Sunday, August 05, 2007

New York Not Immune

Many of my friends and colleagues have bought into the "Real Estate Never Decreases" theory bandied about so much during the peak years of the Housing Bubble. Even when bubblicious areas like Miami and San Diego, once the hottest areas for selling real estate in the nation, started to tank and fell into horrible housing slumps (see here, here, here and here for those stories), I heard how New York will never see real estate values and home prices decline because of the unique state of the market. After all, this is New York and while other areas of the nation have room to build and expand, here in New York land resources are finite and the demand for homes and apartments will never decline enough to cause any real serious sales slump or period of price declines.

But while that theory has so far held true for Manhattan and the tonier areas of Brooklyn (the few areas of the country that are still seeing pretty big increases in home values and real estate prices), it is starting to be tested in some of the other boroughs where the recent credit crunch, the subprime mortgage mess and rising foreclosures that have been plaguing the rest of the nation are starting to hit New Yorkers who live in working class and middle class neighborhoods of color where many people took out risky adjustable rate mortgages to purchase their homes. With many homeowners' mortgages readjusting and interest rates continuing to rise, foreclosures rates have increased 92% in Queens. While foreclosures have actually fallen 19% in Brooklyn this year, Crains Business reports that foreclosures are up dramatically in working class neighborhoods of color like East New York, Bedford-Stuyvesant and Flatbush. The Crains article says the foreclosure rate in these neighborhoods is bad because

whether homes are lost through forces sales or foreclosure, the result is the same: deteriorating neighborhoods. Already, signs of decay are showing up in some areas, housing advocates say. "You find if you drive through these neighborhoods that they are starting to show signs of deferred maintenance on single one-family homes," says Sarah Gerecke, Neighborhood Housing Services of New York executive director. "That is something that we have not seen in years. The fact that they are less well tended is a real sign that people don't have the resources to stay in their homes."

As the conditions in these neighborhoods continue to deteriorate, home values will fall, hurting others who may need to refinance ARMs and forcing even more foreclosures and home losses in the near future. For every foreclosed home in any given neighborhoods, homeowners lose 1% of their home's value. When a neighborhood sees a rash of foreclosures, the cycle of decreasing home values and rising foreclosures, coupled with rising interest rates and the current credit crunch for all borrowers but the few with the best credit ratings, becomes rapid and brutal.

While foreclosures haven't increased in working class areas of the Bronx, Staten Island and upper Manhattan, you have to think that neighborhoods that parallel the demographics of East New York, Flatbush, Bed-Stuy and Jamaica are not immune to future problems, especially now that the credit crunch is so bad. When homeowners with resetting ARMS and piggyback loans in these neighborhoods try and refinance to lower rates, they are going to have the same problems that many homeowners nationwide and those in East New York, Flatbush, et al. are having already. If this happens, the New York real estate market could see the same problems so many other markets across the country are seeing.

Still, so far, New York has weathered the Housing Bubble Burst pretty well and real estate prices in Manhattan and popular areas in Brooklyn like Williamsburg and Brooklyn Heights continue to skyrocket. So does construction. You cannot go down any city block in Manhattan below 96th Street and not see old buildings being knocked down and new buildings being put up. One wonders where all the buyers for these homes are going to come from (especially with the average prices for a one bedroom apartment approaching $1 million or more and interest rates for most loans rising as a result of the recent credit crunch), but so far, there has been no shortage of buyers and no halt to rising prices.

So, can anything burst the bubble of the Manhattan and Brooklyn housing markets?

Yes - an economic downturn. Much of the real estate boom in Manhattan and the tonier areas of Brooklyn has been an offshoot of the economic boom Wall Street has experienced over the last few years. With corporations raking in record profits and many in the financial sector enjoying huge salary increases and extra-generous Christmas bonuses, the retail and real estate sectors have made lots of money off Wall Street people looking to spend their dough. But now that the markets have been roiled by a worldwide credit crunch as a result of the subprime mortgage mess, now that second half GDP growth here in the United States is expected to slow to 1%-2%, and now that Wall Street is bracing for layoffs later this year as a result of the subprime mortgage mess (some layoffs have already been announced at Bear Sterns and CNBC's Jim Cramer made a desperate plea on Friday for Fed Chair Ben Bernanke to decrease the Fed Funds rate in order to save the jobs of many in the investment banking industry), you can make the argument that the cash register that has driven the Housing Bubble here in New York is about to close for a good long while. If Wall Street profits dry up and GDP growth falls into the 1%-2% range or worse (some analysts are now using the dreaded "r" word when talking about the fall-out from subprime mortgage problems) where are the people with the cash to purchase $1 million+ Manhattan and Brooklyn apartments going to come from? The real estate industry says the weak dollar will attract foreigners to purchase into the market and perhaps that will mitigate some of the problem but are they going to be able to find enough foreigners to purchase Manhattan and Brooklyn real estate to make up for the eventual home glut that's going to result from all the construction coupled with the rise in existing home sales and foreclosures that are certain to happen if the economy tailspins into a recession?

I dunno, I suppose it's possible. If any real estate market can escape a downturn, Manhattan would seem to be the one. But for those New Yorkers who stretched their budgets to purchase homes/apartments they could barely afford with exotic mortgages that will reset in the near future, an economic downturn could really test the theory that "New York Real Estate Never Decreases."

I say under the conditions I have noted above, New York will not be immune to a real estate downturn. But I guess we'll see soon enough. It took about 2 years for the subprime mess to really start to hit, so these things do take time. But recessions tend to speed things up a bit. The New York real estate market, soaring as of now, may not soar for much longer.

UPDATE: The Economist says don't worry about the current volatility in financial markets, it's just a healthy "credit squeeze":

The biggest risk to the global economy probably lies with debt-laden American consumers. They have been battered by falling house prices and expensive petrol, and their spending growth has already slowed sharply. A credit squeeze will aggravate the housing bust and falling house prices could drag spending down further. But the rest of the world is growing strongly and unemployment in America remains low, so a recession there is by no means inevitable. What's more, if the economy were to head downhill fast, the Fed, despite its public worries about inflation, has plenty of scope for cutting interest rates.

All told, the credit wobbles so far are likely to have only modest economic consequences.


Credit cycles are unpredictable creatures. Things could still go badly wrong. So far, though, the financial wobbles, however unnerving, look like a healthy repricing of risk. Markets, much like people, sometimes need a good squeeze.

There you go - it's a healthy "credit squeeze" and if the squeeze gets to tight, Uncle Ben can show up with some rate cuts...

That would head off more problems in the real estate market, the financial markets and the American economy.

At least for a while.

I'm skeptical that we'll see much of a downturn here in Babylon by the Bay. Though some counties in the Bay Area are seeing some deflation, Marin, San Mateo, and San Francisco continue to see year-on-year increases (though more modest than in 2004 - 2005). Like Manhattan, our situation is somewhat unique: No affordable housing being built, not enough supply to satisfy demand.

Would another economic downturn hurt us? Maybe, but the last one didn't and we got hit harder by the bust than any place in the nation.
As you say, froggie, SF and NYC are totally different from most markets and the since last downturn didn't hurt SF real estate values it's reasonable to assume the next one won't either. But perhaps it depends on the severity of the downturn. If its slight or contained by another Fed-created bubble, then maybe it'll be just another blip. But if not...
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