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Will the Manhattan Real Estate Bubble Burst?

One million for a studio?!!

Brokers, appraisers and other experts weigh in on the future of the booming real estate market.

Meet the $1 million apartment. It’s only average.

True, mathematical averages are skewed upward by figures at the high end of the spectrum — like the $45 million Time Warner Center condominium, or Laurence Rockefeller’s Fifth Avenue penthouse, which was recently purchased for $44 million. But even the median sales price of a Manhattan apartment hovered somewhere around $700,000, according to first quarter figures from the brokerage firms Prudential Douglas Elliman and Halstead Property.

Although it may seem unbelievable to many of us, some insiders don’t even raise an eyebrow at million-dollar studio apartments anymore. Jacky Teplitzky, executive vice president at Prudential Douglas Elliman, is currently working on a deal for a $550,000 studio in Murray Hill. So for a studio with a Park or Fifth avenue address, a decent layout and good views, she reasoned that a $1 million price tag wouldn’t be a surprise.

“For the last five years, I feel like a broken record,” said Jonathan Miller, president of Miller Samuel real estate appraisers, which prepares market overview reports based on Douglas Elliman data. “When I report on the market, it’s the same story — it’s rising prices, it’s a tight supply.”

That doesn’t sit well with some people.

“It just doesn’t feel natural what’s going on,” said Paul Purcell, founding partner of Braddock + Purcell, a firm that connects clients with various real estate services. Indeed, skyrocketing prices have made people start to wonder if properties are overvalued and if New York City is in the midst of an inflating and unstable bubble. After all, it wasn’t so long ago that city real estate took a nosedive following the 1987 stock market crash. And New York property values have climbed far ahead of national rates. A condo in the Olympic Tower at 51st Street and Fifth Avenue, for example, is expected to sell for $1.8 million, Purcell said. The unit was purchased only five years ago for $810,000.

While sellers are raking in the cash, buyers are getting increasingly frustrated with a limited and pricey supply. “Will there be a point that people will just throw up their hands and say, ‘I can’t afford this, I can’t do this,’” Purcell wondered.

With cooperative apartments off limits for many buyers because of their strict financial requirements, would-be homeowners are turning to “decent” one-bedroom condos, which start at about $700,000. Purcell calls it “the price of admission for living in Manhattan.”

Most experts can agree on the hallmarks of a deflating bubble: a drop in the volume of sales; a surge of listings; extended marketing time; and increased negotiability for buyers, which can mean not only lower sales prices, but concessions (think free health club memberships).

What’s not predictable is how the conditions for a bubble are created, particularly in New York City. “That’s the $10 million question,” Miller said. “Five years ago, I would have said $5 million question.”

But experts can list a number of factors that, if they were to converge, could create artificially inflated prices or devalue the current market.

Probably the most obvious would be a spike in mortgage rates that would chill the buying frenzy, although slowly climbing rates would not be that bad. Two or three consecutive quarters of double-digit growth in median apartment prices could also spell trouble, according to Miller (believe it or not, we’re not there yet).But number one on many experts’ lists was a glut of housing on the market. “Timing wise, if everything hits the market at the same time, someone’s going to get caught holding the potato,” said Henry Robbins, an executive vice president at real estate trade publisher Yale Robbins, Inc.

And while confidence is high that New York City will always be a desirable place to live — it’s the safest big city in the country, according to a 2003 report from the Federal Bureau of Investigation — the recent residential construction boom has caused some concern. According to figures from the Real Estate Board of New York (REBNY), an industry group that tracks new developments, 2004 saw the highest number of new permits issued for residential construction since the 1970s: 25,208 for the entire city. That number has crept steadily upward since 1994, when the number of new permits issued was only 4,010

. If developers continue jumping into the market, “We could very well see things level off,” Miller said, particularly for luxury housing, which has been the focus of much new construction. But Michael Slattery, REBNY’s senior vice president of research, isn’t worried. “We’ve been in a housing crisis for 40 years now,” Slattery said. “Vacancy rates continue to be low, so I think that we’re a long way from having a glut in the housing market.”

What’s more, the new housing may be justified by a new demand. “We have a huge change in demographics,” said Teplitzky, of Prudential Douglas Elliman. Entirely new groups of people want Manhattan apartments, including younger Baby Boomers who are drawn to the energy of the city, retirees who want to be closer to children and foreign investors taking advantage of a weak dollar. Families are not only staying here, but coming back from the suburbs. Pamela D’Arc, a senior vice president at the brokerage firm Stribling and Associates, recently worked with a family of four that had lived in New York City, moved to Westchester County, and wanted to return. “I think that they found the suburbs slightly limited,” said D’Arc, who found them a townhouse in the West 70s.

“The city is safer and cleaner and I think people are very happy to be here,” she said.Simple supply-and-demand economics is the main reason many experts say New York real estate is not about to crash: there are far more would-be buyers than there are available properties, even with the construction boom. But several other factors are likely to prevent local real estate from being devalued.

Teplitzky, of Prudential Douglas Elliman, recently attended an industry conference that focused on the number of new, high paying jobs in Manhattan that are attracting people from all over the country. A volatile stock market also makes some investors feel safer parking their money in property than in a portfolio. “That sounds a little simplistic, but I think that’s actually a pretty significant factor in what has kept demand going forward,” said Miller, of Miller Samuel. Plus, Miller said, unlike stocks, housing prices tend to be “sticky” on the downside, meaning they don’t drop as precipitously as they rise.

The high number of owner-occupied properties, versus investor properties, also protects against unstable market cycles, explained Jeffery Jackson, spokesman and chief economist for Mitchell, Maxwell and Jackson, the largest privately held real estate appraisal firm in New York and Connecticut. When markets start to falter, investors want to get their money out and will sell at a much steeper discount. Owner occupants, on the other hand, can live in their investment and stick it out until the market improves.

And while Purcell, of Braddock + Purcell, expressed skepticism about a market that keeps on climbing, it looks as though overall he views Manhattan real estate as a good investment. After all, he just purchased a new apartment on East 57th Street this past fall.

Why It’s Not Like 1987

In 1987, just before the stock market crash, cooperative apartments were selling for about $400 per square foot. By the mid-90s, they fell in value by almost half, hovering around $250 per square foot, according to a report by Business360, a company that conducts economic analysis. It’s a devaluation no New York homeowner wants to repeat, and luckily many experts say today’s market is much different than 1987’s. Back in the early and mid-80s, the rental to co-op conversion frenzy was flooding the market with new housing. Condominium development was also exploding because of a city tax shelter that was set to expire. People were racing to pour foundations without even knowing what they wanted to build, said Jonathan Miller, president of Miller Samuel real estate appraisers. Mortgage rates were at 8 and 9 percent and rising; today they are between 5 and 6 percent.

The city itself was also less financially stable and not as pleasant a place to live. Then Wall Street took a hit and people began losing jobs. “When you had all these events converging, you couldn’t absorb that inventory,” said Paul Purcell, founding partner of the firm Braddock + Purcell, a firm that connects clients with various real estate services. Prices fell 20 to 40 percent after the crash, said Jeffrey Rothstein, executive vice president and director of sales at Prudential Douglas Elliman’s West Side office. But the devaluation was only temporary. “It did go down,” he said, “but eventually it starts to go back up.”

What’s Safe and What’s Vulnerable

If Manhattan real estate values took a turn for the worse, not all homeowners would be affected equally. The primary factor, according to Henry Robbins, an executive vice president at real estate trade publisher Yale Robbins, Inc., is that old broker’s proverb: “location, location, location.” Perennially desirable areas would be less likely to suffer a slump, but “peripheral areas — [Washington] Heights, the Lower East Side — the areas that are just getting gentrified will be the first to be affected in the valuation process,” Robbins said.

It’s true that the Upper East and West sides may be better protected against a plunging real estate market, said Jeffrey Jackson, spokesman and chief economist for the appraisers Mitchell, Maxwell and Jackson. But that doesn’t mean they’d be immune to it.

“There were plenty of properties in both of the neighborhoods which saw significant corrections in pricing during the 80s,” he said. Cooperative apartments can have unstable financials, or underlying debt — any number of things that would make them unattractive to a buyer.

Jackson was also concerned about midtown real estate, particularly on the East Side, which he sees as largely driven by corporate investors who keep New York City property instead of relying on hotels. If business begins to suffer, “I don’t keep $2 million tied up in an apartment,” he said. West midtown, however, appears to be driven more by residential demand than investors, so Jackson wasn’t as worried.Neighborhoods aside, certain types of apartments are also more likely to survive devaluation than others.

“Pre-war is a fixed form of housing stock, post-war is not,” said Jonathan Miller, president of Miller Samuel real estate appraisers. In a buyer’s market, superior amenities will be in demand. A fifth-floor walk up apartment would be more volatile than a second-floor walk up, for example. “As it tightens,” Miller said, “people are willing to pay more for alternatives than in a weak housing market, where they’ll just simply go to the primary properties.”

Studios and one-bedrooms — starter apartments for most people — would be the most negatively affected by rising mortgage rates. And a tanking economy would spell trouble for the luxury end of the market. But there haven’t been many additions to the middle of the housing market, according to Miller. So two-, three- and four-bedroom units may weather an economic storm relatively unscathed.

 

 

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