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How to Time the Real Estate Market

How to Time the Real Estate Market

September 13, 2018


How to Time the Real Estate Market


Facts and Myths About When to Sell Your Home

 
 

“When’s the right time to buy? Is now a good time to sell?”

As real estate agents, we get asked these questions every single day. Though it would satisfy us to look an anxious seller in the eye and definitively say: “Now is the time: let’s sell your apartment,” or, “Not yet. Let’s wait a few more months. Next year will be better,” these are impossible assurances to give. 

The Manhattan real estate market is exactly that—a market. Price fluctuation is natural, and even a destination city like New York routinely sees peaks and valleys in home value. But what makes our city’s market famous, for better or worse, is the perception that buying an apartment is a guaranteed cash cow. You’ve heard the stories: maybe someone you know bought into an unremarkable neighborhood when prices were dirt cheap, and years later, they’re selling off their pads at all-time highs, taking “home” a fat return on their initial investment.

While these straightforward success stories do exist, it’s important to remember that Manhattan real estate owes its desirability to a far more complex variety of factors. They often pertain to local culture, professional opportunities, and city infrastructure. But it’s gotten to the point that most buyers’/sellers’ fixation on the idea of Manhattan real estate as easy cash flow can overshadow the true qualitative and emotional benefits of owning an apartment in the city.

The saddest problem occurs when the pressure to sell at profit in a market reputed for yielding large returns permanently ruins a seller’s view of their home. In situations like these, we see owners take it way too personally, going as far as to reconsider the value they originally put in their apartments, or even question their own basic aesthetic taste. But this line of thinking is misguided, and sellers who fall into its trap are usually wrong. In our experience, the most critical mistake sellers make is not that they bought high and sold for less, but that they allowed baseless financial expectations of their apartment to outweigh their love for their home.

In this article, we’ll break down the main characteristics that define real estate as a financial asset, as well as what you should and should not expect from your apartment as a homeowner. By the end of this assessment, we hope you’ll be a little more reticent to buy into the long-gestating myth that Manhattan real estate is an easy-to-access, get-rich-quick scheme for any who should choose to invest.

 

Why Markets Fluctuate

In economist Robert Shiller’s landmark book, Irrational Exuberance, the Nobel Laureate takes a magnifying glass to the underlying impulses guiding buyers and sellers investing in the stock market. The collective emotions of these investors, Shiller claims, have the capacity to dictate market fluctuation in a highly underrated yet crucial way. Shiller particularly stresses the importance of regret, citing psychologists who find it to be one of the most motivating sentiments in human behavior. A broker declining to invest in a new stock, for example, can feel sharp pangs of envy and a blow to their ego if they later watch colleagues reap the wealth of an investment they chose not to make.

The herd mentality outlined by Shiller can often work as a self-fulfilling prophecy, especially in today’s news-saturated climate. Even a slight pause or plateau in real estate appreciation can generate enough buzz to provoke a headline or two from the right news outlets, which skeptical buyers then use to validate whatever preconceived notions they had of the current state of the market: “See, I told you the market’s slow. Let’s wait and see how far prices will go down.” The value of real estate is what a group of buyers collectively decides at a given point in time, this domino effect—also known as an informational cascade—can lead to fast, dramatic upticks or downturns in apartment values across the city.

Booms, busts and bubbles in real estate are practically common knowledge. In our own city, the Manhattan real estate market hit a low point during 2010 where prices were down over 70% from today’s levels. Henry George, a renowned 19th century political economist, observed that the real estate cycle tends to have 4 main phases:

 
 

1. Recovery

We know the characteristics of a recession: high unemployment; decreased consumption; and decreased company investment in buildings, factories, and machines. The price of land, essential for economic activity, is at its lowest point in the cycle. As population increases so does the demand for goods and services. This expansion is typically hastened by government intervention in the form of lowered interest rates (the key ingredient for investment). In the U.S., we most recently witnessed this stage play out in the 2008-2010 bubble burst.

2. Expansion

The transition from recovery to expansion occurs when companies and individuals buy or rent out most of the available buildings. Occupancy begins to exceed the long-term average. As unoccupied buildings become scarce, landowners raise rents. Investors, believing the price is justified by the future growth, overpay for the land relative to the current market, and start building for a future market. The boom is on.

3. Hyper Supply

This occurs as new building completions start to quench the market’s thirst for product. With occupancy rates above the long-term average, rents are still rising but the rate changes: rent growth begins to slow down. This is a precarious time in the real estate cycle, and what happens next will determine the severity of the upcoming recession. Wise developers, noting the change in rent growth and assessing the units in development due to end construction, should choose to stop building.

4. Recession

New construction stops, but projects started in the hyper-supply phase continue to be delivered. The addition of surplus inventory leads to lower occupancy and lower rents, which significantly reduces revenue for landowners. Investors must also watch for the third indicator of trouble: an increase in interest rates. The increases in prices throughout the broader economy will force the Federal Reserve to fight inflation by increasing interest rates. The good news is that the increase halts any developers still operating in hyper-supply mode, as the increase in borrowing costs makes new developments financially unfeasible.

These phases don’t necessarily all happen in linear order. For example, we may see signs of a real estate “recession” which is short lived, quickly followed by an expansion phase.

 

A Historical Look at Real Estate Values

 
 

In Manhattan

Between 1974 and 1980, home values increased 29% in Manhattan. Between 1980 and 1989, home values increased 155%. Between 1989 and 1996 values dropped 32%. 1996 to 2006 saw major growth of 185%. And, finally, between 2006 and 2017, home values increased 63%.

Over the last 40 years, Manhattan real estate has appreciated in value, on average, about 9% per year after adjusting for inflation.  To put that into perspective, the S&P 500 has increased 7% per year in real dollars (after adjusting for inflation).

To further illustrate the point:  $100,000 invested in NYC real estate in 1974 would be $24,515,772 today ($4,577,906 in 1974 dollars). The same $100,000 invested in the S&P 500 would be worth $9,823,835 ($1,834,435 in 1974 dollars). By investing in NYC real estate over the S&P 500, you would be up by $13,000,000.

In contrast, stocks have grown an average 7% per year. 2% of this appreciation takes the form of real capital gains, and 5% is comprised of dividends.  The "dividend" equivalent for land would be the value of passive income (in agriculture, crops; in commercial or residential real estate, rental income) while the owner still owns the land.  

This goes to show that long-term investors—investors who commit their money for a full 10 years of ownership or more—do well in Manhattan, especially if they buy their homes at moments when prices are relatively low and sell when prices are relatively high.


Across the U.S.: Hoyt’s 18-Year Cycle

One of the most renowned financial thinkers of the early 20th century, the economist Homer Hoyt developed a model for depicting real estate cycle trends in the United States that continues to be relevant to today’s market. By studying growth, sale and constructions in Chicago and other cities across the country, Hoyt concluded that the real estate cycle ran its course according to a steady 18-year rhythm since 1800.  The table below shows the story:

 
 

With just two exceptions— World War II, and the mid-cycle peak created by the Fed’s doubling of interest rates in 1979— the cycle has maintained remarkable regularity, even in the decades following Hoyt’s original study.


In Amsterdam: The Herengracht Index 

Compared to the stock market, little is known about the long-term performance of real estate.  Indices of real estate returns are fundamentally different than those of stocks.  Long run stock indexes— like the S&P 500— are relatively easy to construct because price information has been available for decades. Prices were not disclosed for real estate properties until about twenty years ago. And in a city like Manhattan, where 80% of the apartment inventory resides in cooperatives, constructing an index to accurately determine the returns on different types of units (while also adjusting for varying amenities, sizes, etc.) would be next to impossible.

Luckily, there exists one exceptional survey that managed to track the long-term appreciation of real estate. In August of 1996, Piet Eichholtz of the University of Maastricht conducted a study using data from a central Amsterdam neighborhood known as Herengracht to look back at real estate transactions from as far back as 1628, all the way to 1973.

Since its original development, the buildings along the Herengracht canal consistently maintained a high level of quality, making the neighborhood an ideal candidate for such a long-term study.  The average real price increase after the second World War was about 3.2% per year. Surprisingly, Eichholtz found that the real value (adjusted for inflation) of the index in 1973 was only twice as high as it was in 1628. Real appreciation beginning from 1628 through 1973 was only .45% per year.

 

The Herengracht Canal

 

Although no data of this time scale exists in the United States, there are century-long studies that corroborate the evidence found in Herengracht. In another book Animal Spirits, the aforementioned Robert Shiller examines home prices in the United States from 1900-2000. Adjusting for inflation, he concluded that real home prices increased only 24%, or about 0.2% year. Once we distance ourselves from the narrative of real estate as a rapid-profit investment and look at the ramifications in a vacuum, there is no rational reason to expect real estate to be a generally good investment.

 

What Can Be Done?

All of that said, real estate does follow certain reliable patterns. Careful consideration of the broader national economy, the local real estate market, and key changes to city demographics and infrastructure can signal major changes to values before they occur.


1. Yield Spread Between the 10 and 2 Year Treasury Note.

In a strong market, the 10-year interest rate is typically substantially higher than the 2-year rate. This is because the economy is expected to continue performing strongly for the next decade, allowing banks to raise the cost of borrowing. When the opposite occurs and there is little to no difference between the 10-year rate and the 2-year rate, the economy is expected to show no real growth in the next 10 years. As a result, a low yield spread between the 10 and 2 year note commonly coincides with a slower real estate market. At the time of this writing, the yield spread has been shrinking, signaling a potential economic slow-down.

 
 

2. Consumer Inflation Rate

A low consumer inflation rate can sometimes foreshadow low appreciation rates in the real estate market. Some of the rise in real estate prices can be attributed to overall higher costs of living on other products, otherwise known as inflation.

3. Demographic Shifts

Net migration rates, as well as the spending habits of various age groups, can sometimes signal the direction of the real estate market. For example, a recent study by The Zillow Group found that 33% of millennials are opting to live at home until the age of 30—in some cases choosing to commute to work rather than settle in an apartment near their job. When more young people live with their parents, or when more people move out than move in, the relationship between supply and demand changes. In the case of New York City’s millennials, owners of “starter” apartments (studios and smaller 1 bedrooms) may experience a shrinking pool of buyers. Such a shift could trigger an overall depreciation in the price of studios and small 1 bedrooms.

4. Mortgage Interest Rates

Mortgage rates are a common-knowledge indicator of the housing market. The Federal Reserve System (known more commonly as the “Fed”), has a storied history with mortgage rates, most recently depressing them in the aftermath of the 2008 financial crisis to encourage more people to buy homes. As a rule, rising interest rates cause the real cost of housing to rise, which in turn may put pressure on sellers to lower prices on their homes to encourage buyers to reenter the market. At the time of this writing, interest rates are at about 4.6% for a standard 30-year fixed loan. This is up about .9% from last year, when rates averaged around 3.75%. Historically, however, rates are still at all-time lows.

 
 

5. Renting vs. Owning

Another key to deciphering the home sales market may lie in the rental market. According to a November 2012 paper by The New York Fed titled “To Buy or Not to Buy? The Changing Relationship between Manhattan Rents and Home Prices”, Jason Bram argues that after studying price-rent ratios in New York City, the rental market is driven by typical economic factors such as supply and demand. This is not the case for the sales market. According to Bram’s research, apartment sale prices are largely driven by speculative factors, and they sometimes rise or fall to levels incommensurate with prevailing rental prices. Nonetheless, sellers can estimate how their home will perform on market by assessing the cost of ownership (maintenance/common charges, property taxes, and mortgage payments) as it compares to renting. In most cases, a relatively weak rental market will pressure the sales market to lower its prices.

 
 

*The ratio represents the median price of a co-op/condo apartment divided by the average annual rent (monthly contract rent on new leases x 12)

 
 

Where It All Began

For most homeowners, the initial motivation to buy a home is fundamentally emotional. We can’t stress this enough. Your career as a Manhattan homeowner will likely see several market fluctuations, and, if you own for at least 10 years or more, you are historically likely to see a net profit when it comes time to sell. But the actual experience of homeownership is rooted in the desire for a good quality of life, and if your apartment provided you with a healthy, safe space to live during a significant period of your life, then you’ve already made your profit.

Because just as timing short-term movements in the stock market is next to impossible, the same goes for Manhattan real estate. As we’ve discovered, Manhattan apartments can be quite volatile in the short term, with price fluctuations in the 15-20% range up or down.  That said, over several decades, Manhattan has done quite well— in fact, better than the S&P 500. A dramatic reduction in crime, new infrastructure, business development, and a healthy and constant influx of new demographics have made New York City an increasingly desirable place to live over the course of the past four decades—and home values have risen considerably as a result. The bottom line is this: if making a profit on the sale of your Manhattan apartment is your highest priority, then we recommend sticking around for a while. Expect a 10-year horizon to reap the real rewards. If you predict your ownership period to be less than 10 years (and the average in Manhattan is actually 5-7 years), we suggest that you accept the role of luck in timing your sale and prepare for a net loss.

None of this is to suggest that buying in Manhattan is an especially risky prospect. After all, you need to live somewhere. Renting an apartment in NYC is not cheap, and there are certain concrete benefits to homeownership that won’t appear on a balance sheet. Ask yourself the following questions, and consider what your goals truly are: Do you value the ability to customize your home? Does the status of ownership bring you a sense of satisfaction and comfort about your place in the world? If your answer to either of these questions is yes, then you may be a great candidate to purchase an apartment. At the end of the day, no profit or loss statement can compare with the happiness of a life well-lived in a place you call home.

Contact Dan Bamberger
A leading Murray Hill Real Estate Broker

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Dan Bamberger

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(917) 903-7237

If you're thinking about buying or selling in Murray Hill , let's discuss your situation. It's completely free and there's absolutely no obligation.

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