Real estate investment sales data is in from 2020 Q3 and the results are cautiously encouraging. There is still a great deal of market, political and public health uncertainty, but the real estate industry is climbing back up from the depths of Q2. I sat down with my partner Victor Sozio, Executive Vice President, to discuss the current situation and the outlook for Q4 and beyond.
The Current Outlook
Transaction volume, dollar volume and cap rates right now look very similar to 2009 and 2010. Higher cap rates generally signal more risk. If the rate goes up, the value of the property is less when compared to the potential income you can make from it. While this sounds like a good thing, it also signals that property is less of a sure investment.
The difficulty of drawing conclusions right now, though, is that the sample size of transactions is small, given the fewer transactions the market has been registering since the start of the Covid-19 pandemic. Even before Covid, 2019 saw dips in investment sales as a result of the Housing Stabilization and Tenant Protection Act, which stymied rent-regulated owners from raising capital to manage and improve properties, causing a stark decrease in activity from potential buyers and investors.
Despite the sample size, there are some tell-tale signs of struggle in the market. One such marker is that the current vacancy rates for market-rate units is high, though Brooklyn and Queens are doing better than Manhattan, partially due to outer borough residents seeming more committed to staying. Brooklyn and Queens are also not as highly dependent on the office and commercial market as Manhattan.
Given the virus levels right now, the success of remote working and the timeline for a vaccine, it’s likely that offices will remain under-occupied until at least well into 2021.
“Uncertainty can create its own cycle of inactivity,” says Sozio. “It makes pricing discovery tough to gauge with so many people waiting for clarity, causing many investors to wait further. However, that’s started to change, and we’re seeing not only more sales, but more deals getting started. The low interest rates don’t hurt.”
Still, with that uncertainty comes more conservative financing. Though lenders are open to deals and becoming more active, they have stricter underwriting requirements and want to take a more comprehensive look at properties and business plans.
“We have what many banks are considering a ‘Covid escrow’ right now. Anything from a six- to 12-month principal and interest reserve has become relatively commonplace,” says Sozio. “One bright spot that is helping rent-regulated buildings has been the higher-than-expected rent collections rates in affordable units. This is an asset class to keep an eye on.”
What to Expect in Q4 and Beyond
Despite the upturn in investment sales activity, investors and owners shouldn’t expect to see a return to 2015 levels just yet. A look at the numbers shows that continued growth and stability should lead to a range of $30 billion to $40 billion in transactions in 2021.
In 2011, as the city started to recover from the 2008 Global Financial Crisis, there was approximately $17 billion to $18 billion in sales. In 2012, that number climbed to approximately $30 billion. We are poised for a similar recovery leading to further long-term growth.
The market can also expect to see a high volume of recapitalization with the historically low interest rates right now. For owners that aren’t highly leveraged, cash extractions could precipitate sales activity.
Lower interest rates and slower activity mean a lot of opportunities for potential buyers, particularly in the affordable housing sector. For responsible affordable or rent-stabilized operators, there are great opportunities for favorable financing right now. 10-year loans with sub-3% interest, and long periods of interest-only payments, are achievable for the right investors.
Lenders have begun to look more favorably on some rent-regulated housing because it doesn’t have the market exposure; while unable to attain the high rents of free market units, they are also largely protected from collections issues and turnover.
Similarly, well-operated rent-stabilized housing is particularly attractive to lenders right now. The HSTPA took away some upside for these properties, but especially right now, the downside protection offsets this, making it a highly stable asset.
“The strong collections numbers during the pandemic mean you can find solid financing if you have a long-term view for the property,” says Sozio. “I’m a big believer in New York City long-term, and I’m a big believer in responsible affordable housing ownership. Now is a great time to strategize and deliver that.”
From the end of this year into 2021, and maybe longer, there will be growing momentum in rent stabilized and affordable buildings, while the low interest rates likely mean there will be activity around note sales, distressed asset purchases and recapitalizations for further investments. This could continue into 2022 and even 2023, depending on the market situation and the path of the pandemic.
It should be a busy last quarter of 2020.