Tom Adams: The NYC real estate bubble is about to pop
This Sunday our friend Tom Adams visited the Alt Banking group and talked to us about how the high-end NYC real estate bubble is due to burst soon, if it hasn’t already.
He introduced his topic with an analogy from oil. When credit was super easy to obtain, post-crisis and during the era of quantitative easing, there was an incredible amount of investment in fracking and drilling. Everyone wanted a piece of the action, and the secondary junk bond and CLO markets were more than happy to oblige with plentiful cash.
The result was an over-supply in an economically stagnant era of low demand. Instead of seeing the economic law of supply and demand kicking in, however, we saw the opposite, at least temporarily: companies that were in need of cash to pay their creditors regularly pumped as much oil as possible to make their payments, resulting in even more supply and the collapse of the market.
According to Tom, we’re seeing a similar dynamic in NYC luxury housing, and for a similar reason: too much easy money for developers to buy and develop luxury housing, without regard for the demand. But, whereas in the case of oil the markets are relatively transparent and move quickly, the real estate market is famously opaque and sly, with information leak managed by real estate brokers who have skin in the game. And while ultra luxury condos are a “hard asset” they aren’t really a commodity: no one “needs” a $20 million condo like they need oil or wheat. It’s really more like art, where the market is whimsical and changes when a particular collector or two die or lose interest.
Even so, it’s possible to do some basic reckoning. If you count the number of very rich people who are on the market for Manhattan apartments that cost more than $100 million, or even $10 million, you’ll soon realize they mostly already bought them. That means that hundreds of units which have come on to the market in the past couple of years, and that are due to come on to the market this year (5126, the most since 2007, of which 63% are luxury, defined here as $2400/square foot or more), are essentially going to just sit there, with no buyers in sight.
Just to give you some apples to apples comparisons, there were a total of 177 apartments sold for $10m or more in 2015, down 13.7% from prior year (205 in 2014). According to streeteasy.com, there are 520 units currently listed for sale over $10m.
How could this have happened? It’s a market failure, but according to Tom it’s not that hard to believe given the availability of cheap, overseas loans and expensive land prices. Everyone and their uncle wanted a piece of the luxury real estate market, which has been a gold mine for developers for years, to the point where they’ve been building like crazy without looking around them for indications to pause.
The dynamic of success has made land prices so high that it’s become unattractive to build affordable housing, and moreover the labor with which the luxury apartment building is built is non-union to save on costs. The developers argue that they simply cannot afford to pay their builders well.
There are already signs that the bubble is bursting. First, look at the number of recently sold new apartments that are already listed as for rent. There are 6700 of them, which is a high since 2005. Also, the count of new listings are up 9% for luxury apartments – while going down 3% for non-luxury housing – to 4,055 units, and the time on the market is also way up.
There’s another connection between oil and real estate markets. Namely, the people who buy the stuff. Lots of the luxury apartments are being bought – often through shell companies – by international elite who got rich in part through their investments in oil and other commodities. So the drop in the price of oil, although great for the average consumer who buys gas (and not great at all for the environment), means that there are fewer potential buyers looking to invest in apartment-shaped commodities. The recent problems in China aren’t helping either for the supply of billionaires.
So, what can we expect? First, a wave of developer defaults, like we recently saw in Harlem, which will slow down or stop the new construction. Second, the apartments that already exist will be rented or sold at below-luxury rates, cannibalizing the market at that level. At some point we might even see land prices going down far enough for developers to consider addressing the needs of the middle class, whatever that might mean in New York City. Fingers crossed.
Most importantly, the impending luxury housing crash should be an opportunity for community groups to demand a new conversation about what land and housing are supposed to be for, hopefully convincing city officials that they represent all New Yorkers, not just the super rich.
mathbabe 
No hope yet for those of us in the San Francisco Bay Area, is there? I hope daily for a tech crash….
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The cause of the higher housing costs in NYC, SF, London and other cities is because of market inefficiencies caused of laws that artificially constrain zoning density (“rent-seeking”) and overuse of historic landmark status.
http://fivethirtyeight.com/features/the-rent-seeking-is-too-damn-high/
“And while Baker is a liberal, conservatives are also concerned about rent-seeking, such as land-use restrictions that make it hard to build housing in high-priced coastal cities.”
Also:
http://www.nydailynews.com/opinion/build-big-bill-article-1.1913739
Harvard Economist Edward Glaeser:
“If we really wanted to rapidly create lots of housing for all New Yorkers — poor, rich and in-between — we would forget about carving out a special class of “affordable” units and embark on another approach entirely: raise height limitations drastically, slow the spread of historical districts, speed the review process in much of the city and radically simplify the zoning code.”
Recall that until Uber came along, because of political restrictions on the number of NYC taxi medallions to about 13,000 the price of taxi medallions were has high as $1.2 per medallion. Now the market value is about $700,000.
So, while may be emotionally convenient to blame others for the higher housing costs in NYC and other coastal cities, the true cause is market inefficiencies caused by politics.
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David, I used to agree with that 538 (originally Yglesias) analysis, but the market has recently been complicated by foreign investors, as Cathy describes. There has been a boom in construction is NYC, which itself is counterexemplary to the Yglesias/538 analysis. That that boom has not eased the housing market also demonstrates that the analysis is inadequate to what’s happening here. The market’s stuck in a dilemma: once housing becomes a speculative market, the demand/supply is divorced from the housing market and belongs to investment only. To drive that speculative market out, you’ve got to deflate it. But that means less construction. Dilemma. But there’s hope: the boom-bust cycle. A busted bubble should provide excess units, if investors divest. And those unused and divested units go into the housing market. And land prices should decrease as well, as Cathy mentions, yet there’s still a demand for middle-class housing, so maybe, if gov’t plays its cards right, developers might go for it.
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Hi Rob,
“rent seeking” the use of politics to create an artificial scarcity — in this case of housing is not an opinion of anyone’s but part of microeconomics. Consult Economist Tim Harford’s book “The Undercover Economist” or read Economist Edward Glaeser’s articles including the one that I provided through the link.
The foreign investors would not be a problem if the “rent seeking” was eliminated which in this case means passing laws to undo the laws that create the artificial scarcity in the first place.
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Hey David —
I replied on a separate thread below, but I want to address the Glaeser article as well. As I wrote above, I used to agree with his recommendation — remove zoning restrictions. But there are a couple of misapprehensions in his piece that implies an ideological rather than practical orientation. He blames a “chill” in development after WWII on rent regulations, failing to observe that newly constructed units n NYC are not regulated, only units existing pre-law. Rent regulations are therefore an incentive to construct, rather than simply jack up rents and evict those not wealthy enough to pay. If landlords have units to rent at any price, one should not assume that they will have any interest in construction, since construction is always, even under the most favorable conditions, more expensive than merely raising a price, and construction would ease the market and slow the rise of the existing rents.
Gleaser also mentions the inefficiency of empty-nesters holding onto regulated units. This is particularly telling to me. One the one hand, most efficiency exchanges are unit-for-unit, not sq. ft. to sq. ft. IOW, an empty nester leaves a unit to a young family that was living in closer quarters. It is rare that a single person living alone will opt to share in a larger space — it’s usually the other direction, shedding roommates for privacy. If there’s little or no unit-to-unit difference in efficiency, and since the wealthy occupy larger spaces freely and without being accused of inefficiency, this sq.ft. notion of efficiency here is just one of discrimination against the have nots. To ease the housing market, it would be far better to incentivize construction (by retaining rent regulations) and let empty nesters alone to enjoy their good luck. So I think Glaeser is in the thrall of a “free market” ideology that is counter to both facts and values.
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Indentifying zoning as the rent-seeking explanation for the housing crunch across the country was the subject of Yglesias’ last book published 2012 “The rent is too damn high.” Of course Yglesias’ was not the first to observe rent-seeking, but more commonly economists, especially libertarian economists, focused on rent regulations. Yglesias gave zoning-as-the-problem wide, popular currency. Re foreign investors: they raise the value of the land and the rents. It’s a straightforward problem of wealth inequality, wealth edging out the local market, spiraling it upward — as the price of real estate rises, it becomes more attractive to high-end investors as speculation.
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Interesting read, thanks! Do you think there will be an impact on the west coast as well?
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