The coming collapse/price cuts?

Rental comps.
https://streeteasy.com/building/the-alyn#tab_building_detail=3
Lower ceilings and a notch down in finishes perhaps not more than 10 percent discount over the 1289 Lexington.

300, certain properties might still “make sense” to buy by your calculus. My point is that they would have made more sense before, despite the rent increases.

But you tell me. At a price of $2.9M, Keith B rebate, etc., would you have rather bought this with:

- 2.5% 30yr fixed against a rent of $15K/mo
- 5.0% 30yr fixed against a rent of $18K/mo

Feel free to substitute in your favorite mortgage product / relationship discount / etc. Increase / decrease the rents proportionally as you like. But the question is whether, relative to a prior equilibrium, has it become more attractive or less attractive to buy?

I would guess by the calculus of most people, it’s “less attractive”.

Clearly with the rates higher, buying is more expensive. The point I was trying to make is that you can find deals in even in new development in select area but the 1289 property in my argument has some flaws (next to subway entrance on a busy corner) and bad developer history.

Personally, many stuffy coop’s in that area seem well priced if you can get or willing to get the approval.

Btw, the rent pressure seems to be the worst in smallish 1 bed rooms.

What do you think is driving that?

All I can say is one bedroom renter tends to me more in transition in life with high expectation of earning growth vs larger apartment renters. Also, fresh highly educated graduate market has been hot for a while and young ones have decided that living with the parents in Covid was no fun.

Maybe I started this thread two months too early...

Probably going to be less contracts signed this month than any October since 2008.

http://olshan.com/marketreport.php

Luxury Market also pumping the brakes.

@nada yes, the real estate sale has begun.
Brooklyn Market appears to be outperforming Manhattan yet again. I don't like to draw attention to other agents specific listings. However we did get out bid on a lovely townhouse in Brooklyn last week. Nothing dramatic, just one other buyer willing to pay the asking price.

On another note we put a downtown Brooklyn two bedroom / two bathroom DM condo in contract at $995k. Most recent ask was $1.135, last closed price for a similar unit was 1.265 earlier this year.

Curious. If you're buying a larger home that you plan to stay in for 15 to 20 years+ would you rather purchase it with a 30 or 15-year fixed at 2.75%, or pay close to 6-7%, with the expectation of a discount over the next 6 to 12 months? This question is for people that would actually buy a home in New York City.

When I was younger, much younger I went to quite a few dinner parties every week with my in-laws at various apartments throughout the city; Brooklyn heights to the Upper East/West Side. The people that lived in these apartments were long-term New Yorkers, owning the homes for 20 plus years back then. We will be listing a four bedroom three bathroom in ps6 neighborhood. I know the owner as we helped his daughter with a purchase not too long ago, they purchased their apartment in the early 1980s, it hasn't been a full-time home for a few years, but now it's time to sell. Just reminded me of 'old New York', when people committed to staying for the Long haul, they just wouldn't want to be anywhere else.

Keith Burkhardt
TBG

If the *only* reason prices were depressed was high rates, that wouldn't be enough to tip me from renting to buying. Gambling on future refis is risky, and there are more efficient ways to place that bet even if you're a true believer.

Otoh, a discount obtained via a more RE-specific trend (whether local or macro) is a real, permanent savings. And I think you're more likely to find "alpha" on the residential RE side than on a rates trade, though that too is diminishing as institutional smart money worms its way into the sector and the supply of undervalued lots dwindles.

A discount on 30yr fixed is also "forever", or close enough for my purposes. Carrying 2.2% in a 7% world gives me a ton of ammo I can fire at falling assets -- maybe even at other RE, if the mood strikes.

I have to disagree with Richard. I haven't bought because cap rates were 3% in a 3% rate environment. Now that rates are 7%, I would buy in a heartbeat at a 7% cap rate. I am much more willing to tie up a lot of cash at that effective yield. A 7% cap rate would imply a property with $3k maintenance and an $8k rental value could be purchased for $860k. I wouldn't really be gambling on a refi in that scenario.

For those hoping price cuts & rent increases will get us to reasonable cap rates..
Maybe its seasonality, but the segment I look at (N BK, 2bed/2bath) rental market seems to have turned over.
No fee rental listings with re-appearance of free months, price chops and inventory sitting there for a while. A good $1000 below what I was seeing at peak.

WoodsidePaul,
How much do you estimate prices would have to come down to make your scenario a reality?

@Woodside/30-

Re: "A 7% cap rate would imply a property with $3k maintenance and an $8k rental value could be purchased for $860k."

For a moment during this peak, before rate hikes, units in my condo with $2-2.5k maint&tax were renting for ~$7-8k that had sales prices of ~$1.6-1.7M!

So a long way to go, no? Plus as I mentioned in another thread, the rents I am seeing now have dropped about $1k!

I don't think that a 7% cap rate will actually happen anytime soon. However, with current rates, I think that we will see cap rates increase to at least above 5% over the next year and we will see where the market, rates and the economy goes from there. I appreciate that the price change implied by the higher rates is draconian.

An apartment that would rent for $8k/month with $3k monthly maintenance would be $1.7 million at a 3.5% cap rate, $1.2 million at a 5% cap rate and $860k at a 7% cap rate. It is a simple (naive) calculation 12 x (rent - maint) / cap rate = price.

I have been looking at older/smaller ~1200-1300 sqft 3 BRs and converted 2 BRs in UES and UWS which I had seen in the $1.4-1.5 million area but now I see a handful of listing in the $1.2-1.3 million range as inventory increases a little. I think that I would pull the trigger right away at below $900/sqft. We are not picky if we can get our kids into the better school zones without higher maintenance (over $3,500/mo) or a land lease.

Woodside, You can get 5.50-5.75 jumbo factoring in 25-50bps relationship discount. 10y 3.90 10/12. Does it change your expectation of what the cap rate should be for you to buy?

>> Curious. If you're buying a larger home that you plan to stay in for 15 to 20 years+ would you rather purchase it with a 30 or 15-year fixed at 2.75%, or pay close to 6-7%, with the expectation of a discount over the next 6 to 12 months? This question is for people that would actually buy a home in New York City.

This is an interesting question. Depends on the discount, I suppose. Personally, I never found 3% rates attractive in and of themselves as “borrowing on the cheap”. For me, it’d feel like paying a risk-free 3% after-tax. Even after the huge jump in 10yr rates from1% to 4%, I still cannot earn 3% risk-free on an after-tax basis. Like you, Keith, I’m not looking for leverage. I know a lot of people were. “In a low-rate environment, leverage is the only think that works.” I never liked that line of reasoning. Juicing low yields with leverage often ends in tears.

So for a buyer who is paying cash, or planning on paying off the loan quickly, a lower price is more attractive. And at 6%, I’d be more likely to pay cash or pay off the loan quickly than at 3%. I think you’d do the same, and I think this is WoodsidePaul’s counterpoint to RichardBerg’s point.

At 7% cap rate, I would go out and buy something today because that is very compelling financially to get 7% post-tax effective yield vs. relative to my other investment expectations. At the 5% cap rate I would still be a buyer but I would want to line up the timing of the close with the school year and make sure to find a property I really liked. Even though I am evaluating the buy vs. rent on a cap rate basis, it needs to work around my life and my son just started the year in three-K here in Queens. While I want to move to UES or UWS for the long-term future and have the ability to, I am paying nowhere close to $8k rent right now and it is still is a while before my son is in kindergarten.

Another angle to look at this from is to ask Mr. Market for the value of a cheap mortgage by looking at total returns in MBS indices, 10yr bonds, etc. The answer is about-15% over the last year. So if you financed 2/3rds, the gain on your cheap mortgage is 10% of your purchase price. If prices go down 10%, it’s a wash.

FWIW, I would guess a change of 3% <=> 6% in rates easily has a 10% effect on price, based on people’s behavior in response to rates, and likely somewhat more.

I think that using the 2/3rds financing assumption is too kind. I don't want to finance that much, but surely the cost of equity has also gone up as much as the yield curve. It would be silly to say that I want to build in the change in mortgage rates to 5.5% but still am OK with the 3% implied rate of return (before factoring market price changes) on my down payment in this inflation/interest rate environment.

I own investment property in Austin. I wanted to sell on lease renewal schedules, and oops.. those are now in a different world away from here. Couldn't finance at 66.66% and make it cash flow at 3.25% (where I am locked in 30YRs), which was the red flag to sell. Rents were going up, but not quickly enough to offset the rise in prices (and tax bills etc.). Values dropping 10% were to be expected, but I'm curious if there is another 20% to come. I still plan on selling at least one unit at next lease renewal to just drop the tighter cash flowing properties, but generally at this point... feel I missed the window to sell.. and now I'm in it for another 10 years. My original plan was to never sell, and hold through maturity... but it went up so quickly so fast... I also took out my cost basis with a cash out refi at 3.25% 2 years ago or so, which had the hidden curse of I cannot really sell the units without incurring significant taxes that basically would take a lot of my after-mortgage proceeds.

@Anonymouse - what cap rates are you seeing in Austin right now? And in the past?

ionada: "I remember Krolik pulling the trigger in 2020 because she saw a cap rate of 3% (assuming 2019 rents, I believe) against 3% 30yr fixed, which was attractive to her."

Almost right but one correction: it was 3% cap rate vs. sub-3% interest rates (even lower after tax) + an expectation of high inflation due to easy fed policy resulting in future rent increases

The high inflation has materialized and my unit's yield (net of maintenance and assuming unit price = purchase price + cosmetic renovations cost) is closer to 4% now (pre-covid rent $4900, and about $5900 now)

Because I got a price that was close to COVID lows, if I were to sell now I would hope to get back what I have put in. If prices go down much further, it will start to chip away at principal.

Krolik,
What do you think the relationship should be between cap rates and mortgage rates, and at today's rates what would prices have to do to get there?

When there is no inflation and in equilibrium, cap rates need to be higher than (after-tax) mortgage rates. However, we do have high inflation and we are not in equilibrium right now.

Let's say you wanted to live in an apartment for 1M (and let's assume there are no taxes, maintenance costs or inflation for simplicity, and interest rates are expected to stay constant). You would be indifferent between renting the apartment for $4,170 ($50k per year), or renting money from a bank @5% (also $50k per year).

Let's add inflation to this thought exercise. If rent is expected to go up every year, it would be better to buy the place using a fixed rate mortgage. Furthermore, one might also think that the area will appreciate faster than the rate of inflation, making the buy decision even more favorable and helping to justify even higher purchase prices.

Right now, there are some temporary distortions due to rate of change in interest rates resulting in cap rates lower than rent yield.

On one hand, prices need to come down to bring cap rates up to rebalance vs. high mortgage rates. Additionally, bonus season is expected to be lighter than in the two years prior, and in this case, as well as in case of a recession in 2023, prices should definitely drop.
On the other hand, many buyers might consider current rates temporary and expect interest rates to come down in the future, at which point they could refinance. In addition, we still have high inflation and expectation that rents will increase while money will loose value. Therefore, there are some factors pointing to Manhattan real estate going up, and some dictating it should come down.

My personal view is that New York market is resilient (or maybe stubborn), and will probably just go sideways for a while with very little transactions (while rents continue to climb). Once rents are high enough, or if interest rates come down, the market should start going up again.

Good summary Krolik. Then there are people like me who prefer not to rent if their life situation is not expected to change much (read min 10y hold).

This whole rent versus buy thing gets very muddy when the weight of the decision is based on cap rates. When my family needed a home, there was a list of things that came way before whether the cap rate was 3% or 5%. Actually I never even considered calculating the cap rate on my primary residence, but that's just me.

And probably significantly more important than trying to time the market, only buying when you know you're going to be able to hold for an absolute minimum of eight years. Although I have clients that have purchased knowing they would not live there for more than 2 or 3 years, a lifestyle choice.

I once had a client, when I met her was all about the spreadsheet. Afterwards I was having lunch with her and her mother, and she said this process is definitely 50% emotional and 50% financial. I thought that summed it up pretty well. She purchased in late 2009, still happily living on the upper west side in a lovely pre-war one bedroom.

Krolik, where do you see CPI inflation & NYC rents headed over the next year and next several years?

On the one hand, I think rate pressure suppressing buying will bolster NYC rents. OTOH, I am seeing inventory buildup in the rental market. Normally, June/July would have peak inventory, with a ~30% drop by October. This year, inventory has increased by ~20% or so. I’m guessing we’ll float at current NYC rents for a while, but in the end they’ll come down next year as the excess $$$ gets sucked out of our rate-levered NYC economy. Nationwide, it’ll simply flatten (economies not as rate-levered), but it’ll still take another year or so to show up in CPI due to the methodology.

Nada, Are you aware of any published measure other than CPI/PCE which does not have the housing lag effect? I would think that the Fed is using some additional measure to adjust for the lag effect. Thank you.

Keith, I agree that most people don’t calculate cap rate on their own residence like I would. However, I think plenty of plenty of people see a $8k rental and then see the all-in monthlies to buy a similar condo are $11k. That is basically the same math.

For non-lagged rent data, Zillow publishes a rent index which is pretty good. It moves much earlier and more than CPI. CPI is for all rents being paid while Zillow is asking rents for current listings.

Woodside, Thank you. I guess I just have to use the Zillow rental index to replace housing component of CPI. Do you know if Fed uses any metric as an alternate view of PCE/CPI to reflect more realistic housing component? I would think that they do with many economists they have.

> Woodside: However, I think plenty of plenty of people see a $8k rental and then see the all-in monthlies to buy a similar condo are $11k.

There is typically difference in quality in non ultra-luxury rentals vs similar condos. In addition, you can customize your condo and get partial inflation protection vs a rental. Essentially what is available in $11k monthly condo is not usually available in a $8k rental. Of course, you have to have a 10y hold period which for many people comes with the benefit of not having to move.

@Keith As a poster above already wrote, most people do calculate cap rates but they just don't know it. Unless very rich and unconcerned with such lowly matters, most people do evaluate how expensive it is to buy vs rent and buy if they believe it is better.
Cap rate is just a number to quantify how expensive it is to buy vs rent. Sometimes people use price as multiple of annual rent instead (I have seen advice like, "rule of thumb is that if the price is 16x and lower, then buy, otherwise it is better to rent). This multiple is basically an inverse of the cap rate (well, not quite, but in a world with no taxes and maintenance, it is). Cap rate is a bit more useful because you can easily compare it to other known rates, like mortgage interest , or expected market return.

@300_mercer Of course one needs to compare apples to apples. Plenty of fancy rentals are available from developers that just could not sell at unrealistic prices and somehow think renting it at 2% cap rate is a better idea than reducing asking prices. I personally bought a nice old coop that is not as nice as a lot of rentals my friends live in and I only compared my buying price to renting a similar unit.

@ionada would-be buyers forced into renting is not too much of a problem for Manhattan as most of Manhattan is renting anyway. 65% in the US are owners, but in Manhattan that number is only 20%, so I think the effect will be much smaller than in the rest of the country. My CPI expectation is there are scenarios based on fed policy.

Sources:
https://www.bankrate.com/insurance/homeowners-insurance/home-ownership-statistics/#:~:text=Homeownership%20rates%20in%20the%20U.S.,reflecting%20a%20shift%20toward%20renting.

https://furmancenter.org/stateofthecity/view/state-of-homeowners-and-their-homes#:~:text=Homeownership%20rates%20declined%20slightly%20in,to%2031.9%20percent%20in%202019.

"@Keith As a poster above already wrote, most people do calculate cap rates but they just don't know it. Unless very rich and unconcerned with such lowly matters, most people do evaluate how expensive it is to buy vs rent and buy if they believe it is better."

We will have to agree to disagree on this point. Certainly no one buying a home in the suburbs is looking at cap rates. And as someone who has sold close to $1 billion dollars worth of real estate in New York City, the majority of people who buy are not calculating cap rates, and yes I understand what a cap rate is.

I understand there are a few people who are crunching numbers between buy and rent as they search for a home. The vast majority of people I deal with put the emphasis on quality of life, ability to customize, no risk of of a lease not being renewed, especially those with children. Renting isn't an option they're giving much consideration to.

I've also dealt with people that just philosophically think it's better to own versus rent. They're hoping that when they sell they will walk away from the closing table with a check. When they're done renting all they have is a box of empty rent receipts. Regardless of what the return is or whether or not it's beaten the S&P 500. And of course there are no guarantees regardless of whether you're socking away all your money in stocks or you've allocated a portion of it towards the down payment on a home. And of course owning a home versus renting it doesn't preclude you from continuing to invest in alternatives.

"the majority of people who buy are not calculating cap rates"
How about those who choose not to buy? It's almost as if you are arguing "an ill informed buyer is my best customer.'

(NB this is just another round of busting chops)

There are many reasons not to buy, However, I'm addressing buyers.

Those buyer's are looking at how their potential purchase stacks up against other relevant comps within the building, and secondarily the neighborhood. Reviewing the building finances, looking at maintenance/coming charges along with the rest of the due diligence that their attorney will perform.

They're drilling down on their own finances to come up with a budget that they can comfortably afford.

So I wouldn't say they're uninformed... I'm just making the argument most are not putting much weight into the cap rate of a primary residence purchase.

Just my two cents. Perhaps others have another experience.

Keith Burkhardt
TBG

Coming =common : )

300>> Nada, Are you aware of any published measure other than CPI/PCE which does not have the housing lag effect? I would think that the Fed is using some additional measure to adjust for the lag effect. Thank you.

Sure. I think this one is commonly quoted:

https://www.apartmentlist.com/research/national-rent-data

The Fed is no doubt aware of the lag and the availability of this data. While they can use this data to predict (as can anyone predicting CPI), using predictions in their line of work is tricky. First, predictions are imperfect, and symmetric mispredictions have asymmetric effects. For example, note the predicament we're in due to their misprediction of inflation being transitory. Second, the Fed has credibility issues (having goofed in 2021) and generally needs to worry about entrenched inflation expectations. Because of those reasons, I think they'll be wary of easing up when CPI is printing (say) 3% even if they think it's heading to (say) 2% on its own accord.

Don't forget a substantial component is Owner's Equivalent Rent which is a hope that if enough people take a random guess at something the average will be the correct answer.

Also the only thing you really need to get inflation is for enough people to expect inflation.

Thank you for the data link and insight into Fed's thinking. Looks like only something breaking will cause them to stop raising before 4.5 fed funds rate unless Jolts data keeps coming down like last month's reading of 1mm reduction.

I agree with Paul and nada that cash on hand is a factor. I have what feels like a lot, to me, but it's not enough to buy a Manhattan home *and* buy the dip in sufficient qty to move the needle on my overall portfolio. I'm willing to pay a small premium for the option to allocate both ways, timed at my leisure. As I said back in 2020, 30yr is a really long time; lots can happen.

If I'd been sitting on an extra zero, however, 2.x% wouldn't have been an attraction on its own. At least not in the moment w/ zero foreknowledge.

Of course, now we do have some hindsight, in which the trade looks good regardless of your need/appetite for leverage. I mean, I could buy a bond today whose *after-tax* yield exceeds my mortgage interest! Sure the real return (above inflation) isn't exciting but anything that's nonzero + risk free is a clear win in modern times. You'd have to rewind to early 00s I-bonds (which I'm lucky enough to own, in tiny qty) to find something similar.

As for the 7% cap rate conjecture, sure I agree in the abstract that it's far more desirable than what's on offer in a low-rate environment...I just don't think we'll see it in Manhattan, maybe ever.

RB>> Of course, now we do have some hindsight, in which the trade looks good regardless of your need/appetite for leverage. I mean, I could buy a bond today whose *after-tax* yield exceeds my mortgage interest!

Well, if you were sitting on an extra zero with a corresponding mortgage, your mortgage interest would not benefit from a deduction and it’d be a wash. The right trade could just as well have been shorting bonds, or to the extent your idea of a balanced portfolio includes bonds, simply not hold any bonds.

Question for you, RB. What fraction of your mortgage do you keep on hand in cash, beyond a safety buffer of X months for personal expenses, to “buy the dip”?

@woodsidepaul I think part of this is a fundamental difference in philosophy. I'm 59, very healthy and active but very aware of how time flys. I remember walking my son to West village nursery school, now he's 36! It's a long time, but somehow when you're on the other side of it, it's puzzling. I remember it so well, thinking, "plenty of time, he's just in nursery school".

My point, if my family, myself is going to be significantly happier in a new home, neighborhood I'm not going to let the difference between 3/7% cap rate keep me from it (assuming I can afford it).

"If not now, when" informs many of my decisions. Within reason, of course.

Just my two cents.

Keith

In Manhattan, the housing supply contains broadly the same inventory for renting vs buying. For me historically, measures like the cap rate served as a point of apples-to-apples comparison for what I could get for a given level of spending on housing. And for a very long time, it was “If I’m blowing $X on housing, would I rather buy a place or rent something whose sales price is double?” For my family, renting the doubly nicer place made us happier.

Nowadays, we can afford anything, rent or buy. But we still find ourselves partial to renting, despite all logic. I don’t think we’ll ever beat our pandemic-era sub-1% cap rate, so there are no more records left to set. But there’s always something new to try. That’s my thinking, at least for now, until we get old mentally and crave stability ;).

The world is your oyster nada! I know you can do whatever the hell you like ; ) !

And the second time it goes by just as quick. I have a little girl that just turned 10! We will be entertaining 18, 9 and 10 year olds at the house this Saturday....

>>"If not now, when" informs many of my decisions. Within reason, of course<<

Amen to that.

"Investors are unloading securities sold by Fannie Mae FNMA -3.46%▼ and Freddie Mac FMCC -0.96%▼ that shift the risk of mortgage defaults away from taxpayers, a sign of growing concern about defaults if rising interest rates cause a severe recession."
https://www.wsj.com/articles/recession-fears-hit-risky-mortgage-debt-amid-default-concerns-11666141828?st=f5v25r33h5h230d&reflink=desktopwebshare_permalink

I get that Keith is trying to make a point about living in the moment, or whatever. I am cheap and a banker. I also am not a Managing Director yet. I cant live with the idea of a $500k overpay, which is at least what the 3% cap rates imply. I can’t go into a situation and watch myself lose six figures quickly.

Also, life is a peach in Western Queens. Family time is great here, we are making memories and that is not the concern. I need to solve K-12, which is why I have time to let this market play out.

Not so much living in the moment as life is short... Glad life is treating you well in Queens.

I thought you were looking for a place for about 1.3. Not sure how you figure you could be paying 500K too much in the current market. Guess I'm misunderstanding something.

Cap rates were 3% recently. $1.3 million at 3% loses $500k at 5.6% cap rates. That is why I didnt buy in Manhattan when I sold my Queens coop to get a 3BR last year and why I am holding out on buying right now. 5% percent cap rates dont seem crazy with the 2022 rate moves. Perhaps I will be able to purchase a formerly $1.7 million place in 2023.

Woodside,

While I agree that prices in NYC have come down, and will continue to be under downward pressure due to rates, in your model above, how do you factor in
1. Current and future increase in rents. The total demand for housing will be relatively unchanged between renters and buyers which could increase rents more than inflation if people aren't buying.
2. Mortgage tax deduction on increased rates for $1mm (call it 25% Federal bracket)
3. High percentage down payment and cash buyers in NYC,
4. Reduction in supply due to the current owners not wanting to sell as they have a low rate mortgage?
5. Prepayment ability of the mortgages if the rates come down.

My overly simplistic model without considering supply and demand factors says,
a. Price would have increased 20% due to rent increases to keep the same cap rate. So 3% cap went to 3.6%.
b. Increase in cap rate is 10y real rate change less tax benefit. Let us call it 80% of real rate change of 1.5%. 1.2%. Using real rate change adjusts rents for inflation but not rent increases above inflation. This assumes future rent increases at inflation.
c. Pre-payment ability which you are paying for in mortgage rates brings b down to call it 1% change without doing any fancy math. 3% cap should have gone to 4% cap but only went to 3.6% in a.

This suggests roughly 10-12% theoretical decline (not a prediction; just simple model calculation). Naturally, people can get their own number by tweaking the inputs. We seems to have at least 5% decline already even though it will take a while for it to show up in Streeteasy Price Index.

https://millersamuel.com/files/2022/10/Rental-09_2022.pdf

300,
How do you factor in rent declines?

Using real rates ties rent changes to inflation and nominal interest rates. A reduction in rents is just scenario analysis using a particular valuation model.

Just my personal opinion, but I don't see prime Upper West Side real estate dropping by 30%.

Keith, you don't think they can fall that much because of your heuristic view on how real estate works? I think it will drop 10-30%, so I will wait a year and we will see what happens then I will make a decision. Doesn't seem to make sense to buy now when I expect price to be lower in the future.

The NYC market is different in a lot of ways, but nationally the affordability is about as bad as the peak during 2006. So nationally, we do need to see 25-30% declines based on the change in interest rates (unless rates retreat quickly from here), which most real estate professionals cannot accept.

300, I don't figure the tax break into my math because both the old rate and new rate are tax deductible. The proportional change in the rate is what determines the change in home prices. Also, I believe that only the first $750k is deductible? Houses are bought with nominal dollars and incomes haven't kept pace with inflation so I don't think that inflation adjusting is valid. Also, if you adjust for rent increases and then also inflation adjust the rate, you are double counting inflation.

Projecting rents is the hardest part and it is hard to believe the trailing 12 month rent increases is sustainable in the face of 5% wage increases and the currently rising rental inventory.

Woodside>>Also, if you adjust for rent increases and then also inflation adjust the rate, you are double counting inflation.

I didn't adjust for futures increase in rents. 20% adjustment is for the rent increases we have already seen. Future rent increases are the same as inflation when you use real rate change. You can't just say that rates are high and not adjust future expectations of rents for inflation.

> The proportional change in the rate is what determines the change in home prices.

No. Net rate change after tax deduction and some allowance for pre-payment ability leaving out rent increase expectations.

Pre-payment option price in bps embedded in mortgage rates increases the higher the mortgage rates are. Currently it is fairly high not only due to higher rates but also due to higher rate vol.

No disagreement Paul that the market is continuing to move down, as evidenced by a thread, I've been saying that since the spring. But I find timing markets is very difficult.

Also I don't think generalizing about prices in New York City real estate is very meaningful. Every seller/developer has a different idea of what their properties are worth. Look at some of the crazy pricing/discounts on billionaires row, however it was never reflective of the entire Market. So theoretically a year from now you may be able to point to a listing and say "see this one fell 30%", however we need to take a close look at where they started.

I also know many people got caught off guard after the last 'market crash' due to covid. By the time they realized the market would not continue to fall, they suddenly faced very stiff competition as they tried to secure a home.

Personally I have a preference for shopping for Real Estate in the midst of the decline, I may not hit the perfect bottom. However, competition should be thinner, along with more room to negotiate if you can find a seller that's either frightened or forced to move for some other reason.

We have an accepted offer on a upper west side doorman condo, a studio. Reasonably priced and we were able to get a 10% discount off the asking price. Guess It could fall more over the next 6 months to a year, however these particular buyers can't wait that long. So combining that discount with a commission rebate, virtually no competition, they felt pretty good. And this is a unit that they will hold until they take them out feet first, to paraphrase them.

Either way, best of luck to you and hope it all works out and you get a truly wonderful deal.

Keith Burkhardt
TBG

@Woodside: " I need to solve K-12, "

Solution: One of the really good Swiss or French boarding schools. Save your housing money and spend it on something that will be truly useful for your kid(s) in the future. And you'll have a nice place to go on your own vacations, vs making the kid come back to the economic and social mess that is NY.

300, I like your methodology. It makes sense to me. On some of the details, however, I’ve got questions.

a. Do you think the 20% increase in rents since pre-pandemic will stick? Although I never thought the pandemic-era lows were a permanent shift, I initially thought the recent highs were going to last. Increasingly, however, I think they might not. Part of it is economic: NYC wages are levered to low rates in a way most places nationwide are not. Part of it is staring at listing inventory increase over the past several months. But more than anything, you sense the softness on the ground from brokers questioning if coming out pricing at peak rents was too much, wondering why a listing hasn’t moved, encouraging a bid to get a deal done, etc.

b. What is your baseline for comparing real 10yr rates? Right now, it’s at 1.7%. A year ago, it was -1%. Two years ago, -1%. Three years ago, 0%.

c. It kinda feels like you’re double-dipping on the prepayment option. Mortgage rates are roughly 10yr inflation + 10yr real rate + prepayment option + credit risk. You used a change in the 10yr real rate in (b). I get that. But then you discounted it by the prepayment option, which seems wrong. The increased benefit of the prepayment option is definitely there, but you should only apply it if your starting point is the difference in real mortgage rates, right?

I live and sell on the Upper West Side, so my lens is D3 schools, but it is difficult for brokers to talk about individual schools without that being seen as a Fair Housing problem, so let me say broadly, "how K-12 is going to play out" is to some extent a Pandemic recovery question.

Your choices might be, in wide strokes, the private system, which has strengths and weaknesses but does not seem to have cost controls -- tuition has gone from roughly $30K to roughly $60K over a five-year-span -- or the public system, which also has strengths and weakness but where enrollment -- and remember, funding is tied to enrollment -- is, AFAIK, down across the board.

ali r.

Nada, On a. I am note sure about rent increase of 20 percent sticking but people can add their assumptions in the theoretical model. The models as I use is rents change being the same as inflation.
b. I am using 1.5 real rate change as a rough number since the 3 percent cap rate in under $2mm 2/3 bed rooms.
c. I don’t have access to advanced financial calculators. My intention is to adjust the change in mortgage option cost (currently certainly higher in bps than when the rates were low) * real rate change / mortgage rate change

On C, what would be your adjustment? We know real rates have volatility which is higher now than before statistically.

Adjustment in Bps.

300, on the value of the increased prepayment option, you can extract it from the rates. Using data from the Treasury and Mortgage News Daily, here are how various rates have changed over the past year (Oct 21 2021 to Oct 21 2022):

10yr nominal: 1.68% => 4.21% (+2.53%)
10yr real: -0.96% => 1.69% (+2.65%)
30yr jumbo: 3.15% => 6.25% (+3.10%)

You can see the 30yr jumbo has increased by 57bps more than the 10yr nominal rates. Why? That’s coming from the increased likelihood of exercising the prepayment option, I think. So the market’s value on the increased likelihood of refinancing at a lower rate is 57bps. But that’s something you should haircut against the 30yr jumbo increase (+3.10%), not treasury rate change.

From another perspective, you can consider the “real” 30 yr jumbo rate to reflect what you want in B: the real financing rate, offsetting the nominal financing rate against expected inflation. This used to be 0.51% (3.15% - (1.68% - -0.96%)). Now it’s 3.73% (6.25% - (4.21% - 1.69%)). So the real 30yr jumbo rate increases by 3.22%, per B. But 57bps of that is an increase in the prepayment option value of being more likely to refinance, per C. Taking this out puts it at a 2.65% increase, which is the increase in the real 10yr treasury rate.

The rates I am seeing agree with Nada. I still dont get how rates up 80% can equate to housing down 10% or less. Yields up price down. Wall St is littered with bonds that have traded down from 110 to 80. Housing is basically
a bond and has very long duration.

This isnt sustainable. For example, 200 Rector 27B. Buy for $11k/month (assumes 100% financed at 5.5%) or rent for under $7k. 2.5% implied cap rate.

https://streeteasy.com/building/liberty-court/sale/1626210?context%5Bcontroller%5D=%23%3CBuildingController%3A0x000055d7bb430c68%3E&context%5Bcurrent_user%5D=1203853&hide_if_empty=true&section=sales&separate_sponsors=true

I don't know much about bonds, but does the quality of the bond affect the amount it will fall in a declining Market?

With an apartment it certainly does, there are many variables to take into account.

I would say your example of 200 Rector, a 1987 condo in battery Park City along with many other older condos in bpc, fidi will fall exponentially further than homes in prime neighborhoods.

There's a supply-side component I haven't seen in these discussions: when money is free or cheap, landlords can afford to park their ask at the top of the spread and wait for motivated move-ins. When the cost of carry goes up, I expect more units will migrate from shadow inventory to the true mid.

I expect this will exert downward pressure on new dev, and even moreso on rents. (Probably not a factor on resales, whose funding is much longer term.)

Yes, the quality of bonds effects the fall in a declining market if you don't think they will get repaid. This is called credit risk. U.S. treasury bonds have the highest credit quality. They will be repaid otherwise dollars are pretty much worthless.

There is another risk in bonds called duration risk. This is how much changing risk-free interest rates impacts bonds. Real estate is a long duration asset. If you buy a place cash, think how many years of rent payments it would take to get your money back.

TLT is an ETF which holds only treasury bonds (the highest quality) but the portfolio has a 17 year duration. Over the past year, the price of TLT has fallen by 35%.

Why don't real estate professionals understand duration risk? Long-term interest rates peaked in 1981 and fell consistently to trough in 2020. Pretty much every real estate professional in the market today has not experienced a rising rate environment.

Woodside,

What you are missing is that real estate is similar to partially inflation adjusted bond as higher rates suggest higher inflation expectation and hence higher rents while you mortgage payments are fixed.

I am sure inflation adjusted 10y bonds have not come down 30 points.

You can use your own cash flow model and inputs for future rent increases and them discount by the new mortgage rates and pre-payment options. I proposed one and one can change the inputs to suit their liking (as Nada is suggesting; more on pre-payment value later) but conceptually it adjusts for future rent inflation.

"Yields up price down. Wall St is littered with bonds that have traded down from 110 to 80. "

The Treasury Inflation-Protected ETF (SPIP) is down 19% in price over the past year. It has a shorter duration than TLT. Inflation expectations have been remarkably stable.

Watch it Paul.....

What WoodsidePaul said. Market inflation expectations are actually lower now (insignificantly) than they were a year ago. While some in the peanut gallery here have long doubted the Fed sticking to its mandate w.r.t. inflation, the market never did.

Based on your timeline Paul and the fact that you're very happy living where you are, sounds like a win-win to wait. We're certainly in agreement that prices have been moving down and will continue in that direction, I think we just differ on how far prime real estate will fall. Time will tell.

I don't personally really keep track of the value of my house, I simply know I need one and I was lucky to have purchased when people were mailing their keys back to the bank. In a nutshell I'm here for the duration.

I am curious how the current fed policy will affect equities in your opinion over the next one to two years. Also curious in particular how these policies will affect these two ETFs, jepi and hyt. Currently paying 11% in 9% dividends.

I'm curious how all you armchair Real Estate investors would value this given the trajectories of mortgage, cap and rental rates.

https://streeteasy.com/building/359-west-20-street-new_york/1?card=1

I'm a rookie when it comes to buying investment properties, however I have owned a few. I recently sold them all because they were oceanfront, just didn't want to worry at this stage of the game.

That said I would certainly look at this the same way I would look at any purely investment property, zero emotion. I would most likely rely on a CAPM analysis of the property, but I'll let someone else here do the math.

Nada and Woodside, Feedback?
I thought about Nada' comments below and also about slow moving nature of the real estate purchases and related decision making. Since the market has been in turmoil due to Covid, I went back to 2019 as a base line for everything. I attempted to calculated real 30Y Jumbo mortgage rate with adjustments. Using 2019 average is just one option for inputs to change in prices using real rate model will be. Meant for $1mm-$2mm basic apartments not high-end.

1. Rent increases.
Average median rent increase factoring in concessions from Miller Samuel. 16.7% from summer months of 2019 to 2022 which is when most transactions are done.
Month Elliman Median Rent
9/1/2022 3982
8/1/2022 4059
7/1/2022 4100
6/1/2022 3995
9/1/2019 3411 16.7%
8/1/2019 3423 18.6%
7/1/2019 3521 16.4%
6/1/2019 3471 15.1%
Average 16.7%

2. Change in real 30y Jumbo rate from St Lois fed (we know Manhattan is little different but do not have the data for that. Embedded in nominal 30y jumbo mortgage rates are prepayment option and breakeven inflation change
30Y Jumbo 2019 Average 4.08
30Y Jumbo 10/21/2022 6.701
30Y Jumbo Change (bps) 262.5

10y Nominal Treasury 2019 Average 2.12
10y Nominal Treasury 10/21/2022 4.24
10y Nominal Treasury Change 211.6

Prepayment Option Change (Bps) 50.838

10Y Breakeven Inflation 2019 Average 1.74
10Y Breakeven Inflation 10/21/2022 2.52
Change (Bps) 78.0

**** Option Adjusted Real 30Y Jumbo Rate Change 133.61 (262.5-50.8-78)

Deduct 15% for mortgage deduction cap of $750k (woodside pointed it out) at call it Federal income tax rate of 25%.

***** Gets you to 115 bps change in cap rate in the absence of Rent Increase in #1.

****** Theoretical Price Change since 2019
2019 Cap bps (Assume) 300.00
Cap with Rent Increases in #1 since 2019 (no rate change) 350.15
Expected Cap due to real mortgage rate change 413.56
Additional Rent Increase Needed 1.18

************ Price Change Needed vs 2019 Average 15.3%. 2019 SE index average at 1108k relatively unchanged till a few months back with market declining 5-7% plus already. So another 8-10% to go theoretically.

--------
>> From Nada:
300, on the value of the increased prepayment option, you can extract it from the rates. Using data from the Treasury and Mortgage News Daily, here are how various rates have changed over the past year (Oct 21 2021 to Oct 21 2022):

10yr nominal: 1.68% => 4.21% (+2.53%)
10yr real: -0.96% => 1.69% (+2.65%)
30yr jumbo: 3.15% => 6.25% (+3.10%)

You can see the 30yr jumbo has increased by 57bps more than the 10yr nominal rates. Why? That’s coming from the increased likelihood of exercising the prepayment option, I think. So the market’s value on the increased likelihood of refinancing at a lower rate is 57bps. But that’s something you should haircut against the 30yr jumbo increase (+3.10%), not treasury rate change.

From another perspective, you can consider the “real” 30 yr jumbo rate to reflect what you want in B: the real financing rate, offsetting the nominal financing rate against expected inflation. This used to be 0.51% (3.15% - (1.68% - -0.96%)). Now it’s 3.73% (6.25% - (4.21% - 1.69%)). So the real 30yr jumbo rate increases by 3.22%, per B. But 57bps of that is an increase in the prepayment option value of being more likely to refinance, per C. Taking this out puts it at a 2.65% increase, which is the increase in the real 10yr treasury rate.

300, I think that the 15% decline ca. 2019 baseline is in my range of potential outcomes, and would represent good savings if I am able to transact at those prices. I would love to be able to lock my money up at 5%+ cap rates instead of close to 4%, but there are a lot of moving variables as we have all noted: rates continue to be volatile, rents can move a lot in both directions, 2023 macro scenario: quick market rebound vs. mild recession vs. meaningful recession, the path of inflation and wages, WFH/office activity and travel rebound. That is why I have a pretty broad range of expecting 10-30% declines.

Another random thought: I wonder if higher interest rates close substantially the condo vs. coop price gap.

Woodside,
While I think I am increasingly comfortable with my theoretical model for rate change impact, the model above does nothing for supply demand dynamics such as people locked in a low rates may choose not to sell, less new development in the long run due to lower final product prices, higher carry cost of construction, real estate tax dynamics, crime, lay-offs, and no new supply in $1200-1500 per sq ft ex Fidi etc. So I find it hard to forecast magnitude of further prices declines vs what discounts you can already get in the market relative to 6 months back.

Posted this in 140 Riverside thread as well.

Let us see what happens to the mortgage rates after the next two Fed meetings when market is expecting some softening of stance as far as the pace of rate increases is concerned.
--
In the meantime, do people believe the article from NYPost of rent going up further?

https://nypost.com/2022/10/29/why-nycs-multifamily-market-just-keeps-getting-hotter/

The articles are all on a national level, but even the landlord's consultants which for 2.5 years have been saying rents have nowhere to go but up are forecasting decreases.
https://qz.com/rents-in-the-us-are-finally-set-to-decline-1849706381/amp

https://www.businessinsider.com/when-will-rents-fall-keep-going-down-housing-outlook-2022-10?amp

Jay Parsons from RealPage:
https://www.linkedin.com/posts/jay-parsons-a7a6656_multifamily-sfr-housing-activity-6992848494709374977-IDFC?utm_source=share&utm_medium=member_android

https://therealdeal.com/2022/11/01/multifamily-sales-in-virtual-standstill/

I've been wait patiently to see if anyone would mention that Manhattan contracts signed activity fell 43.2% YOY for October.

The problem is the cheap asses amongst us (me, that is) do not have a UD subscription. So I have to wait for you to tell me!

Nada I don't think you need a subscription to follow along with their vlog or view there dashboard, which officially posts all the recent data along with some commentary. I've posted quite a few of these and I'll repost this one here.

I think both Noah and John make a good point that comparing 2022 to one of the most active years on record for contracts 2021, is less than ideal. Although it's still down versus say the last normal year, 2019, it's nowhere near as dramatic.

For instance in 2021 I think we signed contracts on close to 60+ properties, that includes properties where contracts were signed and rolled into 2022. So far this year I think we have about 35+ contracts signed (adjusting for the contracts that were carried into 2022).
www.theburkhardtgroup.com

We post all contract signings in real time. Each year there are about 3 to 6 that are not posted due to ndas that I sign.

Urbandigs with some interesting charts and good color on what's happening. I would suggest anyone thats either just interested in following along or more importantly a buyer/seller to watch at least these weekly vlogs on Brooklyn and Manhattan:

https://youtu.be/XyDMxZI7QQ8

Keith Burkhardt
TBG

Thanks, Keith. I always forget. There’s no link to the dashboard from their main page, to give me a little taste & get drawn in….

I'm seeing some price decline in my Co-Op -
The Studio and 1Br in my building are down in price,
but ........the 2BRs are still strong

not seeing prices move down in my coop yet
one apartment has been on the market for a year..

Woodside Paul wrote 6 months ago:
"Cap rates were 3% recently. $1.3 million at 3% loses $500k at 5.6% cap rates. That is why I didnt buy in Manhattan when I sold my Queens coop to get a 3BR last year and why I am holding out on buying right now. 5% percent cap rates dont seem crazy with the 2022 rate moves. Perhaps I will be able to purchase a formerly $1.7 million place in 2023."

Fed hiked rates over and over since then. Banks failed. Lots of layoffs. And I am just not seeing any price movement down like you would expect based on this. Explanations? Btw, brokers seem oblivious to the state of the economy.

Looks like the market is just frozen. Very little transacting happening.
In my condo, 2019 - 5 sales, 2020 - 1 sale, 2021 - 10 sales, 2022 - 2 sales, last sale 7 months ago.

The only open listing has been sitting there for almost a year, and is trying to get 15% more than any unit in the same line has ever gotten, while being the lowest floor in the line, lol.

Granted it is quieter part of the season, but the previous years, Sep-Mar window we have had consistently 3-4 sales, versus this seasons 0 with only 1 out of touch priced listing even open.

Here's a link to Donna Olshon's luxury report, 32 contracts signed above 4 million last week, that's 4 more than the previous week.

In my experience, market's been very busy in Brooklyn, we have two accepted offers on brownstones, participated in the best and final on another one in Cobble Hill last night (we're 300K over ask).

We've been doing more rentals with clients that have decided to take this path rather than sell. 3% mortgages have helped them make that decision along with a strong rental market and don't need to sell to buy another home.

That said, there are plenty of homes sitting, without a doubt it's a very choppy market. I think Manhattan had over 235 contracts signed last week? To my surprise interest rates actually went down, for now. We're seeing rates on 30-year conventional fixed mortgages this week in the low to mid fives with no points.

http://www.olshanreport.com

www.Urbandigs.com

Keith Burkhardt
TBG

Krolik, I think you simply have wrong expectations about how this works.

It’s a lot like banks holding underwater loans to maturity. The assets now yield less than the cost of financing them, so in theory if you sell them it’ll be at a substantially lower price. Banks loath doing this and will try to hold to maturity, in effect amortizing the loss over many years. They cannot afford a 30% hit all in one year, but they can afford to lose 3% each year for the next decade, in the form of bleeding out their income over the next decade. And they foster hope that the situation is temporary: maybe ZIRP will be back soon enough and the problems go away.

RE sellers similarly loath taking a nominal loss. For ones who are not very wealthy, losing a substantial portion in a sale (such as their entire downpayment) is a no-go. For ones who are wealthy, many cannot mentally accept a nominal loss. Like banks, in both cases they’ll take their losses slowly over the years, coming out of their income, with some becoming accidental landlords along the way.

So that basically leaves you with sellers who understand the situation and have the fortitude mentally & financially to realize a loss today. They will accept a 10% loss today, in lieu of a 30% loss over the next decade, in effect taking advantage of buyers who “must” buy today.

That’s where the bank loan analogy breaks down. Although no one will pay you anything close to par value for agency securities yielding 1.5%, some RE buyers will pay something close to ZIRP-era prices.

But for this all to happen, you need the combination of the seller willing to take a loss and a buyer willing to accept negative yield. The market slowly works through the supply of such sellers & buyers. As time goes on, more sellers at lower prices emerge (“I lost 3% hanging onto this property over the last year, why not just sell it now?”), attracting more buyers.

Nada, What you say is generally correct. However, there are three other factors keeping the prices in non ultra-luxury from going down:
1. Strong rents in general.
2. Suburbs are not that cheap on a relative basis.
3. NYC exodus from Pandemic reversing with people needing more space due to WFH.

Krolik said:
"Fed hiked rates over and over since then. Banks failed. Lots of layoffs. And I am just not seeing any price movement down like you would expect based on this. Explanations? Btw, brokers seem oblivious to the state of the economy."

Black Monday was October 1987. Prices didn't move much till middle of 1989. Bottom didn't come until 1992.

300, you make fine points but they don’t convince me that “this time is special”. Your points describe the world a year ago better than the world a year ahead:

1) Rents have already started moving down from their peaks. I’d guess this will continue.

2) Suburbs are down more then Manhattan and will likely head down faster.

3) The big reversal happened across spring 2021 to spring 2022. With layoffs, I am guessing the demand for WFH will wane. People are worried about being cut, so why pay more to WFH when you can just as easily go to the office, show some face time, and hope you don’t get cut?

I’ll also note that Manhattan (according to the SE index) and the Case-Shiller national index show very similar trajectories with when the peak occurred, how much of the increase has reverted, etc. National was much more extreme, but the dynamics look similar.

Not much change in rents using SE index. Dec/Jan is supposed to be seasonally low.
Month Brooklyn Manhattan
1/1/2022 2796 3336
2/1/2022 2832 3396
3/1/2022 2866 3460
4/1/2022 2908 3522
5/1/2022 2952 3589
6/1/2022 3006 3647
7/1/2022 3053 3693
8/1/2022 3096 3736
9/1/2022 3132 3761
10/1/2022 3153 3756
11/1/2022 3147 3741
12/1/2022 3141 3728
1/1/2023 3142 3722
2/1/2023 3141 3736