Cautious Optimism Ahead for 2018 NYC Capital Markets

Despite a slowdown in transaction volume and leasing activity in the market last year, Cushman & Wakefield executives discussed why 2018 will likely be a better year for investors and lenders, at the firm's year-end retail data and capital markets presentation.

Bob Knakal, Chair, New York Investment Sales, Cushman & Wakefield
Bob Knakal, Chair, New York Investment Sales, Cushman & Wakefield

The New York City investment market in 2017 was characterized by a continued softening, with average asking rents and transaction volume down, and vacancies up in many submarkets, according to Cushman & Wakefield’s Jan. 17 presentation of its year-end retail leasing and capital markets data. But reasons for optimism remain, the firm noted, as transaction activity and large deals picked up in the fourth quarter, indicating that this momentum could continue into 2018.

“If you had asked me six months ago, I would have had a very dire prediction for 2017,” said Doug Harmon, Capital Markets chair at Cushman & Wakefield. “The good news is the second half of the year we saw a lot of transactions.”

The retail sector’s sales performance in 2017 also surpassed the firm’s expectation of a 4.2 percent increase from 2016, with total retail sales ending the year up 5.5 percent from last year. 

“For the moment, the retail apocalypse is on hold,” declared Steve Soutendijk, managing director of Retail Services at Cushman & Wakefield.

 

Signs of softening

Source: Cushman & Wakefield Retail & Capital Markets 2017 Review
Source: Cushman & Wakefield Retail & Capital Markets 2017 Review

Transaction volume in 2017 totaled $21.6 billion, a 45 percent decrease from the $39.6 billion transacted last year. But that decrease was headed toward 55 to 60 percent if not for the fourth-quarter pickup, Harmon noted. While only eight deals over $250 million closed from January to November 2017, volume picked up in the fourth quarter to total 15 deals by year-end. Only six deals over $1 billion closed in 2017, down 45 percent from 2016. 

Harmon noted that 2017’s large deals were dominated by partial interest sales, commonly a “fertile ground for foreign investors.” He added that despite the slowdown, there are some large deals in the works now, which should make for “a flat to better year than 2017.”

A lack of large deals was also prevalent on the retail leasing side, with 2017’s largest lease totaling just over $10 million in annual gross rent, compared to four deals above $25 million in 2016. This is in contrast to the Manhattan office sector, which saw an abundance of large office leases in 2017. Some notable retail leases included SL Green’s 4,629-square-foot lease with LINE FRIENDS at 1515 Broadway and Champs Sports relocating its flagship store 10 Times Square, also known as 1441 Broadway. 

The industries fueling 2017 retail leasing activity included food & beverage (with a total of 218 leases, apparel (103 leases), personal services (34) and health & fitness (28). 

The depth of this softening, however, varies by borough, Bob Knakal, chair of New York Investment Sales, pointed out, noting that what happens in the New York City market will happen in Manhattan first and then spread to the outer boroughs. For example, 2017 dollar volume was down 66 percent in Manhattan compared to 27 percent in the boroughs, and properties sold were down 45 percent versus 34 percent. 

Property values have also declined across all six major property types in Manhattan, while they’ve declined in just 25 percent of the 28 property types in the outer boroughs.

Considering downward sales volume has historically lasted four to five years, we could expect another year or two of downward pressure, Knakal said, but the current market is different than the other three corrections (the early ’90s Savings and Loan Crisis; the early ’00s Dot-Com Bubble Burst; and the late ’00s Great Recession) in which there was an event that catalyzed the downturn.

“There was nothing to precipitate this downturn so it could be different,” he observed. “While actual closings in fourth-quarter 2017 were abysmal, the contract execution activity has been up significantly, which will manifest itself in better activity in the first half of 2018.”

He added that favorable tax reform, such as the preservation of Carried Interest and 1031 Exchanges, could also “change the direction of the market.” The lower corporate tax rate will also likely double corporations’ profit margins, encouraging them to hire more people, occupy more space and increase wages, which will help market fundamentals.

Cooped up capital

The slowdown in Manhattan sales and leasing activity in 2017 was not due to a lack of investor interest in the market, the Cushman & Wakefield executives noted. 

“There’s so much capital chasing so little property,” Harmon said. “The problem has not been from the appetite side.” Many potential sellers are holding onto their properties in the hopes that the market changes and values go back up, which is creating a drag on sales volume. 

He added that competition for quality properties is very high, with the “debt market as competitive up and down the capital stack as I’ve ever seen.”

Knakal agreed, adding that lenders and borrowers have been more disciplined this cycle, which is evident in property values dipping more modestly than during previous market corrections.

“Manhattan has had an unprecedented run in transaction volume since 2010, so to us we feel it’s only logical for their to be a pause as the market finds its level,” Harmon noted. “

Some investors and lenders are moving into secondary and tertiary markets to find yield as a result, but Manhattan will always remain a liquid market, he said.

“Even though fundamentals have struggled…values are up 20 to 30 percent on marquee institutional properties, which is a byproduct of people needing to put money out there and wanting to be in the major markets,” Harmon added, noting that as long as investors stay disciplined and interest rates rise don’t rise too fast, 2018 is set to be a stable year for the New York City capital markets.