Picking over pips of the Big Apple

When Richard Bailes and his family paid US$4.1 million ($6.2 million) in March for a four-bedroom apartment in the glass and steel Georgica on Manhattan's Upper East Side, just eight of the building's 58 units were occupied, he said.

Bailes and his family, who had come from New Jersey, had plenty of places to choose from.

About 8700 new condos sit empty in Manhattan, with 75 per cent not even listed for sale yet, according to appraiser Miller Samuel.

Priced at levels the market no longer supports, they're selling so slowly it would take as long as seven years to find buyers for them all, said Jonathan Miller, president of Miller Samuel.

Miller teamed up with Westwood Capital and developer Gerald Guterman to raise as much as US$1 billion to buy empty condos and manage them as rentals. Guterman made his name in the 1980s doing just the opposite.

"Things are going to run out of steam at pretty predictable times," said Daniel Alpert, managing partner of Westwood Capital in New York. "In the case of these condos, it's when the reserve funds run out."

Builders can't afford to cut prices because they borrowed too much at the height of the market, says Miller. He and his partners are betting that lenders will seek to sell their condo units at a loss rather than foreclose on the building and assume all the developer's liabilities until the units are sold.

Developers taking out construction loans borrow an additional amount for interest reserves, which is intended to cover the monthly payments on the loan while the project is under construction and until sales begin, Miller says. Alpert estimates that reserves on loans made in 2007 and 2008 will dwindle in the second half of this year and early next year.

The Georgica's developer started marketing the apartments there in May 2008, and by the time Bailes bought his, 12 had sold, according to StreetEasy.com, a property listing service.

"On one side of the building at night-time, ours are the only lights on," Bailes, a director at the Americas division of the architectural firm RMJM, said in April. "You have all the facilities and staff to yourself."

The pace of sales at the building has subsequently picked up, with 32 apartments closed and nine more under contract, says Judy Kekesi, a senior sales associate for Corcoran Sunshine Marketing Group, the firm in charge of marketing the 58-unit Georgica.

Condominium Recovery, the firm started by Miller, Westwood and Guterman, bases its analysis of the market on Manhattan's "gross rent multiplier" - the purchase price of an apartment divided by the annual cost of renting a similar one.

The relationship between home prices and rents typically remains steady within a market, Miller says. In Manhattan, the average apartment, adjusted for inflation, cost 8.1 times annual rent from 1991 to 1997, according to Miller Samuel data.

That means that in those years, buyers in Manhattan concluded that the long-term benefits of owning an apartment - tax savings and property appreciation - were worth an initial investment of eight times the cost of renting.

Then in 1998, Manhattan prices began a decade-long climb, with year-over-year values rising by 10 per cent or more in most quarters. By the second quarter of 2008 apartment prices peaked at 22.4 times annual rent, according to Miller Samuel data.

At that level, buying rather than renting in Manhattan only makes sense if the purchaser expects prices to continue rising at a meteoric clip, with future sales' profits justifying ownership costs that also include property taxes, interest and maintenance fees.

New York is the No 1 city in the US where the overall costs of buying are significantly more expensive than renting, according to a report released yesterday by property website Trulia.com. Manhattan's multiple in the first quarter of this year was 19 times rent, even as rental prices fell 6.1 per cent from a year earlier, according to data from Miller Samuel.

"That suggests a few things," Miller said. "One is that prices are poised to slip further."

The median value of apartments for resale in Manhattan has already fallen 31 per cent since 2008, narrowing their spread over rents, Miller says.

By comparison, apartments in new developments, which are saddled by debt for construction loans made during the property boom, have fallen by 24 per cent - and much of that drop was due to smaller units being sold rather than significant price reductions by the developer.

New apartments, built with amenities such as pet spas and wine vaults, won't be able to reduce their price tags enough to compete with existing buildings and still satisfy their lenders, Miller says.

Developers are "using their reserves until they've bled out every last dollar", Guterman said in an interview yesterday. "Once they run out, the properties fail. It's that simple."

His firm, Guterman Partners, bought and converted more than 12,000 New York-area rentals into condominiums and co-ops in the 1970s and 1980s. It now owns rental apartments in 10 states.

"As a converter, we had rules," Guterman said. "We used to get in and out in 12 months."

The hurdle for new developments during the slump stemmed from a lack of financing for would-be buyers.

Mortgage-finance company Fannie Mae doesn't back loans made in new buildings where fewer than 51 per cent of the units are in contract.

New development purchases made up 16 per cent of all Manhattan sales in the first quarter, compared with 43 per cent of all sales in the first three months of last year.

The newly built apartment units that did close in the first quarter were on the market for 385 days, while resale properties spent 103 days on the market, says Miller.

Bailes, who didn't need financing for his purchase at the Georgica, said he was attracted to the building in part because it hadn't yet secured enough sales to meet Fannie Mae approval. It made the developers more willing to negotiate on price in exchange for a cash offer.

"You get more of a deal," said Bailes, who purchased the unit at a 17 per cent discount off the asking price, according to StreetEasy.com.

"The market is still not back," he said. "But we're in it at least three years. We're not looking to make any money any time soon on where we live."

The 8700 unsold new condos in Manhattan exceed all residential sales in the borough last year, says Miller. About 6500 of those units are "shadow inventory" and have not yet been listed for sale.

"If you flush that all into the market you tank the market," Westwood's Alpert said. "So the only way you can effectively push that into the market is to bleed it out very slowly.

"Well, the lenders don't really have the option to bleed it out slowly because they can't hold onto it for six years."

- BLOOMBERG