High End Manhattan Coops Always Appreciate--NOT

In my last posting, I discussed the tragedy of Bear Stearns and concluded that even the high end of Manhattan property will probably fall 20-25% in price after years of a "seller's market". (This conclusion also pertains to the high end of related locations such as the Hamptons.)

The transition from a "seller's market" to a "buyer's market" usually involves an intermediate phase, when sellers price at the recent peak; but buyers, sensing the prospect of lower prices, hang tough with their bids. The result is a stalemate, characterized by a reduced number of transactions and a buildup in inventory for sale. The Manhattan market entered this phase during the first quarter of 2008. The number of transactions declined by 34% and inventories rose 20%, much higher than the normal 8%.

The next phase is the beginning of a buyer's market. Those sellers who must sell start to close the gap between bid and asked by reducing their asked price. This starts a downward trend. Given the extent of the property appreciation during the last ten to twenty years, which I would characterize as reaching "bubble" levels, a 20-25% decline seems modest. Afterall, an asset that has sextupled in price could easily correct a Fibonacci 3/8 of the appreciation, which would be a decline of 31%.

Manhattan high end property values are primarily a function of Wall Street's net hirings or firings and the level of bonuses paid out at the end of the year. Most of the prestigious and largest firms pay modest salaries with bonuses accounting for a huge percentage of total income during good years. It has already been announced that employment at Bear Stearns will perhaps be cut in half. The other major investment banks will probably reduce their staffs to some extent. Even if they don't, 2008 earnings for these firms will probably decline significantly. (The first quarter earnings were down sharply.) Yearend bonuses will follow suit.

Most real estate agents tend to appear optimistic most of the time. Afterall, their compensation is a function of activity. They point out that the weak dollar is propping up property values at the high end as foreign buyers with stronger currencies swoop in. That has had some positive impact; but in my opinion, that will eventually be overwhelmed by the developing negative Wall Street situation.

If I am right about this, at some point a great buying opportunity will occur. But when? Historically, it takes roughly a year after a bear stock market ends to clear out all of the excess real estate inventory. Even if the stock market bottomed in the first quarter of 2008, one would have until the first quarter of 2009 to buy.

I would strongly urge any buyer to be a tough negotiator. That involves an initial bid much lower than the offering price. I would also suggest that you, as a buyer, not show that you are enamored with the property.

While the secular trend in the prices of Manhattan high end coops is definitely up, there have been periods of sharp decline. An example is the 1973-74 period. Then a virulent bear stock market, high interest rates, and some risk that New York City was in deep financial trouble created a perfect storm to drive down coop prices. What a great opportunity to buy a coop in one of the premier buildings in New York City! I have a friend who did purchase a seven room tower apartment in one of the great coops in Manhattan during this time. The by-laws of this building allowed the tenant shareholder to sell his shares back to the corporation for nothing in order to relieve the shareholder from having to pay maintenance. (Technically, if other shareholders were bankrupt, the remaining solvent shareholders would have to foot the total maintenance bill. That is why the "put" option was written in.) My friend thought about offering to buy the shares from the seller for nothing, but took a good look at him and realized the seller was much bigger and could probably outrun my friend. He then bought the shares for $125,000. They were, at the recent peak, worth roughly $13,000,000, an unleveraged compound annual 15% return over 33 years. (The National Association of Realtors says that home prices have appreciated at the rate of inflation plus 1.7 percentage points, which amounts to roughly 5% annual appreciation since 1926.) My friend's $125,000 investment would be worth only $625,000 today if it only compounded at 5% a year. What a fabulous investment he made! Not that I expect THAT bad a real estate market this time around. However, this story does demonstrate how important an entry point can be in any asset purchased for investment.