-net-worth investors who have come to the New York marketplace in numbers we haven’t seen since the mid-1980s.
Therefore, the demand side of the equation is in high gear. We will be focused on monitoring the supply side to try to determine what volume trends will look like as we move forward. The available supply of properties for sale is likely to have more of an impact on the future of the investment sales market than any other factor.
Robert Knakal is the chairman and founding partner of Massey Knakal Realty services and in his career has brokered the sale of more than 1,100 properties, having a market value in excess of $6.8 billion.