It is fashionable to debate the fate of New York City these days with the left edge of the argument being it is doomed and the right edge the constant refrain that New Yawkers have GRIT.
New York Post writer James Altucher opines that “New York City is dead forever” whilst comedian Jerry Seinfeld (from his Hamptons mansion) counters that New Yawkers have grit.
This falls under the heading of: “Two Things Can Be True At The Same Time.”
Guy calls me to discuss apartments and asks what happens when markets begin to drift. I had a good long run owning thousands of apartments and was taught some harsh lessons and some good ones by Mother Market.
New York City apartments, current status
How about some basics, shall we?
1. NYC is a big apartment market with more than 2,500,000 units — I peg the market at 2.6MM.
2. Like every market, it is segmented into A, B, C, D and new units.
Huge list of differentiators — views, proximity to retail/restaurants, proximity to transportation, walk to work.
3. Pre-COVID the market was robust and had a lot of new inventory arriving which was being smoothly absorbed at increasing rents. Things were stable, prices had an upward bias, vacancy was low.
4. Recent snapshot has almost 100,000 vacant units <<< indicated 3.8% vacancy. I do not believe this for a second.
As recently as 2018, the vacancy rate was 11%, so this number is suspect to me.
5. Chatter has rents down by 13%. I think this is a moving target and the target is moving lower, quickly. Info always lags reality.
You can get a lot of different views on this, but I think this is a pretty good snapshot right now.
Stop — we are not talking about For Sale condos. A total of 25% of all condos built since 2013 are unsold. That will have an impact on the apartment business if some of that inventory is converted to rentals.
This condo inventory could shift to apartments easily.
The nature of apartments
Apartments are classified as A, B, C, D, and brand new.
These are quality gradations and are reflected in rents asked and received. You can have an A unit in a great location that commands an enormously higher rent than an A unit in a less great location.
Within New York City the physical location, proximity to services, proximity to retail/restaurants/grocery stores/markets — all have a block-by-block impact on value.
It is a complex game, but just like any apartment market.
When looking at vacancies, there are also subtle issues such as the number of renovations, damaged apartments, barely used pied-a-terres, units tied up in litigation, and units owned by persons in the hospital or moving to nursing homes.
These noted units are absolutely vacant, but they may not be a reflection of demand. They are “special” situations.
Apartments rent for a year at a time, so when markets move there is an overhang. Somebody who signed a lease three months ago cannot take advantage of other opportunities or lower rents for another nine months. There is a lead-lag phenomenon.
When they do come to market or discuss a renewal, they will locked and loaded looking for a deal.
What will happen, Big Red Car?
First, let’s identify the drivers:
1. The pandemic is forcing people to look at the density of New York in an unfavorable manner.
2. The economy is forcing people in certain industries to deal with diminished, limited, or no income. Talking to you, restaurant business.
[If the restaurant business goes to Hell — it already has — and the number of seats are halved, is the great food cornucopia of NYC Eats a real deal? Huge real world problem. Particularly at the low end of the food business, the affordable end which has been hit the hardest.]
In San Francisco, 50% of all storefronts are closed for good. I like to watch San Francisco because it performs like a big city, but it is really a small city.
3. There is a perception that an already expensive-as-Hell NYC is going to become progressively more expensive as the city tries to maintain services with a grossly diminished tax revenue flow.
The politicians are just now starting to wake up to this reality. This will drive people away.
There is not a person in NYC who does not think the Federal, State, City aggregate tax burden is not going up. In times of impending higher taxes, people are drawn to places that will protect them — Texas, Florida have no state income tax and no city taxes.
4. There is a concern about physical safety — people being mugged in broad daylight on the UES (upper east side, where the rich folk graze).
5. The whole WFH has people thinking — “Hey, maybe my “home” can be in Charleston, SC or Miami or Austin? Do I even need to live in NYC? Can I avoid the commute?”
6. The whole #DefundPolice/BlackLivesMatter movement has folks concerned about public safety at a systemic level. This really impacts families with young children.
7. In a weakening market, everybody is looking for a bargain. It’s just like Neimans Last Call, it’s all about the discount, the bargain, the deal. Everybody expects and demands a deal in a weakening market. It is in the DNA.
The combination of the above creates the following:
1. In a weakening market, apartment owners with vacant inventory always drive the prices down. They all studied Econ 101, so they say, “If we reduce our prices, we should make more deals.”
The first wave of this works. Then the vacancy is re-deployed (think of it like a bubble or a cloud moving around town, the vacancy is dynamic) and some other apartment owner decides his newfound vacancy can be filled if he lowers his prices still further.
This sets off a race to the bottom. This is already happening.
2. The vacancy will increase as #1 – #7 above continue to spread like COVID. Vacancy is like a virus. Everybody gets it, but the market response is determined by the dumbest owner, the most financially pressed owner, the guy who makes the biggest mistake, and the amateurs.
In the apartment racket, we used to say:
When the dentists get in, get out.
When the institutions get out, get in.
In NYC, with all its money game folks, pick your favorite profession to substitute for “dentists.” There are a ton of folks who do not belong in the business, but they are and their inventory and behavior is in the numbers.
It only takes one panic stricken owner doing an absurdly low priced deal to wreck the market perception. NYC is a tenant rep sort of market — tenants hire brokers to find them a deal — and the tenant reps remember the lowest number they have ever heard.
3. Occupancy drives pricing on the way down, meaning as vacancies increase, prices drop faster. When you get to 15%, the market is in freefall.
Remember that dropping market prices don’t just impact new deals, they drive renewals. The tenant renewing his lease wants the same pricing as the stranger off the street is getting. This drives rent rolls, incomes down.
4. On the way up, occupancy also drives pricing, but with a two year lag. Two years after hitting 97% occupancy, the rents will go up, but they will go up slower than you think because folks have one year leases.
An apartment owner cannot ask for a higher rent from a renewal unless he can find a tenant, a new tenant, off the street at that price.
Hotels are apartments that reset their prices daily — thereby they can capture quick movements and charge you more for the weekend of SXSW, get it?”
Apartments reset their prices with each expiring year long lease and each vacant unit absorbed. It is hard to force increases until the market approaches full occupancy.
A shrewd, salty, seasoned, experienced owner will renew a lease at a lower rate in order not to incur the cost to refurbish the unit for a new tenant. This typically runs 25-30% of a month’s rent or more. This is real money and if spread over a six or twelve month renewal is money well spent, plus there will be unoccupied unit cost while marketing the unit. Vacancy is a real cost to a landlord.
5. People will move — relocate — for a better deal, a lower rent. They will move from a $6,000/month, 1500 SF “A” unit to a $4,000/month, 1200 SF “B” unit in a NY Minute.
This has nothing to do with the quality of the units, but everything to do with real or imagined personal financial situations.
In a down market, people become absurdly willing to embrace conditions they would not a year earlier. Three blocks from the subway? No problem.
6. There will be financial failures, foreclosures, and some inventory will be managed by bank officers who are graded solely on occupancy.
Financial institutions are sloppy, do not bother to learn the business, and turn property managers and rental agents loose with only one direction, “Get that place rented!”
The day after every foreclosure in the history of the world, the rents went down big time.
Bottom line it, Big Red Car
The NYC apartment market is going to explore vacancies and pricing it has not seen in a decade. This is systemic. This is market driven. This will be a blood bath.
1. Vacancy rate, market wide, across all levels of quality, will hit 20%. There are plenty of folks who are predicting worse than this.
2. Pricing will follow suit with the most expensive units seeing the biggest impacts. Rates will come down by 25% at the top end.
Not as much pricing fallout at the lower quality units because the “B” occupants will be moving to the “C” units thereby increasing demand for “C” units.
3. Mentally, the industry will be in the doldrums for 5-6 years. It will feel like when NYC almost failed financially in the 1970s.
But, Big Red Car, do New Yawkers have GRIT?
Yes, dear reader, NY-ers have grit, but that can be true even whilst the apartment market is devastated.
Southerners eat grits and country ham for breakfast, but they still have to live within the constraints of markets.
But, hey, what the Hell do I really know anyway? I’m just a Big Red Car. Be good to each other because you never know what burden that other person is carrying.