EisnerAmper Hosts Real Estate Forum Featuring Briefing from Robert Knakal
The monthly NYSSCPA real estate breakfast forum for September, hosted by EisnerAmper LLP in their New York offices, attracted approximately one hundred real estate principals and professionals. The event’s highlight was the keynote address from Robert Knakal, chairman and founding partner of Massey Knakal Realty Services.
Mr. Knakal posed an initial question: “How’s the market?” He proceeded to present a series of telling statistics. Charts of real estate sales in NYC from 2005 to the current quarter showed $62 billion in sales in 2007 plummeting down to $6 billion in 2009 with a gradual increase back up to $35 billion projected for total sales in 2013 (although he expects sales to even exceed that). Viewing statistics for the fourth quarter of 2012, Mr. Knakal stated that the quarter, representing 47% of dollar volume in 2012, was somewhat distorted, “and there’s no doubt that that was stimulated by the capital gains tax treatment,” referring to its pending increase.
Mr. Knakal went on to express his disagreement with individuals who did not acknowledge the correlation between capital gains taxes and commercial real estate sales volume. He pointed out that since 1984, “three out of the top four years” with the highest turnover of sales in the real estate market “have been years in which there have been significant tax policy changes.” The fourth quarter of 2012 had the highest volume on record due to the anticipation of capital gains taxes being raised in 2013; 1998 was the second highest volume and was the year President Clinton reduced the capital gains tax from 28% to 20%; and the third was 1986, corresponding with the Tax Reform Act of that year.
Mr. Knakal then posed the frequently asked questions, “Are we in a bubble? Is it time to buy or sell?” His feeling was that while the government has kept interest rates unrealistically low; real estate in NYC has nearly doubled in value without any justification. In terms of buying or selling, he said “it’s dependent on your perspective.” For long-term investors, intending to keep the real estate and pass it on from generation to generation, “it’s always a good time to buy,” he said. For institutional investors with defined holding periods of three to five years, it’s a tough call. There’s a lot of uncertainty with respect to what’s going to happen with interest rates, as the government has kept them artificially low for an extended period of time in an effort to stimulate the housing market and bail themselves (the government) out of the mountains of debt on their plate.
According to Mr. Knakal, this unprecedented government intervention was a large contributor to the fluctuations in the real estate market, since the movement in the industry correlated to capital gains tax policy and interest rates. He presented an example of income-producing properties in the NYC market that had stagnant net incomes despite increasing top-line revenues. The reason was because real estate taxes had kept going up and ate away at profits. Between the peak of 2007 and the trough of 2010, average commercial property values decreased by 38% and yet real estate taxes did not drop at all in any year. Because of this, real estate taxes are going to be very important going forward. With real estate taxes approaching 30% of gross revenue, NYC has the highest real estate taxes in the United States with Boston next at 17%. To him, “it seems like politicians look at income-producing properties as an ATM machine…that’s a huge problem moving forward.”
The buyers who believe there is no real estate bubble in NYC think the recovery is just slow, rates will stay low and the fundamentals will eventually catch up to the current values. Meanwhile, the sellers generally believe a bubble exists and rates are going to go up and negatively affect profits. With that said, Mr. Knakal went into important factors to look for in Q413 and 2014.
He first addressed the supply of real estate in NYC, believing such supply is low and forecasting that supply will remain low going forward, because anyone looking to sell in NYC has already sold. Statistics show the average property in Manhattan south of 96th Street is held for 40 years before it is sold.
The next topic of discussion was the demand for real estate in NYC. In the past couple of years, there has been a big shift in real estate as an asset class. In the early 2000s, institutional investors started investing heavily in real estate. By 2007, institutional capital was crowding out the high net worth investors who previously had owned so much in NYC. But by the end of 2007, the debt crisis chased away institutional investors (until they came back around 2010). In addition to the American institutional investors, global investors started flocking to NYC real estate as foreign economies were also suffering. Their acquisition intentions were not to make a profit, but as a hedge to have secure assets (even if Moody’s or S&P downgrades U.S. debt). There is relative security in NYC real estate and, as such, Mr. Knakal expects demand to remain high given the seemingly unrelenting demand of high net worth individuals, institutional and foreign investors. The endurance of NYC real estate through this recession is remarkable.
Mr. Knakal expanded further on the artificially low interest rates. Through quantitative easing, the Federal Reserve has bought 75% of the Treasuries issued in the past several years. He equated this to a developer of condominiums telling his investors that he’s going to sell each unit for $3,000/ft and, upon completion, purchase all the units himself at that price. Ultimately, the Fed will have to get out of the market, and no matter how they do it, through tapering or some other mechanism, that act will increase interest rates. According to Mr. Knakal, the Fed will continuously test the market with different policies each month to try to find the best method to exit the market without raising rates dramatically.
The number one factor that affects the underlying fundamentals of real estate is employment. This brought Mr. Knakal to his next point -- jobs. Young adults not moving out of their parents’ homes and not shopping in retail stores negatively affects real estate. The current jobs recovery, according to Mr. Knakal, is abysmal, and he cited a number of reasons. In the recovery from recession in the 1980s, there were a million new jobs created a month and that was with a 20% smaller population. Today, we’re adding just 160,000 jobs a month despite economic indicators such as manufacturing and service sectors having healthy increases, consumer confidence and spending being up and the housing market improving. Corporate profits are at an all-time high but they aren’t hiring, opting to go long in cash or to pay dividends to shareholders. Contributing to this is the fact that companies are not motivated to hire because they have streamlined their businesses to produce more with fewer employees, and many government policies have made it less beneficial to hire more, such as Dodd-Frank and the Affordable Care law. For 40 months in a row, more people have dropped out of the work force than jobs have been created. In addition, more high net worth individuals are leaving NY to avoid paying the higher taxes which stifle job creation, thus hurting the real estate industry.
Mr. Knakal then concluded with his opinion regarding the importance of the upcoming NYC mayoral race. We are approaching a point where long-delayed municipal labor union contracts need to be addressed and the city has an ever decreasing tax base. Where is the money to pay for these contracts going to come from? One mayoral candidate suggests raising taxes on those making over $500,000. “Not that he has the ability to do that,” Mr. Knakal continued, “Why doesn’t he say he wants to change the tax rate in Afghanistan? He can’t do that either. The problem is, what he can control is real estate taxes. The mayor controls real estate taxes and so if he can’t get the money through taxing high earners, he’s going to get it through the real estate industry.”