buyers & rates

Nada,
RE taxes are indeed not decductible in NYC for most. Some likely explanations I have for people who are buying non ultra-luxury to live in are:
1. A lack of available rental apartments they like including location.
2. "Freedom Premium".
3. Prices have adjusted and if the rates come down, the prices may go up and you can refinance at a lower rate.
4. Cash or mostly cash buyers.

-----------------
I’m with you on inflation protection, but what tax breaks? RE taxes are effectively no longer deductible for all intents & purposes. Mortgage interest still is, on the first $750K… borrowing at 6.x%. So for the first $750K of financing, you’re almost offsetting the cap rate but still losing 0-1% to the spread. After that, you’re losing 3-4% to the spread.

What am I missing?

Fun case, AVM! A few questions while I chew it over:

1) What is an “AM” relationship discount, and what obligations does it entail?

2) What happened to annual maintenance over over the 5 years, as percentage of original purchase price? I’m having trouble squaring how a 3% cap rate became a 6% cap rate based on a 20% increase in rent and a 10% increase in price without something very atypical on maintenance.

3) Absent financial considerations, in how many years do you expect to be “done” with living in this coop? I’m trying to get a sense of your hold period as you envisioned it in (say) 2018, as opposed to a hold period involving staying longer than truly desired so as to improve the financials.

>> Ha. I have to remember this.

I think this is what is very commonly recited at AA meetings. It purportedly is very powerful & helpful to people in that setting, but good words for everyone to remember.

1) I abbreviated Asset Management as AM. Obligation was to move $500k into an account with the financial advisor (could be a new account or existing account). In this case it was a BofA mortgage with money going into Merrill Lynch. There is no obligation to keep the money there -- only had to put it there initially to get the rate; then can take it out after closing if you choose (some might feel a bit guilty doing this?). As I think back i believe it was actually only 25 bps savings. Would have been 2.625% and went to 2.375%. Rates were very low then even for 30yr fixed! (fwiw the original mortgage was 10-yr ARM)

2) The maintenance increase in this building has been atypically low, and I was using current maintenance for both scenarios. But you are right. If I use the original maintenance which was around 8% lower, then it's more like 3.2% cap rate going to 6.0% cap rate. Again, there are some big embedded assumptions like what this unit would rent for. Not an easy thing to estimate especially considering it's a coop.

3) Another tough one. My current math has been assuming stay for the full life of the mortgage. 100% agree with the implication that my calculus has changed in favor of staying longer because I want to preserve the value of the mortgage. I think under the coop's rules I'm allowed to rent it out for 2-3 years out of every 5, and could capture some value that way, but that's also a pain to deal with.

2) (cont'd): Oops just noticed an error in the cap rate calc that is quite impactful. Think it's more like 3.2% turning into 4.5% cap rate Formula wasn't carrying across. :| fwiw, still getting to same ~8% ROE, no error there.

Another datapoint on "freedom premium" of NYC apartment ownership - the other active thread today is essentially "how do I sneak my dog into / get exception permission to bring them in to the apartment I own?" lol.

Sometimes NYC apartment ownership feels about as free as a 23 year old living with their parents.
In theory yes, in practice.. ehh.

Steve, Compare the freedom to a renter not to a suburban single family.

Ah but there are many freedoms.

renter has the freedom to move in 12 months or less at minimal financial cost in the event of getting a dog, bad building management, bad neighbor, construction nearby, change of commute, change of family size / marital status, etc.

How often is a renter forced to move if you rent a condo? If you don’t want to move as a renter, you have to live in a rental building where the floor plan tends to be very compact for the number of bedrooms and finishes are blah.
Some people don’t mind moving due to life stage or for other reasons. So, for them, “Freedom Premium” is zero or negative.

When I saw first "freedom premium" above, my first thought was, it was referring to renters' freedom to move any time, as well as minimal upkeep responsibility. I don't think of homeownership as freedom, probably because I have lived in NYC for so long...

My personal 2021 purchase was based on 1) inflation protection on something we would be using long term 2) desire to get some super cheap liquidity at below 3% rate and 3) news that NYC prices were down a bit relative to pre-COVID, so not a terrible time to buy.

Krolik, Could you have made your rental as nice as you presumably made the apartment (with subzero) you own? Does it mean Freedom to you? Typically Subzero wouldn't be there in a rental apartment unless you are spending $12-15k+ per month.

Nada/Steve, Wonder how the relative pricing of NYC and elsewhere impact long-term trajectory of prices? Elsewhere used to be much cheaper (using pre-pandemic prices as a base) but less so now.

https://fred.stlouisfed.org/series/CSUSHPINSA

To add to above, I am very surprised that National Home prices haven't shown much of decline so far since the interest rates went up significantly.

@300
Yes, my 20 year old Subzero is a luxury I suppose. Although I think comparable rent is about 6,000-7,000, not 12,000. This is still an old coop in a not prime area. (My calculation at the time when I bought it was that comparable rent was ~5,000-5,500, but I was either off in my estimate, or rents have risen a lot since pre-COVID).

But when my bathroom flooded, it was my problem to solve, including finding a plumber, figuring out what to do etc. Whereas in a rental apartment, any such situation is my landlord's problem.
I have a built-in microwave I need to replace soon, and that exact size and model has been discontinued by the manufacturer... I have no idea how a different size could be installed without breaking a bunch of kitchen cabinets. Not having to deal with a project like this is also a luxury!

https://fredblog.stlouisfed.org/2022/10/real-returns-on-major-asset-classes-since-the-start-of-the-pandemic/?

This graph also indicates real estate outperformed other asset classes...

Krolik, Curious if you can post a few rental listings in your neighborhood where the finishes are similar to your coop post your reno.

AVM, one thought I have on your “trade” is to mark it to market. There might be other ways to analyze it, but I’ll run with that one.

Relative to purchase price, I’ll estimate your cap rate at 3.2% for 2 years, 2.2% for 2 years, and 4.0% for a year. That puts you at 2.96% on average. Financing was 3.x% for 3.5 years and 2.375% for 1.5 years. So let’s call it cap rate of 3% against interest at 3%. The financed 70% washes out, but you’re left with a benefit of 3%/yr on the 30% down. With 5 years of that, you’re +4.5% relative to purchase price.

Capital loss is, as you say, -10%.

You seem unlikely to actually hold for 30 years, based on your ambivalence on my question. As a coop with 2-3 out of every 5 years, playing landlord does not seem like a viable option financially. You can use it to stretch the inevitable out a bit, but not a long-term solution to occupancy. For the purposes of amortizing transaction costs (8%), I’ll use a holding period of 13.33 years. That gives a convenient -3% amortization for the 5 years so far.

Which brings us to the value of your mortgage position…. You seem like a typical mortgage holder, not particularly likely to hold longer or shorter than typical. Like everyone, you’ll end up staying longer now that rates have gone up. But instead of wringing our hands over the details, let’s just look at where a mortgage like yours trades. Using:

https://www.spglobal.com/spdji/en/indices/fixed-income/sp-us-mortgage-backed-securities-index/#overview

I see a total return of -11.5% since late 2021. But that includes ~5% of yield, so backing that out it’s -16.5%. Their loss is your gain: +16.5% * 70% borrowed => +11.5% of purchase price. (As a check, I computed TLT’s capital loss at -30% or so over the same period. But that holds 25-30 year bonds that pay down zero principal until maturity. So between principal payments and prepayment likelihood, -16.5% on your mortgage seems reasonable).

Adding that all up, I get +4.5% - 10% - 3% + 11.5% = +3%. On a 30% down payment, so you’re up 10% on your equity, or 2%/yr.

At 2%/yr so far, 5 year in, has that been a “good trade”? Beauty is in the eye of the beholder, but it doesn’t look so pretty to me so far.

In 2018, risk-free on a 5yr hold was 2.85%. Given that the level of risk on 3.3x-levered RE approaches that of holding an equity index, perhaps a few percentage points of risk premium in expectation would be warranted. And then perhaps a couple of points of illiquidity premium. So the nature of your “trade” would have warranted an expected return of 8-10%/yr, and so far it’s 2%/yr. Over a period where inflation ran 4%/yr., so the “real” ROE has been -2%/yr.

>> On the balance, would have been better off renting and investing in stocks. But the pertinent question here, at current market value how does [4.5]% cap rate and 8% ROE look today if the assumptions above are correct?

I see how this could be a way of viewing the situation, but it kinda feels like you’re dealing with a Hobson’s choice.

You don’t really have a choice to sell today, unless you’re willing to get marked down the remaining 5% on transaction costs and lose the 11.5% mortgage benefit I gave. That’d turn your +3% on 30% down into a -13.5% on 30%, or -45% aggregate on equity. The only choice you really have on this as a “trade” is to HODL. Such is the nature of illiquidity from high transaction costs and what is required to realize the value of your mortgage “win”.

The 4.5% cap rate and 8% ROE combines the best of all possible items without recognizing the corresponding losses. The cap rate at the current price is indeed 4.5%, but at the price you paid it was 4.0%. In order to recognize it at 4.5%, we need to first mark you down for losing a third of your equity. And we can give you an 8% ROE in recognition of your 2.375% mortgage, but then we’d have to take away the gain I allocated for mark-to-market on the cheap mortgage.

Having said all that, there are different ways of looking at it, I suppose. I guess I’m a mark-to-market type of person. While I somewhat understand what drives banking regulation to use hold-to-maturity accounting, let’s just say that I would not purchase / buy shares in one on that basis. I’d mark all assets to market, regardless of what it says on the books for banking regulation, and go from there.

Thanks inonada. i don't really disagree with any of what your wrote here. On a 5yr lookback basis versus other alternatives at the time, it doesn't look so pretty, that is true. On a "let's mark everything to market" basis, swallowing the pain of the 10% loss on the asset value, and moving forward, I think it looks ok (certainly not spectacular) under a long enough time horizon. Reasonable people could even see a case for it beating equities or other risk asset classes in some scenarios.

Of all the metrics that are being tossed around -- i think the 8% ROE is the most relevant one here, and on my math this is the result on a "fresh start" basis without having to remove any gains for the mortgage. I would use:

Rent - Current Maintenance - Cost of Debt = Return on Equity. And then divide this by the *original* equity contribution. In this sense, my return is getting diluted by the fact that the asset price has gone down. i.ee., I'm dividing by a higher denominator than I would be today, because i put in more equity 5 years ago than it would be worth today based on today's lower asset value. You could tell me to amortize some transaction costs in there; I'd respond I could also add some tax breaks. Trying to keep it simple. Whatever the case, on my math the ROE gets to about 8%.

And btw, notwithstanding calling it a "trade" for shorthand, I like living in the place and don't spend time agonizing over it. I raised this because it feels like a rather interesting example in the overall context of this thread. In the sense that one can't throw stones based on the "writing's on the wall" nature of a floating rate reset that's on the way for many such purchases of this vintage. This one's got the locked-in ZIRP effect for as long as the owner has the inclination and wherewithal to stay put.

thanks for your thoughts, interesting as usual.

AVM, Is you debt cost Interest Only? If so, how do you factor in incremental property insurance over renting, preiodic assessments and upkeep to maintain the apartment in roughly the same condition?

@300 - good points & non-trivial
Even on a new construction unit I spend the equivalent of 1-2 months of maintenance on random repairs, obviously lumpy but clearly accelerating as time goes on. Not to mention that owners insurance is 10x higher than renters insurance, for a difference equivalent to say another 1 month of my condo maintenance.

So add another 25% on to your maintenance for compare to rental maybe.

AVM, I think I get what you’re saying. You’ll take mark-to-market on price for the “trade” but don’t want marks for the loan, preferring to take it as positive carry over the uncertain future term that you control. So lemme run with that one…

I agree on the 8% ROE in that case, using your purchase price and 2.375% on 70% and a cap rate of 4.5% * 0.9. Right now, your cumulative ROE is in the hole to the tune of (4.5% - 10%) / 30% = 18%. Whenever you sell, it’ll cost you 8% / 30% = 27%. So you’re currently baked in for a 45% loss on equity, but each year you sit tight, you’ll make up 8% and eventually go positive.

In reality, over time the cap rate will improve (increasing rents) and the leverage will decrease (paying principal), having offsetting effects on the 8% ROE. Some tax benefits, some assessments, some upkeep. And of course, some change to prices. When all is said and done, you can fire up a spreadsheet and properly account for a discount rate…

Yes, to try to put it more succinctly than I did before, today's cash-on-cash yield on the original equity, is about 8%, irrespective of market moves in either the asset side, or the liability side, since the time of the original purchase.

A follow-on discussion is how should one think about 8% cash yield versus:

S&P 500 Div yield < 2%
S&P 500 Earnings yield of ~4% ?

Yes, stocks have real growth. But rents can keep going up too over time...

and to be clear, yes -- I understand the way that I'm framing it here is ignoring a subpar investment return in years 1-5. not trying to be dismissive of your point, just trying to frame it this way as one way to look at it -- kind of like, would one want to own this asset with this liability under these current parameters, or not?

>> In the sense that one can't throw stones based on the "writing's on the wall" nature of a floating rate reset that's on the way for many such purchases of this vintage. This one's got the locked-in ZIRP effect for as long as the owner has the inclination and wherewithal to stay put.

Definitely. Those who are sitting on fixed rates will never feel the pressure from negative carry. The pressure will be to milk it out for as long as possible. Those who are sitting on ARMs will feel the pressure, and that may range anywhere from now to 8 years from now depending on the ARM (and whether or not we go back to ZIRP).

"AVM, Is you debt cost Interest Only? If so, how do you factor in incremental property insurance over renting, preiodic assessments and upkeep to maintain the apartment in roughly the same condition?"

300_Mercer: I'm being (conveniently?) lazy in ignoring these issues. The reality is I should increase maintenance by ~10% based on historical capital assessment needs. I should add in some additional insurance. Upkeep? The apartment is recently renovated so there is not a near-term need, but probably should account for something there too. Others may disagree but in my experience there is also a cost in rentals to keep renovations fresh -- you pay for it one way or another.

In any case, I gave a pass on these items by not including any tax benefits.

As one can see, I don't maintain precise calcs -- was doing a bit of back of the envelope that I felt was generally accurate, but not precise. with the exception of that one big earlier error on the 6% cap rate--- thanks inonada for not hammering me on that!

and debt is amortizing, not I/O. sorry for the multiple posts.

>> Nada/Steve, Wonder how the relative pricing of NYC and elsewhere impact long-term trajectory of prices?

I don’t have any sense for pricing outside of NYC relative to fundamentals. I don’t believe moving out of elsewhere into NYC because one is “priced out” will be a thing, but who knows. My opinion on elsewhere is mostly that it continues being a good time to be a developer… for now.

@AVM - re: Upkeep
Given NYC construction costs & tastes.. how does one account for the periodic need (or at least pre-sale?) need for a very expensive renovation. Something like $250K every 15 years or $500K every 20 years?

Re: outside NYC
I still see elevated prices on low inventory, but it depends .. I think if its an outer ring commutable burb, this holds true.

My brother lives outside of another northeast city in a 30min commute range, and was looking to buy a home, the few places he saw were dumps (unrenovated 1000sq ft with 1 bath) going into bidding wars at 20% above ask.
Given that and rates, hes going to keep renting.

> I don’t have any sense for pricing outside of NYC relative to fundamentals. I don’t believe moving out of elsewhere into NYC because one is “priced out” will be a thing, but who knows. My opinion on elsewhere is mostly that it continues being a good time to be a developer… for now.

Agree that no one is moving from elsewhere to NYC to relative spread narrowing but I was wondering whether it will reduce number of people moving from NYC to elsewhere as the housing cost spread has narrowed.

>> with the exception of that one big earlier error on the 6% cap rate--- thanks inonada for not hammering me on that!

I make those sort of errors all the time as well. Easy to make them, so I’ve become attuned (via my day job) to checking answers from various angles to make sure they pass the sniff test. E.g., checking losses in MBS index against TLT to make sure it seems reasonable.

@steve123:

This is s a tough one -- I don't have a strong POV. Depends on the answers to questions like, when landlords renovate, do they have the power to push none, some, or all of the cost into rent?

To take your case and turn it the other way around: if someone lives in a rental for 15 years or 20 years, one which has not been renovated over this period of time, and they desire a fresh renovation that costs a landlord $250K or $500K, how do they achieve that? Do they: a) move out and pay whatever higher market rent is required to get them a better apartment; b) convince the landlord it's time for a renovation and they miraculously keep the rent flat on account of their long-term loyalty; or c) convince landlord to renovate, but the new lease reflects a shared cost between the landlord ($ up front) and the tenant (with higher rent), to whatever degree they agree upon.

I guess my point is one can't have it both ways -- you can't hit the homeowner/landlord for 100% of the cost of the renovation without also acknowledging some equivalent-rent increase for the purposes of calculating the Cap Rate or ROE.

>> Given NYC construction costs & tastes.. how does one account for the periodic need (or at least pre-sale?) need for a very expensive renovation. Something like $250K every 15 years or $500K every 20 years?

At some point, I thought through this from various angles and concluded with a 7% per year depreciation rate. Multiplicative, not linear. My reasoning is as follows. After 10 years, a renovation is looking decent but a little dated & scruffy. Think 2013 renos. Perhaps 50% of the value remains. After 20 years, it’s looking pretty dated & scruffy, but still usable. Think 2003 renos . 25% of value remains. After 30 years, it’s kinda at the end of the line. Think 1993 renos. Some people will live in it for a time, but most will do a fresh reno. 12.5% of the value remains. After 40 years, ….

I came up with this formulation in comparing rentals, FWIW. If I’m comparing two options, both at the same sales value, should I pay more for the one with the shiny new reno vs the one with the 10 year old reno? Yes, because using up one years worth of a reno is more valuable in the first year than the 11th or 21st or 31st year.

@AVM - I guess what I am pointing to is that the renter may have more optionality here. On a yearly basis they can decide stay/trade up/trade down. As an owner I have a lump-sum problem and it also impacts my liquidity when I want to exit. It also works against holding period duration.

We talk about how holding periods of 0-10 years you likely end up flat/down on resale.
However beyond year 10, you are then likely hit with a need to renovate or to take a pricing haircut because you didn't!

In a world where people holding a stock for 1 year is "long term", it's quite a stark difference.

@nada - 7% of the price of renovation or 7% of the property value?

Nada, Your model is generally valid. Reno cost which should go into your model should be reno with everything in place as in bathroom fixtures don't move. Walls don't move. Electrical doesn't get upgraded. AC likely got repaired or replaced over time. Doors more of less stay what they are. Kitchen cabinets/countertops and appliances get replaced. Floors likley get refinised.

So we are talking about proper repainting, re-finishing the floors, replacing bathroom fixtures and retiling, replacing selected light fixtrues, and kitchen update. That kind of "refresh" is much cheaper that a reconfigure and redo infrastructure reno. Probably no more than $100 per sq ft for mid level luxury not ultraluxury. Otherwise, it would be an upgrade vs what the apartment was 30 years back.

>> Agree that no one is moving from elsewhere to NYC to relative spread narrowing but I was wondering whether it will reduce number of people moving from NYC to elsewhere as the housing cost spread has narrowed.

Probably. But I don’t know how that counterbalances against the seemingly-permanent shift to WFH from a lot of employers. The longer employers retain flexible WFH policies, whether it’s 5 days a week or 2, the more people will view elsewhere as a viable long-term option. At 3 in-office days, even if mandatory, a worker inclined to live in FL could make an easy go at it. Fly in Tue morning, fly out Thu night. Cost is perhaps $40K per year, including non-fancy hotel. On the flip side, no NY or NYC statutory residency means the income you retain after-tax goes from (say) 50% to 62.5% on a marginal basis. That’s a 25% boost on an after-tax basis, nothing to sneeze at. At an income of (say) $800K, it works out to an incremental $100K per year after-tax. $60K after commute expenses. Perhaps people should adjust for their time spent on commute, but many won’t. For the elsewhere-minded, that is a continuing and ongoing powerful incentive as WFH solidifies. So I’m not sure which way it all goes.

>> @nada - 7% of the price of renovation or 7% of the property value?

I mean it as 7% of the price of a cosmetic renovation. What 300 classified as $100 for mid-level luxury. Structural renovation has a longer life, as 300 suggests. Perhaps 3.5%/yr for that, meaning a useful lifetime of 60 years instead of 30 years? What do you think, 300?

100% agree with 300_mercer here. there's worlds of difference between a moderate-cost, high-quality refresh as described, one that will have broad appeal and can be achieved without cutting corners.

versus the complete-gut job which is a totally different animal and cost profile

Nada, 60years for infratructure like electrical is generally correct. Moving the walls I am not sure. That depends on the configuration. Chances are some reconfiguration will be done due to changes in how people live. Open kitchen general preference now vs hidden out of the way kitchen etc.

FWIW, we still enjoy our 25 year old high quality kitchen cabinets from the previous owner and they probably have another 25 years to go. Countertops I think I would want to change due to preference for lighter color but existing are perfectly fine and great shape. That said, we are very careful users of everything and previous owner's kitchen cabinet choices still look current.

OK so on an average luxury-enough 1500sq ft 2/3 bed @ $100ish sq/ft you are talking $150K depreciating 7%/year. And depreciating the more durable infrastructure of the unit 3.5% of a full-on gut reno which is what.. $450k?

So between the two we are talking $25k/year of reno-depreciation on year 1 on a, ballpark $3M unit?
Roughly in the ballpark of the monthly maintenance (ex tax) that someone might pay on a unit that size/price?

So on your $3M unit, bank on $25k/year out the door to your board, $20k/year out the door to the city, and $25k/year of depreciation? Plus $5k/year insurance maybe?

Ignores if you have a mortgage & interest expense.

>> I guess what I am pointing to is that the renter may have more optionality here. On a yearly basis they can decide stay/trade up/trade down.

The benefit of the “freedom premium” has certainly balanced positively for me. In my 20 years in NYC, I only had to move once because the owner was selling. It was annoying, but on the other side I have a lot more experienced positives. Time to trade up for life circumstance? I’ve done that many times, much more than if I’d bought. Time to hit the market for cheaper / better options after a downturn? Done that a couple of times so far. A giant 3-year construction project starting across the street, facing a bedroom window? Time to move on. That’s come up once. Last year, I looked at one option that had scaffolding. I looked at the details, and it was caught up in some Landmark hellhole. Since 2019, if I recall correctly. That was a pass. Feel bad for the owners living with that for 4 years.

Same thing financially. More than once, I have been able to redirect funds into unplanned super-compelling investment opportunities because I retained liquidity. Beyond tied-up principal, I didn’t need to worry about a sizable buffer to be able to maintain debt/carry payments in the case of a loss of income. Can’t afford the rent anymore => just move.

>> OK so on an average luxury-enough 1500sq ft 2/3 bed @ $100ish sq/ft you are talking $150K depreciating 7%/year.

$150k cosmetics depreciated over 30 years. Another $150k (infrastructure, re-configure ex cosmetisc which we counted already. Assuming some upgrade vs 60 years back; what people call gut renos are ** significant upgrades ** vs what it was 60 years back) depreciated over 60years.

So straighline, $5k + $2.5k. $7.5k per year average for $3mm luxury property. First few years more depreciation realistically and later less. People may think that appreciation more than makes up for that but NYC for the last 15 years has not seen much of that.

Forgot downtime/lack of use when you reno. So make it $10k.

@300 - I don't think you can straight-line it
Think about it - is the $150k 2023 Reno going to cost $150k in 2053?
Was it $150k in 1993?
$150k infra upgrades on a $3M unit seems a bit anemic, though my $450k could have overshot.

Agreed either way that aside from buying pre-bubble, or right after GFC bottom, or during the brief ~9 month COVID bottom.. NYC has not seen enough price appreciation to beat the depreciation..

Presumably rates will remain a headwind to NYC price appreciation another 1-3 years. Can add NYC/NYS fiscal issues driving RE taxes up + labor inflation driving maintenance up as more headwinds.

@inonada - yeah I rented for 11 years. Only once did I have a condo owner decide to sell out from under me. Otherwise I traded up as my circumstances changed. Would have done so by now had we not bought. On the other hand, I don't need "as much" apartment now as pre-covid, but I bought and have a great rate, economics on selling are bad.. and so.. I hold.

I think people don't always do this calculus.. I have a number of friends who didn't buy til their kids were in middle school. So they were already past the K-5 zoning arb, and were basically looking at their kids moving out in 5 years for college / 9 years to their first full-time job.

>>Think about it - is the $150k 2023 Reno going to cost $150k in 2053?
Was it $150k in 1993?

Remember we are doing current depreciation for $'s which may be spend on the reno in the future. If you are factoring in increase in future cost, you need to add interest on what you have not spent yet which will be more or less a wash on expected basis.

>> though my $450k could have overshot.
Your $450 was double counting cosmetic reno which you are already depreciating.

@300 - fair point on interest, though assumes NYC renovation costs trade along with US inflation / US rates, and do not exceed :-).. which may be a bold assumption!

Curious what you think is the reno cost for this one which seems like have not been redone for 50 years. No upgrades which will improve the propery vs what it was 50 years back. Essentially no central ac.

https://streeteasy.com/building/1120-park-avenue-new_york/7a

What I see, almost everything can stay in place and you likely need an electric upgrade for $50k for washer dryer which is an upgrade over 50years back. Without reconfiguration, one can get done for $300k with electrical upgrade. No skim coating etc. No central ac. No new built-in finished closets etc.

People will likely spend a lot more as they will upgrade vs what it was 50 years back with washer dryer, double sink, fancy millwork, and central ac and reconfiguration.

Got to an accepted offer on a studio @5.3% cap rate (my estimate). Plan to pay all cash (cash is currently parked mainly in Apple/GS acct yielding 4.15%).

Do you think it’ll pass the board, or will they say “too low”?

>> Adding that all up, I get +4.5% - 10% - 3% + 11.5% = +3%. On a 30% down payment, so you’re up 10% on your equity, or 2%/yr.

I have a revision on this estimate on your “trade”. While I like the idea of mark-to-market, it is based on fair market value. You’ve got two illiquid assets in your trade basket. The first is the apt, the second is the mortgage. Assigning fair market value to illiquid assets can be tricky. In this case, we used a liquid index measure to estimate the value change in the illiquid mortgage. That seems OK: there is some liquidity premium separating the two, and as long as that premium is unchanged, the percent value change in one reflects the percent value change in the other.

The problem with valuing the apartment, on the other hand, is that we are using an illiquid measure. While both your estimate and the SE index say -10%, because it’s an illiquid measure, it contains serial autocorrelation. Would you be willing to get into a swap transaction with me on where the SE index will land in 3 months or a year based on its current value? Probably not, because as a measure on an illiquid asset with high transaction costs, we all know where it’s likely headed. If you disagree, I’d be happy to get into a swap with you at the size of your choosing.

So this leaves me wondering how to haircut the -10% to get to FMV. I.e., the price at which I’d be willing to swap money for your basket with no expectation of gains or loss baked in, separate from risk premium I’d plan on collecting.

My board does not seem to be policing prices, but we will see. They also don't have to name the reason for any negative decision.

The unit is in poor condition. If I account for a $50k+ gut renovation (for a small studio), the cap rate is not as high (as I think the market rent price would not increase in proportion).

Isn't this unit is a great deal for someone looking for space:
https://streeteasy.com/building/1175-york-avenue-new_york/phb6

Maintenance is a little high, but it is a top floor and a 4br.
If we did not have golden handcuffs in the form of a low, low mortgage rate, I would consider trade.

What is the estimate of the cap rate (at list price) of the apartment I posted above? I have not rented large apartments, so don't have a sense of what this could be worth in the rental market.

@ inonada
"at the size of your choosing"

presumptuous! :)

kidding aside, does the SE index still exist? I recall there was a Condo index for a number of years, which was robust in terms of the supporting data and methodology. Then they seemed to stop publishing it for whatever reason and I haven't been able to locate a SE Index since. Must be looking in the wrong place.

My -10% assessment was based on same-buildings comp sales, and market reports from various broker firms.

Not really in my rental wheelhouse, but my gut said $10K. The most recent rental in the building, similar elevation and size, went for a last ask of $9K after some time and price chops:

https://streeteasy.com/rental/4037993

At $1.5M and $6250 monthlies, that’d put it at a 3% cap rate.

AVM, It is simply called "Price Index" now and included stuff beyond condos. It is on Market Data page.

https://streeteasy.com/blog/data-dashboard/[object%20Object]?agg=Total&metric=Inventory&type=Sales&bedrooms=Any%20Bedrooms&property=Any%20Property%20Type&minDate=2010-01-01&maxDate=2023-05-01&area=Flatiron,Brooklyn%20Heights

Market Data > Data Dashboard. Scroll to the bottow and it will let you download.

>> presumptuous! :)

LOL, yes you are right.

>> So this leaves me wondering how to haircut the -10% to get to FMV.

OK, I’ve done my homework. Autocorrelation in the SE index returns shows ~75% of the average of the past 6 months being significantly predictive of the next month. Applying that recursively into the future based on prior months, we can predict a 5.6% drop over time (with error bars, of course). The SE index’s latest print was for May, which held a blend of March/April/May closed sales. I’ll assume your 10% estimate is based on comps and market reports that are a couple of months more recent, so I’ll cut a 0.8% expected over the next two SE prints as being already baked into your -10% estimate. That leaves me with a -4.8% haircut. That number passes a gut check, I think, based on average sentiment from commentary here?

So given that, I’m gonna change my mark on your “trade” to +4.5% - (10% + 4.8%) - 3% + 11.5% = -1.8%. With a 30% down payment, that’s down 6% on your equity, or -1.2%/yr.

Krolik, I’m glad you found an arrangement that’ll work in time for your incoming kid. What percent below ask did you end up striking the deal?

Sample size of 2, but here are the same-building comps. Identical footprints. These are view apartments so the elevation matters.

Apartment in question: Late 2018 closing. Condition: Mixed, but best of the 3. e.g, high-end recent kitchen reno, but other areas needed the "refresh" type of thing discussed above.

Early 2020 closing. Price: -11.4% to the above. 5 floors down and this matters, because the south views become obstructed as they don't clear the south facing building across the street. Condition: Needed the "refresh" throughout. Everything dated but structurally sound.

July 2023 closing/ early 2023 contract. Price: -18.6% to the first one. 4 floors down but this doesn't matter as much, because the views still clear everything, S, W, and N. Condition: worst of the three. Needs somewhere between a full refresh and a full gut.

This is TMI but the recency of the 2nd comp makes it notable. Putting everything together i'll stand by the -10% on a like-for-like basis. I guess if someone wanted to be paint the most negative picture possible they'd say that's a headline -18.6% and the market has continued to deteriorate since the most recent contract was signed?

@ inonada
With a 30% down payment, that’s down 6% on your equity, or -1.2%/yr.

perhaps we can find the right terms/structure to wager a cocktail or glass of wine. a reasonably priced vintage. Feeling less prosperous now that the fine-tuned analysis is saying my equity gain has turned into a loss!

>What percent below ask did you end up striking the deal?
~12-13% (depends which ask)

Close to ask for this unit, there was a very, very nicely gut-renovated unit available. We might have gone for that one instead, if sellers did not move on price.

>Not really in my rental wheelhouse, but my gut said $10K. The most recent rental in the building, similar elevation and size, went for a last ask of $9K after some time and price chops:
https://streeteasy.com/rental/4037993
At $1.5M and $6250 monthlies, that’d put it at a 3% cap rate.

Wow, not a high cap rate, the monthlies just kill it. Gorgeous unit though.

@AVM, I trust your -10% comp. You seem not to be one who’ll put on rose colored glasses to make themselves feel better. The market has probably deteriorated since the early 2023 contract, but I accounted for that (and more). Sorry to put you in the red ;(.

As for a friendly wager, we have the SE index print as of May. Could do it based on whether the Aug print ends up higher or lower than the (then-revised) May print. That’d be an awfully generous wager, so I don’t recommend you make it…

>> Close to ask for this unit, there was a very, very nicely gut-renovated unit available. We might have gone for that one instead, if sellers did not move on price.

It sounds like if you do a gut reno on the one you’re (likely) buying, you’ll end up in the same ballpark as this one. Why didn’t you just go for this renovated one? Not as physically close to your current apt, renovations not to your taste, or just a glutton for punishment on renovations?

>> Got to an accepted offer on a studio @5.3% cap rate (my estimate). Plan to pay all cash (cash is currently parked mainly in Apple/GS acct yielding 4.15%).

Would your calculus have changed if you were financing with a mortgage rather than cash?

Any takers at Hudson Yards?

https://www.wsj.com/articles/hudson-yards-condos-14aed09e

If you buy, maybe inonada will rent and pay off your mortgage.

@nada
For someone who is an exec getting driven everywhere & has a home in NJ, seems like Hudson Yards makes sense.

Otherwise, meh.

> Got to an accepted offer on a studio @5.3% cap rate (my estimate). Plan to pay all cash (cash is currently parked mainly in Apple/GS acct yielding 4.15%).

5.3% cap rate is very good. It's better than the 4.15%. 4.15 % becomes post-tax 2.xx-3.xx% , it's even more better.

I just checked the four apartments sold after June of 2022. Only one apartment had the record with the mortgage record (INITIAL COOP UCC1 in acris), the other three were presumably cash sale.

I guess most of the low-volume sale have been supported by the cash buyer.

> Would your calculus have changed if you were financing with a mortgage rather than cash?

Yes and no. If mortgages were reasonable, I would want to do a different trade all together: sell my current unit and buy a 3-4br (if I could find a decent deal, would be in another building most likely) on UES in a good public school district, or in Sutton place.

And in this instance, if I could not afford to buy without a mortgage, I would rather just not consume as much housing and save money.

>Why didn’t you just go for this renovated one? Not as physically close to your current apt, renovations not to your taste, or just a glutton for punishment on renovations?

It is actually closer to the current apartment, but has a lot of (very, very nice, thoughtful, brand new) built-ins, including a murphy bed, and larger kitchen that make it slightly less ideal for our specific purposes. Would have been a better choice if our seller did not come down on price, but since they did come down, the unrenovated studio became a better choice. Also, we would have the flexibility of renovating in stages if we needed to, rather than all at once.
I cannot resist going for the cheaper thing. Getting a more expensive unit might require a small mortgage (to make sure my cash cushion is up to both my (with a baby) and board's standards; I am not rich yet, if I were, I would be living in Sutton Place).

What are the implications of the market rally for home buyers?

1) For savers, opportunity cost of capital is going up. Frankly my cash is in GS account yielding 4.15% BECAUSE I am trying to buy a property. Otherwise it would be in stocks/money market funds.
What do others feel is a reasonable expectation of a return in the market is for the next 12 months to 3 years?

2) For working people, there is optimism about the economy. Near-term earning potential and prospects of staying employed are improved as well.

I think its finally dawning on people that we are going to have a "soft landing" in the rational rather than aspirational sense.

That is - decent economy, everyone keeps their jobs, inflation cooling to 3-4%, no big crash.. but rates will remain elevated for a while.
We may get another 1-2 hikes, or zero.. but we certainly aren't getting any cuts for the foreseeable futures.

But this is fine! The absence of cuts means the Fed thinks the economy is fine.

People got too addicted to ZIRP sugar.

The 2022 blow off top was really something to watch in JPEGs, used cars, crazy pay bumps, etc.
Welcome back to reality, folks.

Personally I don't think we're going to get off that easy.

steve123>> People got too addicted to ZIRP sugar.

Ya think?

Krolik>> If mortgages were reasonable, …

It’s language like that which makes me think people are still addicted, but the dealer’s no longer handing out freebies. Take a look at this chart, and you’ll note that for 40 out of the past 50 years, mortgage rates were around current levels or higher:

https://www.freddiemac.com/pmms

Now, I’m not making any prognostications about where mortgages are headed. But the connotation of ZIRP- and QE-fueled mortgage rates as “reasonable” strikes me strangely. What exactly is “reasonable” about savers losing 2%/yr in real money, year after year for a decade, and the Fed buying up a large fraction of all mortgages ever issued? I understand why it was done, but to verbalize it as “reasonable” simultaneously perplexes and enlightens me.

@30 - yeah I mean, that's still in the back of my mind for sure
The most dubious part was that tech's reckoning lasted all of about 6 months before the AI hype re-inflated them. They managed to take down regional banks in the meantime. Absolute clowns.

The big question mark for me is CRE.

@nada - exactly, the idea that 2.5-3% mortgages are anything but a historical aberration is funny right?

@30 and steve
I thought we would for sure hit a recession in 2023; I still think suburban housing must go down a bit, reversing some of the pandemic trend. Commercial real estate was overpriced before the pandemic, squeezing small businesses out of NYC, and must come down to a level that makes sense.

@nada but take a look at the last 10-15 years (which would be my entire working career), and mortgages are above trend..
I realize that sub-3% mortgage was a gift, which is why I am unwilling to sell that home and loose the 30 y fixed mortgage I have on this residence.

Also, if you look at other countries, say, France, you realize, very low mortgages are less of a US exception, as they have been happening in other places too
https://www.statista.com/statistics/916114/annual-average-interest-rate-on-new-residential-loans-in-france/

>> @nada but take a look at the last 10-15 years (which would be my entire working career), and mortgages are above trend..

But… so what? That last 10-15 years saw S&P rates of return range from 16%/yr at the best entry point and 11%/yr at the worst (pre-GFC). Do you consider that “reasonable” too, just because it was the trend during your entire working career?

>> That is - decent economy, everyone keeps their jobs, inflation cooling to 3-4%, no big crash.. but rates will remain elevated for a while.

It’s increasingly apparent that the economy has shifted to no longer requiring ZIRP. With Fed funds at 5%, the economy seems to be humming right along. Jobless rate still at historic low. Unemployed per job opening still at historic lows. Job creation per working-age adult still humming along at an unsustainably high pace. New home construction increasing again after a brief falloff.

Is 5.x% gonna do it, or will the Fed get caught flat-footed again? I don’t know. Where will it eventually settle? Not sure, but it sure seems like the training wheels have come off. ZIRP and trillions of dollars per year in bond & mortgage purchases seem a thing of the past.

So maybe another 1-2 hikes this year are in order to solidify the win against inflation. Looks like the economy at the moment is taking higher interest rates well, but we know there are faults under the surface, with some of the most obvious ones being geopolitics, commercial real estate and banks that are lending to the commercial real estate sector. If one of these factors (or maybe some other one we cannot see) triggers a recession down the line, the fed might have to cut the rates and we might go back to the 5% mortgages level that was "normal" in the last decade? Clearly, 3% isn't coming back and was an anomaly, but I do think that "equilibrium" rate in 21st century might be lower than the long-run averages.

>That last 10-15 years saw S&P rates of return range from 16%/yr at the best entry point and 11%/yr at the worst (pre-GFC). Do you consider that “reasonable” too, just because it was the trend during your entire working career?
No. Some of the increase was caused by increase in valuation multiples driven by increased money supply and globalization, so I would imagine stock market would have to perform below trend for a while given the opposite fed policy and de-globalization.

>> I realize that sub-3% mortgage was a gift, which is why I am unwilling to sell that home and loose the 30 y fixed mortgage I have on this residence.

Yeah, that locked-in effect is interesting to think about. For a lot of people over the past decade, 2-4% cap rates were justified by 2-4% mortgage rates. Yeah, it’s a meager cap rate, but account for rent growth / appreciation, sprinkle in some leverage, and voila — you’re at an acceptable ROE!

But everyone is now kinda “stuck”. ARM-ers will tend to stick it out until they reset. Best-case, we’re back at ZIRP and they can merrily sell at a profit or roll into another 3% mortgage. But the way things are looking, the choice will likely be to sell at a loss or roll/float into a negative-carry 6% mortgage ad infinitum.

Fixed mortgagers will hold longer, wanting to monetize their 30yr mortgage. But as time goes on, this will be less and less tenable. I’m sure some NYC-ers retire into whatever they bought 30 years ago, but for many, life happens. Kids come, kids go, finances mean an upgrade or downgrade in necessary, move to suburbs, move to another state, etc. Condo-ers have the choice to play LL. Coop-ers do not: they will be forced to sell or else carry a yield-less unit out of principle. Regardless, as principal payments overtake interest, it becomes increasingly clear that ROE is no longer leveraging cheap money. Rather, the realization dawns that the ROE calculus also involved an implicit agreement to replace the cheap 2-4% funding with your own capital over time, effectively earning 2-4%, irrespective of opportunity cost for that capital and option value.

I’m not suggesting doom & gloom here. Even if this plays out, it just means people will stick it out in their housing longer than they “should” and ROE will suck. But at least people had a roof over their heads, so it’s not the end of the world.

The locked-in effect also has an interesting effect on macroeconomic policy. I think it significantly reduces the effectiveness of the Fed’s rate increases in slowing down the economy, which works most effectively through housing. Sellers have gone on strike, understandably so, reducing inventory and stoking construction. The embedded option in a 30yr mortgage means Fed policy is more effective in one direction than the other. Another reason why ZIRP seems off the table for the indefinite future.

Nada, In the long run, if Fed keeps the short rates rates high, aren’t they increasing inflation at the margin by keep new home building expensive and contributing to the shortage?

Do you think it is sustainable long term that mortgage rates and bond yields are higher than cap rates and stock market returns?

>> So maybe another 1-2 hikes this year are in order to solidify the win against inflation… If one of these factors (or maybe some other one we cannot see) triggers a recession down the line, the fed might have to cut the rates and we might go back to the 5% mortgages level that was "normal" in the last decade?

Maybe. But I think there are equally likely scenarios where another 1-2 increases are not enough. 30yr mortgages tend price at around a 2% spread to 10yr treasuries. The spread is a bit wider when rates are higher, or if volatility is higher, because of the embedded option. If you look at market expectations, volatilities will likely come down as the economy’s neutral rate becomes more clear to everyone (Fed included). But the entire forward rate curve points to expected 10yr rates at 4% well into the indefinite future. Which means 6% mortgages.

The 5% scenario is definitely plausible, but so is a 7% scenario. Labor markets are still too tight. While the problem has stopped getting worse — unemployment is not going lower, and openings per unemployed has finally leveled out — these are still at inflationary levels. The hope is that the lagged effects of 5% Fed rates will be enough to turn them around. It might happen, but historical experience if anything points in the other direction. In any case, it’s not a “given”.

Ask yourself this. Do you see a decrease in spending of those around you? Do you see an increase in people working? Demographically, we have a retiring generation of boomers who are sitting on ZIRP-fueled wealth. They will spend, because, why not? So that demand seems like it will remain. Meanwhile, the younger generations just have less people, meaning labor supply is constrained. And then there’s the issue of the Instagram / TikTok generations, who seem to be animated by conspicuous consumption to degrees their predecessors were not. Are they gonna cut spending? Behavior that was previously perceived as tacky has become normalized. I state that not in judgement, but rather as a force on the inflationary balance.

>> In the long run, if Fed keeps the short rates rates high, aren’t they increasing inflation at the margin by keep new home building expensive and contributing to the shortage?

I see how you could make that argument, but I imagine it’s really at the margins. It certainly runs counter to what pretty much any serious economist will tell you. Rate policy primarily affects demand, not supply. I’m sure you’ll be able to find all sorts of seemingly-authoritative alternative views on the Internet or filtered via ChatGPT. I’m not an expert on the fundamentals of this sort of thing, so I’m relying on the experts here. Experts who disagree significantly on where rate policy should be headed all have the same underlying views on how rates affect things. So to me, it starts diverging into the sort of fringe theories we saw here a couple of years ago: “The Fed cannot raise rates ever again, despite runaway inflation, because the US govt cannot afford it because it’d push the US into bankruptcy.” I guess it could happen, but it sure hasn’t seem to yet.

>> Do you think it is sustainable long term that mortgage rates and bond yields are higher than cap rates and stock market returns?

Define “long-term”. Without going into what I consider out-of-whack, all sort of fundamental relationships can certainly go & stay out-of-whack for entire generations before they correct. Can they stay out-whack with fundamentals for 100+ years? Perhaps, but at that point I question the measure of “fundamentals” used.

Do you see a decrease in spending of those around you?

Lately I personally spend very unwillingly on all but baby-related stuff (including more space, out of network doctors, etc). I don't trust this economy and have not bought a designer handbag in a while.
I do notice among the fans of designer handbags an outrage over price increases in the last few years, and decreased enthusiasm around purchasing these overpriced luxury items. A number of luxury-associated influencers have quit recently, all at once (search for keywords like "death of luxury youtube").

But baby gear and nannies are expensive, so I will be spending more than usual in the next few years, at least until my baby goes to public Pre-K.

On number of people working, I do not notice an increase, but there is a lot of talk of productivity gains from AI. It is overhyped and blown out of proportion, but there is no smoke without fire. In the near term, I am afraid supply side will be constrained by de-globalization even more than demographics.

I don't see that influencers quitting is anything less than fantastic for society. Although I suspect a certain amount of it is entitled brats without jobs being pissed off that there are a growing number of everything that won't give them free shit anymore. That market is way oversaturated. Some surveys suggest that 55% of young persons career goals is to become an influencer. I posit that maybe 1 in 1,000 could actually become one successfully and truthfully.

I agree about influencers quitting... it was a bubble anyway.

On consumer spending, I have seen data from a credit card issuer that June spending was down slightly YoY, with a greater decline among higher income consumers, and steady spending among the lower income segment (which makes sense to me given the layoffs have been concentrated among the white collar workforce, and also lower income people spend more on necessities).

On the other hand, Prime Day sales last week were up 6% YoY .
https://techcrunch.com/2023/07/13/amazon-boasts-record-sales-for-prime-day-as-us-shoppers-spent-12-7-billion-during-the-sales-event/

Amazon is another tech firm engaged in illegal monopolistic practices but our antitrust laws are now largely toothless.

>> search for keywords like "death of luxury youtube"

I missed the birth, adolescence, and middle age of luxury YouTube. Nevertheless, now that I hear about its death, know that my thoughts and prayers are with the community. A great totem to the cause of conspicuous consumption has been lost; may a worthy successor rise from the ashes on TikTok.

BTW, perhaps “conspicuous consumption” is the wrong phrase for what I meant. More the normalization of narcissism, where so many people measure themselves via how they are perceived and increasingly seek to feed. Sometimes, I see a couple where one is repeatedly taking pictures of the other in an endless series of increasingly desperate poses (to my eyes, anyways). Why, and for whom? I kinda want to go whisper in the picture-taker’s ear…. RUN!!!! But in reality, I accept people for who they are, it’s not my place to judge. But I am happy to draw conclusions about implications on spending. If you care so much about what other people think, maybe it won’t be designer handbags, but it’ll be something.

>normalization of narcissism, where so many people measure themselves via how they are perceived

That's not a recent phenomenon. Private schools and prestigious Park Ave addresses are exactly that, and predate instagram, youtube and influencers.

It feels different. Culturally, rich people were the butt of stereotypical jokes on TV 30 years ago. Now, (sorta-)rich people have reality TV shows where the audience is not watching it as some sort of performance comedy.

The Park Ave set was always there. The difference now is the mass of people engaging in “look at me” behavior in ways unlike before. People are still people, with a spectrum of beliefs and values that does not vary hugely over time. But on the margins, people are influenced by societal shifts. And the economics of spending & demand are all about the margins. If everybody suddenly cut their spending by a mere (say) 2% or whatever, we’d be dealing with deflation.