Manhattan Real Estate More Mental Than Rental

Although the Manhattan real estate sales market has long been a full-blown spectator bloodsport worthy of an X-Games-like nightly television special, the rental market has patiently remained in the background, a cerebral cousin who stays home and plays it safe.

The rental market is much more responsive to changes in economic conditions, especially rising unemployment. Many firms are cutting back on hiring or are downsizing. In better times, new hires were a key driver of the rental market as new employees often rent first, then buy.

Many spectators incorrectly assume that the falling sales market would yield a rising rental market, that would-be purchasers become renters as credit went sour. After all, our second quarter market sales report showed a 25.6% year-over-year decline in resale apartment prices and a 50.3% decline in the number of sales. Therefore the rental market should jump, right?

But there's more to this. The modest 8.7% rise in sales inventory over the same period reflected the emergence of "shadow inventory" as a two-tiered formidable market phenomenon. This inventory type is comprised of apartments ready to be listed for sale but are withheld because of weak market conditions.

Many individual sellers who would throw their apartment onto the market at a price they demanded, opted to wait until the housing market improved. This had the effect of keeping the pace of rising sales inventory in check, but raising the probability that sales inventory at some point in the near future, would suddenly become bloated.

The more serious form of "shadow inventory" relates to new development and it is rising. A developer does not usually offer up all available units for sale as a marketing technique to create urgency. For a 150-unit condo, a developer might offer 50 units for sale initially and as those units sell out, release additional blocks of units until all units are eventually sold.

What happens if the initial block of apartments do not sell out?

A significant backlog has developed market-wide as new buildings enter the market and aren't being absorbed. As a result, a large number of units that are completed or nearing completion, have accumulated behind the public view. By some estimates, there are about 7,000 of these condos units in "shadow inventory" and growing. Add them to the 5,000 condo resale and new development listings formally on the market and there are roughly 12,000 condos to sell in Manhattan.

At a post-Lehman bankruptcy pace annualized pace of 3,200 condo unit sales per year, it would take 45 months to absorb all condo listings, 5 times more than the 9-month average absorption rate of the last decade.

Enter the rental market. That's got to be in better shape, right?

Developers and banks holding construction loans on new projects will likely be forced to rent out the remaining units on the rising number of stalled new development projects adding to the rental inventory. If the developers are foreclosed, the banks -- many of those have serious balance sheet pressures--will need to stem their bleeding by renting out the remaining units until they can sell them off. Individual sellers who need to sell but can't or won't sell at a loss, opt to rent out their apartments. Rental inventory continues to rise and rental prices fall.

We just released our rental report for the second quarter and the results sounded vaguely familiar to the sales trends. Rental inventory is rising at a 28.8% clip. There was a 17.5% year over year decline in rental price per square foot and a 58.3% decline in the number of new rentals.

One of the key culprits for the rental price and activity drop was the record low mortgage rates in the spring, which pulled many first time buyers out of the rental market (if they could qualify under the banks newly-found underwriting conservatism). Combine that shift with rising unemployment and there is less activity and downward pressure on rental prices.

One could therefore argue that the rental market is a leading indicator for the purchase market, at least in Manhattan. When the economy improves and the pace of unemployment begins to ease, the number of rentals should begin to rise, eventually followed by sales activity.

In other words, Manhattan real estate is more mental than rental.

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Comments

[chiquiquita]

There's a reason why inventory and price/sq ft aren't used in the rental market.

- Inventory is opaque: inventory numbers on the rental side are highly unreliable as landlords do not disclose all of their inventory and because they don't even all calculate it the same way, let alone share it all, inventory is amorphous at best.

· Square feet are non existent: fewer than half of rental buildings actually have calculated or shared square feet per apartment, to be able to accurately calculate price per square foot as noted.

· Quarter on quarter mistakes: quarter on quarter comps are just silly - of COURSE Q2 will be busier than Q1, as it is every year. Year on year comps are more important - but even there, you can't compare. Why?

· Inventory constantly shifting: use the Lower East Side as an example: pure 2007 to 2008 comps would show something like 25%+ increase in rents. Why? Because the Ludlow, a top-of-the-line rental building unique in the neighborhood completely skewed the comps. You must look at the actual on the ground inventory (which does change and evolve year to year).

· Coop and condo rentals: lastly, does this report likely does not include coop and condo rentals, which make up a greater percentage of inventory than ever; they're a different beast but still compete with traditional rental buildings.

Any thoughts on this?

[JonathanMiller]

Sorry for the delayed response - getting used to HuffPost's procedurals...

I'm guessing you are a rental agent. The comments here suggest no tracking of the rental market can be done, which is very old school. Same sort of discussion that occurred with the co-op market way back. Great questions/comments though:

[ Inventory is opaque:] not really - the same exact phenomenon occurs in new development. It collected to establish trends and will likely improve as the market becomes more transparent.

[Square feet are non existent:] not really - about 2/3 of the sales have sq ft associated with them plus we can extrapolate from historical and agent comments. We have a good start.

[Quarter on quarter mistakes:] Seasonality is alive and well. Nearly all my commentary on all my reports focuses on the year over year. However, how can one ever determine if the uptick in the spring was "more" than a seasonal rise unless the historical trend from, say q1 to q2, has been established?

[ Inventory constantly shifting:] Yes this is absolutely true and one of the reasons we track based on quarterly rather than monthly.

[Coop and condo rentals:] We actually track this, but the trends are nearly identical and given I only have room for 2 pages in the current report format, I opted to omit. I'll publish something with this data in the future.

[chiquiquita]

Indeed, there's a reason why inventory and $/sq ft numbers are not usually used in the rental market:

- Inventory is opaque: inventory numbers on the rental side are highly unreliable as landlords never fully disclose all of their inventory and because they don't even calculate inventory the same way, let alone share it all, inventory is an amorphous statistic at best.

- Square feet are non existent: fewer than half of rental buildings actually have calculated or shared square feet per apartment, to be able to accurately calculate price per square foot as noted.

- Quarter on quarter mistakes: quarter on quarter comps are just silly - of COURSE Q2 will be busier than Q1, as it is every year. Year on year comps are more important - but even there, you can't compare. Why?

- Inventory constantly shifting: take the Lower East Side as an example: 2007 to 2008 comps would show a 25%+ increase in rents. Why? Because the Ludlow, a top-of-the-line rental building unique in the neighborhood, completely skewed the comps. You must look at the actual on the ground inventory (which does change and evolve year to year) for a true analysis.

· Coop and condo rentals: lastly, does this report likely does not include coop and condo rentals, which make up a greater percentage of inventory than ever; they're a different beast but still compete with traditional rental buildings.

Any thoughts on this?

[rstok]

TREGNY's Manhattan Rental Market Report http://www.tregny.com/manhattan_rental_market_report doesn't seem that optimistic for the next quarter. If the rental market really is a leading indicator, it could mean a long recovery for the sales market.