Rob Hinckley, HFF
New York City multifamily has historically been a darling of the real estate industry — and for good reason. It is arguably the most sought-after investment product type within commercial real estate investment’s most targeted city. It is the perfect demographic storm on the demand side: two-thirds of the population rent versus own; the population is arguably the best educated and includes the highest income generators in the nation; and the market continues to exhibit vast growth in household creation and population. Not to mention, the supply side is both geographically and politically constrained. These limitations are further exacerbated by very high costs to build.
However, even with the dual push of supply and demand continuing to be in investors’ favor citywide, there are some areas that are softening. Two areas that seem to be softening are luxury condominiums in Manhattan and rental product in Long Island City (Queens) and the downtown Brooklyn area.
Manhattan Luxury Condo Sales Slowing
Manhattan is often a trendsetter that is months and years ahead of the rest of the country when it comes to real estate trends, and the return of the luxury condominium market is a prime example of this. Some 2,500 units were delivered in 2014 with an additional 6,000 luxury units (those that are $2,000+ per square foot) slated to be delivered over the next three years. Prior to the delivery of this overwhelming amount of product, unit sales are already slowing in Manhattan. We will see far less of this product, with capital already weary of this type of investment.
Over the next year, a prime opportunity will be in the conversion space from rental or office use to residential. With land pricing at all-time highs and the increased risk of ground-up construction, conversions will continue to occur. These are especially attractive if you can locate or identify a property with a “middle market” story. For New York City, middle-market condo projects have a projected sell out in the $1,700 to $2,300 per square foot range; offer a unit count of fewer than 200; and include available amenity space. Properties that are more expensive on the sell out or buildings that are too large (in terms of unit count) are deemed too risky for the returns from a capital standpoint. The increased risk on the sellout is not commensurate with the additional gross return and inhibitive from an IRR standpoint if sales stall.
Supply Concerns — Not Yet
There are countless new rental projects going up around New York City with several key areas receiving the vast concentration of these units. These areas include Long Island City and downtown Brooklyn with 58 buildings and nearly 17,000 units under construction, planned and proposed between the two. Although this does sound like an extraordinary amount, this should be viewed from an overall market perspective. In terms of aggregate building permit issuance, New York City is still only around 60 percent of any given year of the past cycle’s permit issuance average during the four years from 2005 to 2008. Permit issuance would need to increase another 70 percent from levels today and sustain itself for four consecutive years in order to be back at the levels we saw pre-crisis. Additionally, household growth is projected at 122,399 additional households over the next five years, according to the U.S. Census. However, there are only 72,500 potential apartment units in the queue. Even if every unit of this pipeline were built, we would still be short of keeping up with demand. Developers will continue to build in some of these concentrated areas but until the supply catches up with the demand, we will continue to see extraordinary absorption and moderate rental growth.
Trends for 2015
- Super-luxury condo sales will continue to slow and some projects will stall. If the spigot of foreign investment decreases, watch for even slower absorption.
- There will be opportunities for middle-market conversions in Manhattan.
- Demand continues to outpace supply, even in supply-heavy markets in the boroughs. Continue to watch absorption, but in the long term these areas will be stable with higher-than-inflation rent growth.
- Merchant builders with shorter term views will push further into the boroughs, particularly in Queens and Brooklyn.
- Both build-to-core rental capital and condominium developers will be active in the rental supply heavy markets.
- Development site trades will stall until a new 421-a program (a real estate tax abatement program created to spur development) and direction is announced. Most likely, there will be an extension of the current program through year-end.
— By Rob Hinckley Director, HFF. This article first appeared in the March/April 2015 issue of Northeast Real Estate Business magazine.