Investing in a New York City Complicated by the Pandemic

No city has incited more debate in the world of commercial real estate than New York City. Even before the pandemic, fears of overbuilding, a growing deficit, and onerous taxes weighed heavily on the City’s present and future. Heading into the fourth quarter of 2020, we face a difficult question: Is NYC a solid investment? While there are differing opinions on the answer, below are some of the most striking statistics from the last six months: 

• The apartment vacancy rate in Manhattan exceeded 5% for the first time in August since real estate firm Douglas Elliman started recording it 14 years ago (Douglas Elliman)
• As of July, Manhattan rental inventory grew to 37k listings in the market, representing a 65% growth rate year-over-year (Freakonomics Podcast)
• 250k individuals submitted a change of address to the Post Office, doubling last year’s 125k (ABC)
• Manhattan landlords offered an average of two months free rent as of October – representing a 17% reduction in rent (CNN)
• NYC Comptroller Thomas DiNapoli said one third to one half of restaurants will close (CBS)
• Only two U.S. cities have seen nearby suburban housing markets surge – New York and San Francisco, the 1st and 2nd most expensive cities in the U.S. (Zillow)
• The MTA reports a $16.2 billion deficit through 2024 (New York Times)
• Moody’s has downgraded New York City’s general obligation bonds to Aa2 from Aa1 and its outlook on the City remains negative (Moody’s)

I love New York, but considering the facts above, we must be cautious about investing and lending in Manhattan today. In boxing, the one-two punch wreaked havoc until Muhammad Ali proved the power of the rope-a-dope, a tactic used to tire out one’s opponent by coaxing them into throwing ineffective punches. And right now, New York is up against the ropes and weathering a series of formidable blows. However, it was flirting with disaster prior to the pandemic for several reasons:

• Overbuilding: Even before the pandemic, headlines like “One in Four of New York’s New Luxury Apartments Is Unsold” dominated the news in the back half of 2019. According to a StreetEasy report, “there have been some 16,242 new condos constructed in the City in the past six years. Of those, more than 25 percent are still sitting on the market.”
• Empty WeWork Spaces: The struggle of NYC’s single-largest tenant has left office buildings with significant exposures to the co-working concept in a vulnerable state and landlords in a precarious position.
• Migration to more business-friendly cities: Prior to the onset of COVID-19, people were already moving out of New York due to high taxes, the cost of living, and the added difficulties of doing business in the City. Yes, the virus has contributed to this trend, but according to the U.S. Census Bureau, in 2019 people left New York faster than any other state, topping out at nearly 300 individuals per day.

This leads me to today’s New York City market, which has been ravaged by the coronavirus. No one expected that a global pandemic would be the last domino to fall to push the City from the brink of a downturn into its current predicament.

Ramifications of Covid-19

• Remote Work: The scariest question on Manhattanites’ minds is “How much less office space will employers need now?” The stats point to an alarming trend that work-from-home policies may not be a passing trend, but our new reality. Not only is the office sector projected to incur significant distress in effective rents, which may fall by as much as 21% in New York, but new leasing in Midtown in Q220 fell to the lowest quarterly total in 22 years, with only 1.6 million square feet transacted (Cushman & Wakefield).
• Public Transportation Unhinged: A key component of the City’s future growth, social distancing spells dilemma for New York’s public transportation infrastructure. This problem has forced the Port Authority of New York and New Jersey to project $3 billion in losses until March 2022.
• Delinquencies: More than $3 billion worth of loans backing commercial property in the five boroughs are delinquent, according to Trepp, and loans in creditor negotiations total an additional $4 billion.

We must acknowledge where New York is today so we can honestly assess potential investments. However, history serves as a thoughtful reminder that iconic cities rebound. In 2010, when my partner Justin Kennedy and I purchased LNR Property with a savvy group of creditors and private equity firms, Miami had 150k empty apartments representing a nearly 10-year supply of empty housing. The minute these apartments were priced below replacement cost, massive amounts of global capital absorbed the entire supply in 18 months.

With the rope-a-dope, Ali let his opponents tire out while he waited for the right time to strike. So too will thoughtful investors find the right time to invest in New York. This will not take long, and NYC will come raging back.

Until we have a clearer understanding of New York’s path to recovery, we at 3650 have positioned our portfolio accordingly. We have only two loans in Manhattan, as we had factored the aforementioned reasons for caution into our underwriting. Therefore, our philosophy endures now more than ever: the only force that prevails in the face of uncertainty is unwavering discipline. This is a notion that is embedded in our DNA. We did not need to adjust our habits to safeguard our investments. The market environment changed, but our investment principles did not. More broadly, our track record today sees only one of our loans in special servicing, amounting to just 0.8% of our portfolio vs. the CMBS industry, which hovers around 10.35%. 

Let me be clear on one thing - I love New York. While we may be pressing pause on commercial real estate investments in Manhattan, we will never stop supporting New York City’s businesses. And more importantly, we will never stop supporting its people.  

New York, just like Ali, IS THE GREATEST!