Why Sellers Should Sell and Buyers Should Buy

Whose kidding whom? Sellers will only sell if they want or need to and buyers will only buy if they believe they see a good opportunity. Brokers can’t “sell” a client into acting but I wanted to discuss some reasons why sellers might want to sell today and buyers might want to buy today.Clearly, there is tremendous uncertainty in today’s investment sales market. Values are far below their peak and are expected to continue dropping. The volume of sales is also far below its record peaks as activity has ground to a halt. As a broker who sells buildings, the level of sales activity is far more important than the direction of prices. The activity just has not been there in 2009.I am asked several times each day by clients who would like to purchase properties if the time is right to buy. They think prices will continue to drop so the inevitable question is, “Why not wait until prices hit bottom?”. Potential sellers constantly ask when the optimal time to sell is ( I rarely suggest that sometime in 2006 or 2007 would have been optimal). “If I wait a few months will prices be better?” and “How long do I have to wait until my value will be higher?” are the most frequently asked questions from them. As uncertainty rules the day, how do I answer these difficult questions without sounding self-serving? Let’s take a look at current market conditions to set the stage for the discussion of perspectives relayed to buyers and sellers. I will discuss conditions in the New York City market as that is the only market I know. I assume most markets around the country are experiencing similar dynamics, to differing degrees perhaps, but still heading in the same direction.  Using the Manhattan marketplace, for example, in the first three-quarters of 2009, there were 209 investment property sales having an aggregate sales value of $3.2 billion. The $3.2 billion in sales represents a 92% reduction from the activity in the peak three-quarters of 2007 in which there were $40 billion in sales. The 209 properties sold represents a reduction of 74% from the peak number of properties sold in the first three-quarters of 2007 which totaled 803.The Manhattan market has a total of 27,649 investment properties (south of 96th Street on the eastside and south of 110th Street on the westside). Over the past 25 years, the average turnover of this stock has been 2.6% or approximately 719 sales. The lowest turnover we have ever seen was 1.6% in 1992 and 2003, both years were at the end of recessionary periods and both years experienced cyclical peaks in unemployment.If we annualized the activity in the first three-quarters of 2009, turnover was running at 1.0%. (It is actually trending up as, in the first quarter, the volume was running at 0.7%, in the first half it was 0.9% and 1.0% for the first three-quarters). We believe turnover will finish the year at 1.1% to 1.2%, establishing a new low since we began tracking this data in 1984. In the Manhattan market, the average sales price in the first three-quarters of 2009 dropped an average of 32% from the peak prices achieved. In order to understand this reduction more clearly, we need to look at how different property types are performing. Multifamily properties have performed best with walk-up properties having lost only 16% from the peak with elevatored properties dropping 20%. Given the fact that consumer spending has been greatly reduced, retailers have had a difficult time which has resulted in large reductions in retail rents. It is, therefore, not surprising that mixed-use properties (those having at least 20% of their square footage occupied by retail tenants with apartments above) have lost 46% of value while retail properties have lost 49% of value from their cyclical peak.Office buildings have lost 62% of their value from the peak. However, if we look at office properties which are well-leased on a long-term basis without market exposure, average values have dropped only 25%. Those with significant vacancy, or a large percentage of leases rolling in the short-term, have seen values fall by 70%.We believe that value will continue to fall into 2010 as unemployment continues to rise. As unemployment rises, real estate fundamentals become stressed and as fundamentals become stressed, value falls. Economists expect unemployment to peak in the first half of 2010. It is at this point that fundamentals will be at their weakest and value will, presumably, be at its lowest.Why should sellers sell today?With values well below their peak and expected to fall a little more, why should a seller sell today? As counterintuitive as it may be, there are several reasons why a seller could benefit from selling today. This, of course, assumes that an owner is compelled to sell or has some external pressure motivating them to sell within the next year or two.The first thing to consider is that the extremely low volume of sales has been caused by supply constraint not a lack of demand. The fact is that demand is significant. We have received dozens of offers on each of the income producing properties we are selling and have received over 50 offers on each of the notes we have sold this year.Additionally, there is a massive amount of capital sitting on the sidelines waiting for an opportunity. We can refer to this patient capital as “shadow demand”. Much of this is from institutional distressed asset funds which are currently being pressured by their investors to show some activity. The lack of supply has created frustration for these funds and their appetite is currently very large.Another reason to put a property on the market today is that the supply of properties available for sale is extraordinarily low. The massive demand that is chasing few assets is actually driving property prices above the level that fundamentals would dictate (notwithstanding the price reductions we have already seen). It is anticipated that distressed assets will be coming onto the market in significant numbers over the next couple of years which will provide more choice for investors, placing downward pressure on prices.Potential sellers should also consider that prices have not yet hit bottom and they may be able to get out prior to the market hitting its bottom. Value will be lower in the future before it increases.Financing, particularly for smaller multifamily properties, is plentiful from portfolio lenders for cash flowing properties. Community banks and small regional banks have remained very active and continue to look for additional opportunities.Additionally, mortgage rates are very low by historical standards providing buyers with the ability to pay a relatively aggressive price. Given how much the Fed has increased the money supply and has increased spending, there is nowhere for rates to go but up. We will have to pay for these policies in the form of higher long-term interest rates , higher taxes or, most likely, a combination of both. As mortgage rates increase, values will face additional downward pressure.Today’s market also provides an opportunity for portfolio reallocation. Several clients are looking to sell “maxed out” properties or smaller, non-core assets in order to take advantage of the more reasonable pricing of core assets.Why should buyers buy today?So, with value expected to drop further, why should buyers look to purchase now. The first reason is that it is nearly impossible to time the exact bottom of the market. Value has fallen so much already that it is expected to bottom out in the short-term, only falling another 10% or so. If this is the case, and a buyer has a long-term investment strategy, buying today may not be such a bad move.The supply of available properties in New York is always very low. If you consider that the average turnover rate during a 25 year period has been 2.6% of the total stock, this means the average holding period is 40 years. Yes, some properties like the GM building have traded several times within the past 15 years but properties like that are offset by properties which have been owned for over 100 years by the same family. For these reasons, when an asset becomes available, if an investor wants to own that asset, they should move on it because is will likely not be for sale when the buyer decides the market has hit bottom. (We will only really know we have hit bottom after we have emerged from it.)If a buyer believes that the government’s reaction to the recession will lead to inflation, hard assets are great things to own in an inflationary environment. Commercial investment properties are excellent hard assets. Investors would want to ride the upswing in inflation but with inflation comes Fed tightening and higher interest rates. However, if properties are purchased now, locking in today’s low rates on a long-term, fixed-rate basis, they will be sitting pretty when inflation hits.After the market hits bottom, we expect value to just bounce along the bottom for 2 or 3 years as the market goes through deleveraging. Whether, and to what extent, properties appreciate will be dependent upon a fight between upward pricing pressure created by excessive buying demand and downward pressure created by the massive deleveraging that will be necessary as 2006 and 2007 vintage loans mature in 2011 and 2012.Regardless of the incentives created by the dynamics mentioned above, we still believe the volume of sales in New York City will be lower than the 1.6% level in 2010. We hope that we are wrong but the congestion in the distressed pipeline is not expected to loosen up until the later half of the year.So, should sellers sell and should buyers buy? The answers to these questions will be decided by participants in the market and the timing of these decisions will determine who the winners will be coming out of this downturn. One thing is clear, a significant transfer of wealth will occur over the next few years and the results for each individual (other than those who are forced out of positions by lenders or note buyers foreclosing on them) will be based upon how they answer those two questions and the timing of the decisions they make.Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.