The Institutional Risk Analyst

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Jonathan Miller on the U.S. Real Estate Market

New York | Jonathan Miller is President and CEO of Miller Samuel Inc., a real estate appraisal and consulting firm he co-founded in 1986. In addition to a command of the particular when it comes to asset valuation, He covers 35 different markets around the U.S. for Douglas Elliman, making Jonathan a keen judge of the real estate market environment and the economy. The Institutional Risk Analyst spoke to Jonathan from his lockdown operations center in Connecticut.


The IRA: Thank you for taking time Jonathan. The onset of COVID19 and related hysteria is a shock to many people around the world. We are hearing reports of falling rent rolls and defaults by large anchor tenants here in Gotham. What is it like in the world of New York real estate for landlords?


Miller: The overview is that landlords are between a rock and a hard place. There has been a tremendous drop in new leasing activity. We are seeing new leasing activity down year over year some 70 plus percent. Brokers cannot show space due to the lockdown, so this has an impact despite virtual tools. This is not lease renewals, which we cannot see. A typical building might have one third new leases and two thirds renewals. If we are seeing a drop in new leases, then we are probably having a spike in renewals. But that is information that is never shared with the public.



The IRA: How about pricing? We are hearing stories of tenants asking – or demanding – rent reductions due to COVID19? Is a tenant rebellion underway?


Miller: We certainly are facing liquidity issues in the markets. You might expect to see lease pricing falling, but not so far. We are actually seeing pricing flat to slightly up for rentals. On the sales market we are seeing not much activity at all. The process of getting the deal written up, reviewed by counsel and finalized has slowed considerably. There has been contract activity that brokers will point to as evidence of activity earlier in 2020, but most of those deals were initiated prior to COVID-19.


The IRA: Poor pull through is not a good thing. The April number was bad, but May will be even better, yes?


Miller: In most markets around the country, the first quarter of the year was better than expected. If you are a weak market, it was a little bit stronger. If you are a strong market, it was even better than that and so on. And this was both in terms of transactions and price trends. So for all intents and purposes, the Spring 2020 market looked to be pretty robust – up until the last two weeks of market. We only really got two and a half months in before the crisis hit mid-March.


The IRA: So, the first quarter results are shy two weeks. What’s next? Any happy thoughts on Q2 2020?


Miller: The second quarter is likely going to be as bleak and dark as you can imagine and it will be accompanied by a sharp drop in overall activity. In some ways, this trend is going to run counter to the increase in activity that will occur as the shelter in place protocols are lifted. You’ll see a ramp up in listings coming onto the market and contracts being signed. There will be a disconnect between what the numbers show in terms of closings and pending transactions, vs the surge in new listings. What you can actually feel and see in person is not going to be reflected in the results as measured by closings.


The IRA: So is this "a short, sharp shock," to borrow from Gilbert & Sullivan's Mikado, or does the real estate market rebound take years?



Miller: The market will over-correct in the second quarter and then will still be negative but better in terms of activity. One point on top of this to say that there is no Spring Market this year. It has been surgically removed from the calendar. We are going to transplant elements of it atop an existing market down the road, whether it’s the Summer or the Fall. Let’s just say it happens to be the Fall season. The Fall is the second hump of a two-hump annual cycle in terms of new inventory coming to market. Now you’re going to take the pent-up supply and demand from the Spring and put it into the Fall. Inventory is going to ramp up to a high level. I don’t think demand will meet supply because of economic damage, layoffs, etc.


The IRA: That makes sense, but is there more to it than merely a delay coming to market? Spring vs Fall sounds so pleasant.


Miller: Yes. There is this idea in some circles that inventory is scarce because people pulled properties off the market or didn’t bring them onto the market at all. The narrative goes that falling inventory will support prices. I have heard this talk in a number of circles and find it rather bizarre. What is really going to happen is that we’ll see a significant runup in supply that will make pricing less than where we went into the COVID19 experience. The real question is whether and how fast we see demand rebound.


The IRA: That sounds reasonable. More supply than demand suggests a buyers’ market in real estate. We’ve been thinking that net loss rates are about to rise back to and above the long-term averages in bank prime mortgage product. Does that sound right? How has the collapse of the private label loan market affected the availability of prime mortgage from banks?


Miller: From my standpoint, jumbo financing is extremely limited in availability. We can see it. Lenders have pulled back from the jumbo market, but banks are still mitigating risk, which is a big difference compared with the 2008 crisis. Banks are doing what they are supposed to do as unemployment rises possibly ten-fold. But whereas the national mortgage rates from Freddie Mac are lower, we are seeing jumbo rate actually rising. We are seeing much more equity required, higher credit scores, and lower LTVs as a result. And the banks really only seem to be interested in writing loans for existing relationships.


The IRA: Correct. Once the private label market and the REITs stopped issuing new MBS deals and buying new jumbo loans, the entire channel for non-QM loans effectively stopped. The banks and non-banks then dropped correspondent and wholesale business lines, where they buy from other lenders, cutting off the brokers and small IMBs. So now that bid for bank portfolio is the only game in town outside of the conventional and government markets.


Miller: We are certainly seeing that behavior on the front-lines. We expect to see huge demand for appraisals in the next six months. A big junk of our business stems from litigation support and restructuring. Looking out several months and even out a few years, sadly we are going to have more business than we know what to do with as the flow of foreclosure, bankruptcy, REO, workouts, refis, divorce and other matters starts to peak.


The IRA: What is the situation for New York high end residential over the next several years?


Miller: Going into the crisis, New York high end residential was under siege. The SALT tax change was already hitting valuations hard and Albany came along and passed a mansion tax that further weakened prices. It was like somebody flipped a switch and prices simply fell. And we just dodged a bullet last year when Albany almost passed a pied-à-terre tax. As proposed it mandated annual tax on second homes worth $5 million or more. Instead, it was replaced with the progressive mansion tax, a one-time fee that affects home sales of $2 million or more starting at 1%, capping at a 3.9% tax on home sales of $25 million or more. This was a terrible move for the City and the New York City real estate market. We saw an immediate drop in home sales activity and a surge in high end rental activity. We call it “camping out” while people decide whether to leave the City entirely. And on top of that we had the new rent law from Albany, which essentially punished high end condo and home investors. Investors are now subject to all of these archaic landlord type rules including one that allows only one month rent to be collected in advance no matter the risk presented by the tenant.


The IRA: Albany does not care about investors any more. They are seen as the enemy. Until New York State finally comes to a day of reckoning financially, the madness in Albany will continue.


Miller: On top of everything I’ve just described, the new condo development market was already suffering. Think of 2014 as the peak in terms of development and sales for new construction in New York City. As we went through 2015 and 2016, prices weakened. So that now, looking back over the past five years, pricing has already fallen by an average of 25% and we are not nearly done. You can see this in the apples-to-apples comparisons of units that went to contract in 2014 and units that went in 2016 and after. Prices were cut by developers anywhere from 15 to 40% depending upon how aggressive the ask was from the developer.


The IRA: That is rather breathtaking. And we have more fun yet to come?


Miller: One of the things I have learned in 40 years in the real estate business is that it generally takes one to two years for the seller, whether it is a developer or homeowner, to capitulate to the lower market condition and not feel that they left money on the table. In 2019, we had started to see sales activity that reflected a more realistic perspective on the part of sellers. The price cutting paid off and we saw an increase in activity. Then boom, we had this crisis.


The IRA, Yeah, boom. Be well Jonathan.

"What the boom-and-bust cycle of non-QM lending can teach us"

National Mortgage News, May 7, 2020


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