In the last two editions of The Apple Peeled, we said the conditions for investing in newly developed New York City real estate are P-E-R-F-E-C-T.
Prices are down. Rates are down. Developers are offering massive concessions.
We said all of the stars were aligned.
When we made that assertion, we unintentionally ignored perhaps the most crucial factor in evaluating the performance of an investment. Through an extremely narrow lens that doesn’t account for tax or emotional benefits that are sometimes associated with owning property, it’s accurate to say that real estate is only a good investment if it becomes more valuable than the price you paid for it. Certainly, we can’t guarantee that will happen.
But maybe it’s not entirely accurate to say we ignored making specific forecasts about value. It makes more sense to say that we assumed that every property in the city will eventually become more valuable because history tells us that’s a given. In defense of making that assumption, we’d point out that NYC property values have always made a comeback after a downturn and values have gradually ascended throughout this city’s resilient history, even through wars and depressions and recessions and pandemics. While making a case for now being the perfect time to invest in New York City, we didn’t provide any historical data that backed up our assumption.
To try to understand how long it might take to for the market to recover, we decided to take a look at the past.
Our first instinct was to look closely at what happened to the housing market in the aftermath of the 2008 economic collapse. In the second quarter of 2009, closings were down by about half and prices were down almost 25% compared to the same period the year before. The market started showing signs of life beginning of 2010, when the median sales price for a Manhattan home was at $466,000 according to a report issued by Douglas Elliman and Miller Samuel. The median sale price momentarily dipped slightly below that number in the 4th quarter of 2011 and the first quarter of 2012, it has gradually increased until it peaked at $815,000 in the 2nd quarter of 2019. ($570,110 – Q4 2013, $676,250 – Q3 2015, $795,000 – Q2 2017)
We also tried to recollect how quickly the housing market came back after the 9/11 attacks. In a Wall Street Journal essay from 2008, Jonathan Miller, the author of the previously mentioned Douglas Elliman report, was asked to compare the period following 9/11 and the Lehman Brothers bankruptcy of 2008.
Miller pointed out that the Federal Reserve “pushed rates to the floor,” which caused mortgage rates to drop sharply, creating a surge in demand beginning just 5 weeks after the attacks. He told a story of a 5-way bidding war on a 1-bedroom apartment his firm was hired to do an appraisal on. It signaled to him the beginning of a boom that was on its way.
There Is More To Timing Than Time
Since it’s virtually impossible to know if you’re getting in at exactly the bottom of the real estate market and if you’re getting out at the tippy-top, we think it’s important to recognize that timing isn’t only about dates on a calendar.
Even if a wizard cast a 50-year spell that automatically alerted you when we were at the precise bottom and top sides of a fluctuating real estate market, other factors would have a massive impact on the overall grade of the investments you might make when supplied with that information – even with perfect timing, the other factors that are outside your control would determine which investments you made during that 50-year window were the most successful.
It’s the factors we’ve been sounding the alarm on for the last 3 months that should stand out right now — Lower Prices. Massive Concessions. And ridiculously low interest rates. It’s the convergence of all these things at the same time that makes the opportunity to invest right now so appealing, and it perfectly illustrates why these conditions should be factored in when deciding if you’ve perfectly timed the market.
Between 1989 and 1996 housing prices in Manhattan declined a total of 32%, according to a 2008 study published by The Furman Center at NYU. The same study showed that housing prices increased in Manhattan by 185% between 1996 and 2006. With the benefit of hindsight, someone would likely assume that they perfectly timed the market if they purchased NYC real estate in 1996 and sold before the economic collapse in 2008.
But would their timing have been perfect in every sense?
Consider the following:
According to historical data compiled by Freddie Mac, mortgage rates averaged 8% in August of 1996.
- If you borrowed $1M to purchase a property in 1996 at 8%, after 30 years, you would have paid $1,641,552 in total interest payments. If you borrowed $1 M at today’s rate of 2.75%, you’d pay $469,668 in total interest payments. (That’s a difference of $1,171,884)
- If you borrowed $1M to purchase a property in 1996, at 8%, and you made only the regularly scheduled mortgage payments, and you sold the property in exactly 10 years, you would have reduced your balance to $875,758. If you borrowed $1M to purchase a property today at 2.75%, and you made only the regularly scheduled mortgage payments, and you sold the property in exactly 10 years, you would have reduced your balance to $750,625. (Leaving you with an additional $125,133 in proceeds from the sale of the home.)
- If you borrowed $1M to purchase a property in 1996, at 8%, your monthly principal and interest payment would have been $7,337.65. If you borrowed $1M to purchase a property right now, at 2.75%, your monthly principal and interest payment would be $4,082.65. (A difference of $3,255.24 per month). At 8%, over the course of 10 years, you would have paid an additional $390,628 in mortgage payments compared to the total payments you would make if your rate was 2.75%.
Conclusion: Even if you “got in” in 1996 and you “got out” in 2006, the stars were not perfectly aligned.
More Examples that Show the Power of Low Rates
30-year fixed rates are in the two’s! Rates are so good we wanted to spend even more time further articulating the point. For a borrower, there are massive benefits that come with lower mortgage rates.
- Reduction in total interest paid over the life of the loan. (See 1996 example above. Bullet point 1)
- Mortgage balances are reduced faster, increasing the velocity in which borrowers build equity in their property. (See 1996 example above. Bullet point 2)
- Money is cheaper. AKA, monthly payments are much lower when rates are lower. (See below – Money is Cheaper)
- Borrowers qualify for higher loan amounts when rates are lower. (See below – Borrowers qualify for bigger loans)
Money is Cheaper: At around this time last year, a well-qualified buyer could lock into a 30-year fixed rate mortgage at around 3.75%. Today, an equally qualified buyer could lock into the same mortgage at 2.75%, maybe even lower.
- The principal and interest payment for a $1 Million mortgage with a rate of 3.75% is $4,631.
- The principal and interest payment for a $1 Million mortgage with a rate of 2.75% is $4,082.
- So, borrowing $1 Million costs $549 less per month this year compared to last year.
- The principal and interest payment for a $2 Million mortgage with a rate of 3.75% is $9,262.
- The principal and interest payment for a $2 Million mortgage with a rate of 2.75% is $8,165.
- So, borrowing $2 Million costs $1,097 less per month this year compared to last year.
Borrowers Qualify for Bigger loans: What a borrower is qualified for is based on a lender’s calculation of the borrower’s “debt-to-income ratio.” In a nutshell, they compare a borrower’s monthly debt (including the total projected housing payment) to their gross monthly income (The amount before tax & benefit reductions). Typically, a lender doesn’t want a borrower’s monthly debts to exceed 45% of gross monthly income.
Let’s assume that a borrower earns $20,000 in gross monthly income. Forty-five percent of that is $9,000. If that borrower carried no debt, and the combination of taxes, insurance and common charges was equal to $3,000, that borrower could carry a principal and interest payment of $6,000 per month and still maintain a 45% debt to income ratio. With a rate of 3.75%, that borrower would qualify for a loan of about $1,295,000. At 2.75%, the same borrower qualifies for a loan of about $1,470,000 (A difference of $175,000).
Before the pandemic, the market was already correcting itself in the $4M+ category, but developers were trying their best to drag-out any major correction at price points below that threshold. But coming out of the quarantine, it does seem like developers have come to terms with a new reality, and we’re witnessing an “instacorrection,” with new condo units selling at prices around 15% lower compared to before the city’s housing market went dark in mid-March.
In Douglas Elliman’s signed contracts report for July, the discount from original asking price for a Manhattan condo increased from to 16.4% from 9.7% the month before, and the discount from last asking price increased to 13.1% from 4.8% last month.
Many developers are offering concessions that would completely cover a buyer’s closing costs. Lenders dictate that contributions toward closing costs cannot exceed 6% of the total purchase price, an amount that is almost always enough to cover all buyer related closing fees.
In addition to covering closing costs, we’ve seen sellers offer to pay common charges for 1, 2 and 3 years. Be careful though, many lenders will count those common charge credits toward the 6% contribution threshold. It’s important to know which lenders will allow for both so you can take full advantage of what’s being offered.
The “Holy Grail of Real Estate” is to perfectly time the market.
For too many, chasing perfection will represent lost opportunity. Right now, rates are mind-blowingly low. Concessions are maxed out, and NYC prices are 15% lower than they were at the beginning of the year. If that’s not a perfect situation, it’s pretty damn close.
Still, many will wait because they’ll assume there is a little more room for conditions to further improve. They’ll ask: Is my timing absolutely perfect? Will rates fall even lower? Will prices drop even more? Will sellers cover even more years of common charges?
Timing is important, but great investing does not require perfection.