Financial services cuts to push vacancy higher, but long-term Manhattan forecast remains positive

Based on the effects of previous job losses in the financial activities sector on housing demand, the ongoing difficulties with investment banks on Wall St. will likely weaken the rental housing market in Manhattan this year and into 2009. From 2000 to 2003, more than 59,000 financial services positions were eliminated in the borough, a period during which vacancy in large, market-rate rental buildings rose 350 basis points to 4.7%. Diminishing housing demand will lead to a 60 basis point rise in the vacancy rate at these structures this year. Some current trends may mitigate the expected near-term increase, however. For example, job growth remains robust in the health and social services and leisure and hospitality sectors, helping to maintain apartment occupancy. The needs of an aging population will sustain employment gains in the former segment, while the still steady arrival of foreign tourists will bolster growth prospects in the latter. Despite these challenges presented to the market by Wall St., new confidence among proprietors in the Manhattan multifamily sector emerged when the Treasury Department decided to bail out Fannie Mae and Freddie Mac. This federal action should ultimately increase multi-family investor activity during the long-term as conduits and CMBS issuers find renewed stability upon reports that the Federal Housing Finance Agency is currently backing these securities. In early September, responding to increased risks to global financial markets and the broader economy from the mortgage crisis, the U.S. government seized control of mortgage giants Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac hold or back $5.2 trillion in residential mortgage debt, or roughly half the total outstanding. The government's takeover provides assurance to GSE bondholders by essentially elevating the status of agency mortgage-backed securities to U.S. Treasury debt. The collapse of one or both of the companies would have had devastating effects on the mortgage and housing market, in addition to the broader economy and global financial system. The government's move is not seen as the cure to the housing market ills in New York City, but it is expected to propel the process of re-establishing credibility and, most importantly, reduce uncertainty in a critical component of the global capital markets, which should have a longer term positive impact on the region's apartment market. Since the announcement of a takeover, the average conforming 30-year fixed mortgage rate has declined approximately 45 basis points. Fortunately, the multifamily sector has been a bright spot for the agencies, and indicators point to continue funding of transactions. During the past 12 months, transaction velocity has decreased. Investors in small buildings have decreased their activity, as sales of assets with 20 or fewer units have declined 34% in that time. The median price was $259,500 per unit during a recent 12-month span, representing an increase of 9% from the preceding period. The median price of $362 per s/f recorded in the last year marks an advance of only 2% from the previous 12 months. Cap rates in deals closed during the past six months have varied from the high-4% range to about 5.9%. New offerings are currently being listed in the low-5% area. Cap rates are inching up, but buyers should not expect substantial adjustments from current levels, given constant demand for rental housing in the city and a history of steady price appreciation. In the Manhattan investment market, interest in local properties remains strong, albeit not quite as vigorous as several quarters ago, when lending standards were less stringent. Cap rates on local apartment assets generally average in the high-4% to high-5% range. Large, market-rate buildings continue to attract interest, as do smaller, rent-controlled properties that offer substantial upside when units can be marked up to market-rate rents. Recently, the city's Rent Guidelines Board authorized raising rents 4.5% on one-year leases in rent-stabilized units and 8.5% over two years. Another recent development for owners and investors to consider, however, involves water and sewer rates. Specifically, the New York City Water Board enacted a 14.5% increase in water and sewer rates for 2009, a move that will significantly affect property operating expenses. Manhattan remains one of the healthiest multifamily markets in the U.S. Rental rates continue to rise, property values continue to increase, cap rates are low compared to other regions of the country and the federal government's bailout of the GSEs should bring more stability to the market. Looking out over the long-term expect the Manhattan apartment sector to record substantial gains, driven by solid demographics. Adelaide Polsinelli is an associate vice president investments in the Manhattan office of Marcus & Millichap Real Estate Investment Services