Voodoo Real Estate

Just a quick note: sometimes we need to remember that talk of ‘markets’ is a massive abstraction. A market is simply us. Or a collection of us. So when we speak of markets doing something or other we are really talking about us doing something or other. In this context a walk around my neighborhood here in Manhattan is quite illuminating. Clearly the next recessionary shoe has yet to drop.

Yes there are plenty of empty store fronts. Commercial rents are obviously not fully adjusted to the more limited cash flows that small businesses can generate from the spaces that, only a year or two ago, could have been much more lucrative.

But the big issue is commercial real estate. There are so many empty buildings within a short walk of here that I can only conclude that a race is on to garner the few remaining sales. Once those dry up completely – and who says they haven’t already? – and the entire financing arrangement of whatever is left surely crumbles. These are big ticket items. They have cost multiple millions to build and all are massively reflective of the gaudy days gone by. They appear doomed.

They are condominium buildings with all sorts of ‘amenities’. One has a fireplace in its ‘all season pool’ area. Others boast lavish lifestyles with pompous catchphrases supposed to reflect the upper echelon folks who were going to snap up the over-decorated and over priced ‘luxury residences’. The collapse of finance and its bonus structure, even though it may bounce back, has devastated this part of the market.

And because of the cash treasure trove these buildings once represented no other construction went on recently. Every corner seems to have a huge, and generally ugly, condominium building perched on it. They all have silly market researched names. All are pretension personified. And all are empty.

Rumor has it that at least one is approaching the end of its financiers patience. Another has been so incapable of selling its ‘starting at $4 million’ luxury spaces that it wants to cut prices. But, and here’s the real insight: the banks won’t let it do so. The problem is that the prices necessary to sell these ridiculously ill conceived places is below that needed to repay the loans. So a stand off has emerged.

The developer cannot sell at the listed price. The bank cannot afford to let the prices be cut. Why not? Because once the condos are sold for the lower market price the bank will be forced to recognize a loss. So, even though we all know that the market clearing price is much lower than the listed price, and even though there is ample evidence that the building as originally conceived is a hopeless money losing proposition, nothing happens. It sits. Ugly. And very overtly a loss.

On the bank’s balance sheets these buildings are still shown as good assets. Any casual observer walking by knows they are toxic. The bank’s regulators and auditors endorse the charade. The forlorn hope is that the market recovers. Or, more likely, each developer and its banks hope that their building is the lucky one to sop up the few remaining buyers leaving all those other buildings to take the loss.

So a race has begun. It is a war of nerves. The first building to blink loses. Its bankers have to write down the loan. The advertising against each other is insane. Do a Google search on one and the chances are another will pop up on the same page. Bottom fishing lawyers are in on the act. I came across one law firm advertising its prowess in getting people out from underneath the deposits they might have already made. These are fun times as we watch the inevitable losses mount amongst the developers who are responsible for the pandering to the well heeled ‘proper’ folks who they want to populate their buildings. The regular people of New York, the ones whose neighborhoods were torn down to make way for these ‘stylish’ behemoths, can savor this moment.

What goes around …

And think of the ‘knock on effects’. As each of these new buildings struggles to fill its street level commercial space it has the potential to rob tenants from existing buildings. If that happens the older building is left with a gaping income hole to fill. If it fails its occupants have to make up the loss. Simple finance tells me that those old condos are now worth less than they were. So the new buildings produce a glut of space that presses down on real estate values generally. It is the Manhattan version of the foreclosure blight Florida, Nevada and California have experienced. Even ‘good’ buildings can get dragged down when there is an excess of ‘bad’ buildings.

Meanwhile, the lesson to take away from a quick walk around this part of New York is that those bank balance sheets are full of assets that are already rotten. If only the banks were telling the truth.

That’s the emerging wave of commercial real estate losses I have warned about for months. That’s why I thought the stress tests were inadequate.

Maybe the next wave of losses is coming to a street corner near you.

Maybe its there already.