Manhattan Real Estate Within the International Market
Our “Macro” View of the Market
We’ve spent many years working to decode the mathematics of capitalism and social engineering in to a geometric river through which capital flows, guided by incentives. Our global view of the markets is that each country is like a company fighting for market share with its own currency.
We believe the ultimate currencies are commodities- especially those which produce income such as real estate. Inflation is an illusion of growth to sustain interest rates so more money can be printed even if nations commodities remain mostly stagnant. Real estate absorbs inflation like a sponge at a rate superior to other commodities and services, especially in Manhattan.
We are in a time of disruption requiring evolution of how capital in preserved or invested. Similar to how agricultural revolution and industrial revolution, we are in a new era where society is changing through the digital / technological revolution. This is changing the balance of demand and supply between goods and services, making tech the gold of the new generation. The result is new growth in many niche markets.
If each country is viewed as a company, its citizens are the investors/employees. The market cap of each company is the currency in circulation plus its debt. The balance sheet of each company is based on its credit, liquidity, value of hard and soft assets and income/growth.
In this scenario, each country is competing to absorb the most amount of currency versus commodities in demand by its “investor population”.
Leveraging income-producing commodities creates highly attractive tranches of credit and profit. The asset absorbing inflation is absorbing capital. Banks will lend currency against assets as collateral. Investors borrow at fixed rates and sweep all absorption of inflation with a fraction of the capital while maintaining cash flow from asset / collateral.
The rate of inflation absorption is disproportionate between investors vs. banks
Refinancing as you absorb more inflation tax free or taking advantage of 1031 exchange law incentivizes incentivizing the market cap to continue to inflate. Refinancing and borrow capital covered by the assets income is not a tax event as it is in a form of a loan.
Inverse Relationship Between Commodity Prices and US Dollar
Manhattan Macro View
Symbiotic Relationship Between Money Supply (M2) and Real Estate Values
In my analysis of the Manhattan Real Estate market, I concluded that Manhattan Real Estate competes with Treasury bills in safety/risk from a long term prospective, offering a much higher potential return.
Consider the traditional assumption of a healthy business paying 10% of its gross operating revenue, as rent. This makes rent the first tranche of expense any business pays, prior to paying taxes and earning a profit. Real Estate is essentially the first and highest position partner in any company.
If you look at Manhattan as a company and breakdown its value based on income, the value of its hard assets, value of its labor quality/quantity, debt amount, fixed costs like taxes, payroll, debt service etc., and calculate its health ratio, you will find the fundamentals of a very strong company. You will also find an amazing symbiotic relationship, parallel to inflation and unique to the Manhattan investment landscape.
Manhattan is a market, mature in the quality of its tenancy/labor, while highly dense. Its landscape is fixed in size, maintaining high occupancy. The result is a highly desirable landscape for all companies who can afford to tap in to its labor pool. As liquidity increases, it incentivizes healthy growth in rents, making the market cap of the “company”, highly related to the amount of money in circulation.
The expansion of markets are driven by debt. The federal reserve-driven system requires a long-term increase in currency supply in form of debt. Due to the unique position of the Manhattan Real Estate market, it is my firm belief, that in case of Manhattan, what would slow down its long-term growth would require a major systematic change to capitalism, which would stop further printing of currency on a local and global scale.
Such an event would only happen if the government and Federal Reserve failed, which is considered highly unlikely as treasury bills are priced with the highest creditworthiness. A full-scale collapse of Manhattan as a “company” would require the same catalyst. This assessment puts Manhattan, as a company/market, in the “too big to fail category”, as its failure poses systematic risk and vice versa.
The current political climate and what’s happening in democratic governments right now does not threaten the dollar or process of inflation. However, it is shifting the incentives of how the government shares revenue with its citizens and vice versa. I believe in the time where there was competition amongst capitalism and communism, before capitalism spread, capitalism was a concept where citizens were going to be shareholders of the “company”. But many companies had monopolies in that period and controlled much of the market share of capital. By designing the Federal Reserve as a separate entity from government, this gave ownership over money in circulation outside of the government.
Manhattan’s relationship to the absorption of long-term debt cycles has an advantage in inflation absorption ratios, due to its unique dynamics within the local and global institutional-quality investment landscape. There are further incentives for continual of market inflation.
Citizens are not in a shareholder position when government not in ownership or in full control of currency supply. Due to such an architecture, there cannot be fixed pricing of goods and services, or limits on currency in circulation, further incentivizing continuous market inflation through issuance of debt and other balancing stimulus measures.
This makes the citizens purely forces of labor for capital rather than shareholders. Currently, the same scale of disruption of wealth is taking place as during industrial revolution, through technological revolution. There is now an evolved competitive landscape with competition for custody of currencies due to innovation. In this new ecosystem, intellectual capital and investment vehicles become shareholders in currency, as they are the pipeline for its circulation.
I believe, as we are in a period of populism globally, citizens are going to see lower tax rates and higher wages to keep balance. This, combined with Federal Reserve incentives to take further stimulus measures marks the start of a period of higher interest rates and increased lending activity encouraged by deregulation. To offset the balance of increased rates, markets will likely see interest only loans to compensate.
In theory, inflation is an illusion where as more money is printed, it spreads across everything in same ratio between wages and goods. But since wages are fixed, there is an imbalance in how much is spread between wages, goods, services and hard assets. This creates an advantage for commodities limited in supply such as gold, silver, and potentially bitcoin as a modern limited currency stored digitally. Yet, there is still an advantage for real estate as a commodity.
Not only does real estate enjoy increases in value through inflation, but it provides cash flow and credit for ownership. Real estate has the same utility as currency in top tier markets with high liquidity while generating dividends. While real estate in Manhattan is a commodity with the same utility as currency, each printed dollar will have a share in its pool as a hedge and/or for cash-flow.
This can be a great tool for absorbing inflation through the proper balancing of debt ratios and interest rates, providing more growth than the cost of interest rates through inflation cycles. Such a balancing act will provide investor-adjusted risk as banks maintain much lower ratios of liquidity. If you consider investors capital as their deposits vs leverage, investors are 1 to 1, and up to 4 to 1 ratio, in debt vs equity in Manhattan.
According to the Chapwood Index (“measuring the unadjusted actual cost, and price fluctuation of the top 500 items on which Americans spend their after-tax dollars, in the 50 largest cities in the nation”), New York shows average inflation of over 11.3% over five years.
I believe in the event of acquiring quality assets in Manhattan with no more than 50% leverage over the course of a 10-year period, a 20% IRR is conservative to forecast. Recapitalization or refinancing of all equity in year five is highly probable while taking virtually no risk and maintaining positive cash flow due to low leverage while withstanding all market fluctuations.
Profile of Manhattan Investors
International Demand for Manhattan
- Chinese investors are very eager to move their wealth to New York and diversify in to hard assets
- China’s investment in foreign real estate grew but 41.5% in 2015 to $21.37B driven by attractive returns and exchange rates. As of 2016, another $13B has been committed to investment in US Real Estate.
Chinese Investors in New York
There is a lot of demand from Chinese in the condo market. Many Chinese investors like development deals because of that. Chinese institutions such as conglomerate HNA Group have deployed enormous amounts of capital in New York, most recently their purchase of 245 Park Avenue for $2.2B. Other examples include Fosun’s purchase of One Chase Manhattan Plaza in 2013 for $725M and the Anbang Insurance Group’s purchase of the Waldorf Astoria for almost $2B and 717 Fifth Avenue for $415M.
14,000 New EB-5 Visa Applications Were Filed in 2016
- Unstable currency
- Austerity mentality limiting potential for growth
- High terrorism risk
- Disruption amongst European Union
European Investors in New York
There are many European investors in New York. They tend to be more passive. The owner of Zara has been active on a personal level and for the company. Inditex bought SoHo flagship location and a hotel in Midtown on Park Avenue. There are many family offices who have been quietly co-investing. Other European investors include German Real Estate manager Deka Immobilien (partnered with Ashkenazy).
Collapse of Euro vs. USD Post-Brexit
- Energy driven markets
- Energy is seeing more competitive landscape due to new technologies making it more difficult for price fixing
- Energy has been a big part of government balance sheets pegged by the dollar incentivizing governments to slowdown the technological evolution that’s taking place. Since the value of tech has been more for companies than governments.
Middle Eastern Investors in New York
Middle Eastern capital traditionally invested in Euro zone and London and looking for a better currency trade and upside. We expect this trend to grow and for Manhattan to catch a new wave of Middle Eastern investors. Sony Building recently sold to a Saudi billionaire family. QIA also invested $8B with a REIT Boston Properties. Owners of the formerly World Financial Center downtown developed by the Reichmann Family. Q Invest invested in two major deals, one over 1M square feet. Middle Eastern investors are seeking cash flow or core quality assets and hotels.
Ever since President Trump’s May 2017 trip to Saudi Arabia and Israel, many Arab countries have an elevated comfort level with investing funds in the US, especially the Saudis. The Saudis have been buying up large quantities of US Treasuries. The price of oil is strongly correlated with the value of currency, real estate is a much better hedge against inflation as it is income producing.
- Currently undergoing negative interest rates
- Japanese investors are good candidates as long term investors for Core+ assets
- Examples include Mitusi Fudosan, a Japanese developer with major investments in Hudson Yards, and Mitsubishi Real Estate backs the Rockefeller Group.
- South American investors recognized New York as a good place to do business and a hedge for their currency.
- They like the currency trade in New York and have a good eye for trading.
- Eduardo Elsztain made a major trade on the Lipstick Building and HSBC tower with an Israeli Company (IDB Group).
- Israeli economy has been expanding.
- Private and institutional investors have been investing in development and value-add opportunities.
- Strong Israeli Bond Market tapped by NY-based investors such as Extell, Moinian Group, Jeff Sutton’s Wharton Properties among others. Israeli bonds offer an inexpensive source of capital compared with their American counterparts.
Israeli Bonds Have Consistently Lower Yields than US Bonds Offering a Cheaper Source of Capital
- There is a lot of activity from Korean investment banks, and financial institutions recapitalizing core assets in preferred equity loans with a promote structure.
- South Korean investors are exempt from capital gains tax on equity investments made abroad to help ease a surplus of foreign currency
- South Koreans recognized a buying opportunity after the prior collapse in 2008.
- The list of some investors that have been recapitalizing with South Korean investors include:
- RFR, Vornado, Crown Acquisitions, David Werner, Ivanhoe Cambridge, Callahan Capital Properties, Edward Minskoff, Lotte hotel & resorts, Monday Properties, and Invesco.
South Korean Real Estate Investment Abroad Spiked After the Recession
- Open competitive landscape
- Tax efficient for foreign investors especially for real estate
- Trump Era
- America is changing from an austere to prosperous mentality.
- We are going from a company that was cutting expenses to show profits to a company that’s looking to generate more revenue in order to be more profitable while being more efficient. “Share less with less vs. Share more with more”.
- Experienced CEO and new management aims to absorb much foreign capital by creating incentives
Among other nationalities, it is currently an opportune time to direct Middle Eastern, European, South Korean, Chinese, Israeli, and South American Capital into the US. Empire has worked for many years to cultivate these channels and offer an experienced asset management conduit.
Oil is now a dissipating commodity and Middle Easterners are very savvy and catching up with technology. They have a certain confidence in the dollar that is now more apparent due to departure of Great Britain from the Eurozone. South Koreans recognize safety in Manhattan, and their capital is inexpensive. The Israeli economy has created much wealth, and is a close connection to New York looking for value add propositions. South Americans recognize the strength and growth potential, and are less hesitant as they recognize New York as an obvious hedge for inflation to their currency. Chinese recognize New York as a great investment to protect their wealth, next to rare diamonds, and have become a boost to land development and the trophy office market. Europeans are seeing much change in government and facing times of uncertainty. This among many other local, national, and international players like Turkey, Germany, Azerbaijan, Canada, etc, investing in different sectors, with various strategies incentivizing, balance, and continued strength/growth.
In light of Donald Trump’s recent meeting with Benjamin Netanyahu, as well as a clear message to the UN by Ambassador Haley, I believe it is a unique time to direct capital from Jewish families heavily invested in Europe and the Middle East, to the US for better protection, inflation hedging, and currency trade.
The European families still have a very short memory about what happened with them in the times of war with Germany and are very cautious of such events repeating in history. Europe has been slowly taken over through immigration. Trump’s immigration policies and open alliance with Israel will be very attractive for such a demographic of capital.
Manhattan Real Estate Market Analysis
The Federal Reserve has maintained historically low interest rates for the past 8+ years
Amortizing debt results in the reduction of debt and thereby the accumulation of equity (growing market capitalization) at a pace that outpaces inflation. Historically low interest rates allow amortizing debt service at levels supported by the cash flow produced by a given property.
The Manhattan residential market is comparable to Monaco and London, retail to London and Tokyo, and stands apart from all others as an office market. Manhattan blends high quality tenancy and ownership in a highly developed landscape, growing infrastructure, and demand. Its market is flexible and doesn’t only rely on one sector with strong retail, residential, hotel, and office demand, in symbiotic support of each other, through incentives throughout each portion of the cycle.
The prior collapses of the market has strengthened the residential market by providing more conversion opportunities, strengthened the retail due to the growth in the residential population, and strengthened the office market by continuously depleting its supply.
Manhattan’s rental rates are below its competing international markets, creating global growth speculation and demand. It has rebounded from 9/11 and one of the biggest economic collapses of our time and is still growing stronger.
Manhattan supply is limited with growing demand. Inflation is increasing while the cost of construction is on the rise (both labor and material). The demand is strong from various liquid investors such as pension funds, endowments, insurance companies, users, REITs and high net worth individuals on a local, national, and international scale.
Manhattan real estate is perceived globally as one of the best locations to hedge against other currencies because of the steady strength of the dollar. Furthermore, its historical growth rates and ongoing evolution for the long-term making it a double-edged sword in both value and safety. In the case of Manhattan, demand increases during times of rising markets but also during times of global instability, as international investors deploy capital to safety due to local instability.
Manhattan’s limited in supply maintains a mature level of occupancy with strong tenant financials. Manhattan’s strength is constantly increasing, as is its pool of currency in demand and ready to be absorbed by the market. The dynamics are such that the total supply will always be relatively constant or diminishing in some sectors, while the constant increase of money entering its market due to inflation, acts as a hedge.
Opportunities can sometimes be unrecognizable to some investors evaluating the markets using cap rates and other traditional assumptions. However, there is nothing traditional about Manhattans dynamics and statistics, requiring more abstract metrics for its valuations. Cap rates translate to more than a relationship with interest rates.
Historically, after each cycle the Manhattan market has bounced higher than its previous cycle through stimulus, which increases the market basis. One reason for that is that the overall basis of the owners increases after each cycle, creating fixation of pricing. This creating a scale of the relationship of dollars vs square footage purchased. Furthermore, the market fundamentals have continued to support a healthy competition which pushes rents and values through growth in quality.
Since Manhattan is an island, the majority of its undeveloped lots have been built. The availability of land is limited to undeveloped parking lots. Additionally, knock-downs and assemblages of buildings with air rights are hard to justify demolition due to replacement cost, zoning, and tenant complexities.
Those who own undeveloped land are many times unmotivated to sell and the time to sell is when the market is lacking development supply. Assemblages pose many complexities and are many times dependent on long-term leases or regulated tenants holding out for unreasonable premiums as well as occupancy of regulated apartments.
Throughout each cycle, development land trades at a price derived from the condo market priced for end users. This makes it a challenge to buy and develop land for office use or residential rentals. As the supply pipeline dries, land trades for increasing premiums. However, at some point in each cycle, the supply will outweigh demand. At that point, construction financing dries up causing a sudden imbalance in supply and demand. At this point development deals become more viable for more conservative investors who push down pricing and acquire with lower leverage.
When there is oversupply and lack of development interest, it is an ideal time to acquire land at pricing suited for building rental properties. Eventually, developers will be well positioned for when there is sudden lack of condominium supply due to lack of years of new development pipeline.
Vacant Land Sales
Most of the new office buildings that are newly built need to be leased pre-construction and demand record-breaking rents to offset increasing replacement costs. Also, since land is generally priced based on residential condominium development value, existing office buildings with competitive infrastructure are very valuable in the long-term. The dynamics are such that the supply is fixed with limited potential for a sudden supply increase, while the residential condominium market absorbs office buildings with expiring leases due to high demand from developers converting office buildings to condominiums.
Considering that every growing global corporation needs to have a presence in New York to tap into its labor pool, Manhattan is considered one of the top tier cities on a global scale and an important anchor location.
In the international landscape, the office supply in New York competes with markets such as London, Tokyo, and Shanghai. However, New York is behind in rental values providing a top tier competitive landscape with more growth potential. All of the above occurs, while undergoing constant cyclical depletion of supply.
It also my conclusion that the demand for office condos will increase over time as further depletion of office supply continues to insure the longevity of companies’ presence in the market through ownership. This phenomenon has already been significantly strengthening the retail market as demand from user investors continues to evolve.
Manhattan Net Effective Rents per Square Foot
Largest Manhattan Office Tenants
After 9/11, an estimated 60MM square feet of office buildings were converted, reducing office supply to about 390MM square feet. This supports the theory that Manhattan is a market of safety, resistant to downfalls and driven by the international community where retail investors purchase bulk quantities of such converted and developed condo supply. In all cash purchases, foreign investors protected their capital and hedged against inflation.
As the condo market matures, the quality of neighborhoods increase. Luxury rental product becomes scarce due to the conversion of existing free market buildings and lack of economies of scale due to land prices that are too high to build rental product. Because of the lack of luxury rental properties, lower quality neighborhoods go through a resurgence as new rental properties are built there.
The residential market offers the most security, as it generally captures market rent due to high demand, hedging properties against sudden vacancy. Furthermore, the rental market benefits from depletion of supply in to the condo market and lack of incentives for developers to build new rental housing.
The strength of Manhattan’s labor pool, infrastructure, and diversity of culture sustains demand from various demographics such as millennials, corporate executives, tech entrepreneurs, artists, financiers and bankers, retailers, students, academics and families, amongst many other quality tenants.
The pricing for rental properties is attractive when oversupply in the condo market combines with rising interest rates, as they become priced based on cash flow rather than development potential. At the tip of such an event, purchasing incomplete condo development and bulk condos presents much opportunity, especially because developers will need to consider the difference between paying ordinary income tax vs capital gains tax. Selling an entire project in bulk will allow for a 1031 exchange. Historically, such oversupply will lead to the opposite extreme of a supply drought. Banks pull back on construction lending and equity investors hedge their risks.
Due to the dynamics in the employment market, there is demand for corporate housing for young entrepreneurs and graduate students, creating a new sector of tenants seeking furnished micro housing.
We have recently entered a lease agreement with a strong guarantee from Medici Living to explore such an opportunity. We have also been in touch with AKA to partner in acquiring properties where they provide a lease or management agreement.
Manhattan Multifamily Pricing
In Manhattan, the retail landscape has a very low ratio of space in comparison to any other asset class. While other asset classes are “vertical”, the availability of retail space is limited to the lowest floors of a building. As an asset class, retail is positioned for highest inflation absorption over longer term debt cycles.
In today’s environment of growing E-commerce, Manhattan is protected from retailers who are moving their presence online, unlike suburban retail markets. There is always necessity for a class of tenants servicing the residents, the working population, tourists and visitors.
New York enjoys strong tourist traffic, estimated at over 60MM visitors per year and growing. Additionally, there is a new generation of international retailers who need to create a street presence for showroom space and brand recognition for their E-commence businesses.
Due to new development in the condo and residential markets, neighborhoods go through a resurgence in quality and density. The retail demand increases, benefiting from the residential development activities throughout each cycle. Where quality in demographics increases, so does the demand in the neighborhood’s retail ecosystem. This increasing quality in demographics ultimately results in growing rents.
A portion of the vacant retail spaces is owned by low leveraged, non-institutional landlords with much patience and no pressure to lease quickly. Furthermore, many owners don’t have the proper relationships with the brokerage community directing the traffic of tenants. Such owners are not broker friendly and this significantly shrinks their network of potential tenants.
Many tenants look for turnkey space and much of the vacant properties need significant capital expenditures. Many owners plan to provide a Tenant Improvement allowance or free rent after they secure a tenant rather than invest the money beforehand. Spaces that are turn-key lease faster and for more rent, with minimal free rent or TI allowance, since many retailers lack the expertise and vision necessary for such construction.
It is also our observation that in addition to retail rent per square foot, the monthly price point is a crucial factor. This metric truly reflects affordability. The ratio of frontage to depth is also an important metric.
Currently, we forecast continued demand from European tenants present in London and Paris, as well as tenants from California expanding to New York. Manhattan will also see a new generation of tenants tied to technology and E-commerce, who want to establish a global presence in key cities such as New York. Department stores with micro concepts as well as international department stores such as, Primark, Harrods of London, Isetan Mitsukoshi, and Bosideng will also enter the New York market.
The influx of new tenants has created a dynamic where the existing pool of tenants are moving to side streets or lower parts of Avenues as outside tenants are paying new premiums. This phenomena has been occurring in all major retail corridors in Manhattan anchored by department stores. As this evolution expands, so does the imbalance between rents and sales in competing retail corridors. As growth occurs in new pockets and veins, it connects traffic and sales. This has been most apparent in the parallels in growth between Fifth Avenue and the Plaza District, vs SoHo and its side streets.
It is currently part of our strategy to grow our retail leasing division with a focus on tenant representation, targeting new tenants as well as existing expanding tenants, and offering our expertise and assistance in introducing them to retail properties that we are live underwriting as actionable transactions. Such a vertical approach will benefit our portfolio, acquisition targets, and will help tenants enter the market with a unique approach.
Positive Growth of Both Brick & Mortar Retail and E-Commerce
In spite of the growth of E-Commerce, physical retail sales are still showing positive growth. Maintaining storefronts along prominent Manhattan retail corridors is still an integral driver of sales.
Traditionally, hotels have been the highest revenue-generating asset class, demanding the highest price per square foot in sale value. As a commodity, hotels are generally unencumbered by long-term leases, furnished, and have the highest ratio of rentable units vs total square feet. This allows the asset to capture the highest price per square foot in rents. Such dynamics create an environment where hotels typically sell for the company value rather than the real estate value. The potential for hotel revenue lies within the operating company and its human capital. In a healthy hotel market environment, the company value is traditionally priced higher than its real estate value.
Due to the current dynamics in the hotel market, there are buying opportunities where we can purchase hotels at a valuation of the company for less than the real estate value while acquiring high quality properties.
Hotels attract much attention from international investors due to the appearance of stable cash flow and glamorous appeal. The hotel investors typically value hotels based on a price per key. This can be misleading, since it doesn’t take retail value into consideration and does not weigh the asset as a price per square foot to compare potential to other asset classes.
Hotels require an operational skill set and infrastructure not typically necessary for other asset classes. This results in much inefficiency in the market through the division of self-managing owners and owners who are relying on third party management. There is also the distinction between hotels that are managed with union labor vs nonunion employees. If the Food and Beverage operation is unionized, it is almost a guarantee they will not only fail to profit, but also be a strain on the hotel payroll and profitability. As a result, retail value is often not factored in to the valuation of hotel assets. Many times, the same dynamics are applicable to hotel garages.
Furthermore, hotel management companies and Food and Beverage operators with a traditional structure does not incentivize profitability. It is customary for managers to operate by taxing a percentage of the gross operating profit, before making money on the bottom line. This incentivizes managers to focus on strategies which grow revenue, but not necessarily profitability, while spending massive budgets on marketing to boost their brands. If managed by a flag, it is very difficult to replace management, as more established management companies only sign long term agreements.
It is our strategy to primarily work with management companies who are experts in efficiency, booking and revenue management, without long term agreements and lower fee structures. In parallel, we are creating partnerships with Food and Beverage operations incentivized by profit, with high existing name recognition. We will always have the operation pay rent for the retail as an initial hurtle, that is not currently traditional, prior to paying fees or profit sharing.
With such a strategy, we anticipate establishing our own brand, internal management and Food and Beverage operation, significantly increasing profitability and scalability.
New York City Tourism
Annual Manhattan Hotel Sales by Room Price
Land Area by Use Type (As Classified by the New York City Department of Finance) (2013)
From 2003-2013, residential condominium inventory as a percentage of total real estate in New York increased over 73%.