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The Institutional Risk Analyst

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The Interview: Dale Hemmerdinger on the Outlook for New York Real Estate

New York | Dale Hemmerdinger is the consummate New Yorker. He is a real estate executive and active public citizen. He oversees the properties and service subsidiaries of his family real estate company, ATCO, as well as its parent company, The Hemmerdinger Corporation and The Hemmerdinger Foundation. In 2007 Governor Eliot Spitzer nominated Dale to serve as Chairman of New York’s Metropolitan Transportation Authority. He formerly served as Commissioner of the New York City Conciliation and Appeals Board during the Administration of Mayor Ed Koch. Dale is active in many public and private organizations in New York and is known for his honest and incisive perspective on the political economy.

The IRA: Dale, thank you for taking the time. Let’s start with your perspective on the New York real estate scene. How do you put the boom of the past decade into perspective?

Hemmerdinger: There have been a number of cycles over the years. New York tends to follow the direction of the national economy but it also has its own real estate cycle. Like many other businesses, when times are good the lenders tend to lend and the builders tend to build – often too many buildings all at once for the demand. Demand for any type of real estate at a given moment is difficult to determine. What tends to happen, when there is a real need for office space or residential space, we all tend to build together and therefore we build too much.

The IRA: Certainly looks that way. Are landlords actually getting squeezed at the moment and contrary to the popular press?

Hemmerdinger: In the 2008 down cycle, we had a squeeze on rents for almost everything in New York. In the financial business, the situation was even worse. The overhang of office space in New York that was no longer needed by banks, insurance companies and financial firms was huge. All of these constituencies were cutting headcount and reducing space. As the economy improved and we started to come out of the slump, there was a presumption that rents were going to rise at a very steep angle, which has been the history of New York real estate. In previous cycles, rents went up fast and higher than before. This time that really didn’t happen. The slope was very gradual if positive at all.

The IRA: That certainly does not track with the rising rent narrative in other markets around the U.S. What happened to make New York different?

Hemmerdinger: A decade ago the City and New York State changed the law regarding what you could build with how much state subsidy, etc. The threat of further change to things like the 421a exemption for affordable housing caused many developers with buildable plots to decide that this was the moment to build. The combination of this need for space together with a change in the law, these two things coming together, gave us the building boom you see today. All you need do is walk around the city to see the construction activity. And it is not only in Manhattan, but in Long Island City and the other boroughs. There is a huge amount of building for New York at a given time.

The IRA: Long Island City is certainly amazing. Multifamily buildings, hotels and even retail along some of the side streets. Does this construction make sense economically in terms of the market for this new space?

Hemmerdinger: It costs a lot to build in New York. The problem is whether there are enough people who can afford to move into this new space. There is no question that there is demand for the space, but at what price? That gap between cost to build and the rental market is going to be a big problem in terms of new residential construction. On the commercial side, we started this cycle with double digit vacancy rates already. Anything over 10% vacancy is what I call a renters market. Keep in mind that vacancy rates are determined by estimates from real estate brokers…

The IRA: You mean like the way bankers in the City of London used to determine LIBOR?

Hemmerdinger: It is an approximate number determined by the major brokerage firms. Thus anything over 10% in terms of published vacancy rates for commercial space is a tenants market. So we started this cycle with 11% vacancy and no surprise there is a lot of pressure on high-end commercial rents.

The IRA: Are you referring to the Third Avenue corridor, for example, where there is ample vacancy for office space?

Hemmerdinger: Glad you asked. That is one of the myths of real estate. The old buildings are actually terrific. It’s the middle layer of buildings in terms of age that have problems. Older buildings built before the age of air conditioning have high ceilings and windows that open. Very attractive for tenants. There’s a middle layer of buildings from the 1960s and 1970s where the ceilings were very low and are difficult to retrofit. That’s why you see some of the lovely older building around town being renovated. They are really wonderful properties and affordable for the tenants and amenable to modernization. You give me Rockefeller Center, which has high ceilings and beautiful windows, and we can make it as modern and attractive as any new building.

The IRA: Agreed. Look at the renovation of the old New York Times building as another example. The location of older properties also tends to be better in terms of proximity to transportation. We started talking the other day about the new developments over on the West Side of Manhattan, which are absolutely beautiful buildings but a hike even from Penn Station. How do you see those properties positioning in an already glutted commercial market?

Hemmerdinger: First thing, the public transportation to Hudson Yards is not adequate to make it work. It’s great for the chiefs who have cars or drivers, but it will be very tough for the regular people who go there every day for work. When I was on the MTA Board, I argued with Governor Spitzer that we should demolish the Jacob Javits Convention Center, which is now too small for events, and then redevelop the entire area with more transportation. We should have residential where Javits Center sits today and then a new convention center and business space going east towards Penn Station. But again the construction cost and also the politics intervened. The assumption that the area on Eleventh Avenue will gentrify and attract businesses is going to be very tough to achieve. They are doing a lot of deals to fill the space, but will these deals work over the medium to long-term? The West Side is very different from what Larry Silverstein is building downtown at the Freedom Tower. Everything is there; shops, amenities, transportation. The presentation is fabulous.

The IRA: Given the amount of empty storefronts visible in midtown Manhattan, we agree that growing a healthy street level economy on Eleventh Avenue will be a challenge. But what about other areas of the City that are seeing a construction boom?

Hemmerdinger: Ultimately it is the peripheral stuff that always has trouble. Its already starting in Long Island City where we have 16,000 new apartments. That is a lot. We are already dealing with an overcrowded subway system coming in from Queens, so there will be a transportation squeeze in Long Island City over time.

The IRA: Long Island City is a barren urban landscape. Not much natural pedestrian traffic and the dominating shadow of the Queensboro Bridge. Very much like the West Side and particularly the High Line Park in some respects. There is only so much you can do to beautify Eleventh Avenue or Queens Plaza without a total redevelopment, correct?

Hemmerdinger: Most of the most precious public spaces in New York like Central Park have evolved their own support networks over time. There are a lot of rich people who live around Central Park and pay directly though taxes and by donating to the Central Park Conservancy to maintain it. The Conservancy has done a fabulous job. Public fixtures like the High Line have a much smaller base of supporters, but funding from the community and also from real businesses, above and beyond public funds, is needed to make any neighborhood work long-term.

The IRA: But why did we see the enormous scale of development in New York over the past 10 years? Even with the legal changes, it seems like the scale of development has soared compared with past cycles. How did the low level of interest rates contribute?

Hemmerdinger: The first thing was the legal changes we mentioned before. Owners did not want to take the chance that future laws would be less permissive. Then interest rates were really low when all of these projects started. Also, there was an awareness that you could purchase air rights and create buildings that were really remarkable. The view of Central Park from the 80th floor is fabulous. You’re in the clouds sometime. So they were producing a product that was limited and very desirable. The problem is that you don’t make money selling the penthouse to a Saudi prince.

The IRA: No?

Hemmerdinger: No. You have to sell the middle of the building as well. Selling the properties that are not so glamorous at premium prices is the key. There is a real question as to whether there are enough people who can afford these new developments, which will likely put downward pressure on rents. My sense is that there has been enormous overbuilding at the price. You can already see the pressure on rents as unsold condo properties go onto the rental market.

The IRA: So what is the outlook for New York City high end residential over the next 18-24 months? Our friend Jonathan Miller at Miller Samuel refers to it as “aspirational pricing” in the current market when it comes to offered prices. And he says capitulation could take years.

Hemmerdinger: It is not a question of whether there is demand for the space. The question is can you afford to live there given the cost of rent, which is a function of the cost of construction? Building in New York is very expensive. I think things will get worse as more of these new condo projects come on line, are unsold and they end up in the rental market. If you remember three and four years ago, almost half of condominium sales were to out of town buyers. That flow of cash has slowed. Our experience is that the purchase market for high end properties is down about 10% from peaks of two years ago. When these condos don’t sell, the banks will force the developer to put them into the market as rentals. You will see increasing concession to buyers and falling rents for tenants as landlords try to at least fill buildings so they don’t feel like mausoleums. And then we will have a normal recession.

The IRA: Nice. So what is coming in the event of rising interest rates and perhaps a slower economy? Do we have a crisis in commercial real estate in New York?

Hemmerdinger: For projects that are not yet completed, they will be facing an increasingly hostile financing market. You can’t get out of a construction loan until you have a certificate of occupancy. Hopefully the developer has a take out for the construction loan, but the debt market is going to be very tough if rentals are soft and the purchase market is even softer. When it comes to prices, think of it as a cake. The top part of the market can squish the most while the bottom of the market will barely move. The higher the initial price of the property, the bigger the potential percentage drop in a down market. In the suburbs, for example, there’s a vigorous market up to a million dollars or so, then the volumes drop dramatically. Greenwich has a ten year supply of homes available for sale. But as you know I like to be optimistic, both about the property market and New York in general.

The IRA: Thanks Dale


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