One of the most frequently speculated about and most difficult statistics to quantify in our marketplace has been the drop in Manhattan’s commercial real estate sales values. Thus far in 2009, a lack of abundant data points makes this difficult, and I have read estimates ranging from 20 percent to 70 percent. Ironically, both ends of this range are partially correct. The reason for this is that we must conduct this analysis utilizing market segmentation in order to get a real sense of how different product types are performing.
It is important to realize that value is predicated on two volatile items: revenue and yield expectation (operating expenses are fairly consistent on a property-to-property basis). We have seen across-the-board reductions in market rents across all sectors of the marketplace. We have also seen increases in the capitalization rate, or yield, demanded by investors in the marketplace. The combination of these two metrics affects prices per square foot, which, ultimately, determines the relative price fluctuations in the market.
Let’s take a look at how each Manhattan property type has performed year-to-date and how this performance compares with peak levels achieved in either 2006 or 2007. The year in which the peak occurred is dependent upon the property type.
• The rent-regulated apartment building sector is, clearly, the best performing. Thus far in 2009, walk-up apartment buildings have had an average capitalization rate of 5.28 percent, up 128 basis points from its low in the first half of 2007, of 4 percent. This increase in cap rate (without taking into consideration revenue fluctuation) equates to approximately a 24 percent reduction in value.
Interestingly, if we look at price per square foot, walk-up buildings are averaging $511 per square foot this year versus their peak of $605. This represents only a 16 percent reduction in value. The reason that this percentage reduction is lower than the cap rate expansion would dictate is because the revenue in the rent-regulated sector (unlike in any other sector) has continued to increase on a building-wide basis even though market-rate rents have declined. This illustrates one of the advantages of rent-regulated buildings in that there is significant embedded upside potential based on the artificially low rents that regulation caps and an owner’s ability to increase rent-regulated rents to unlock this potential. This analysis is reflective of this unique dynamic.
• In the elevator building sector, average capitalization rates this year have been 4.08 percent, also up, coincidentally, 128 basis points from their low point in the first half of 2006, of just 2.8 percent. The 2.8 percent cap-rate average in 2006 is reflective of the condo conversion craze during which these buildings were, essentially, selling on a price-per-square-foot basis with little attention paid to yield.