The U.S. economy continues to strengthen, expanding at its most vigorous pace in more than two years in the spring. While the Federal Reserve’s days of monetary policy easing are over, muted inflation should keep interest rates attractive for the time being. That bodes well for commercial real estate financing throughout New York City, particularly in Queens, where enticing property prices and stiff competition amongst lenders will keep borrowing activity robust.
(From left to right) Matthew Swerdlow, Director of Capital Services and Brett Campbell, Senior Analyst of Investment Research
With the unemployment rate hovering around a 16-year low, the labor market is by far the economy’s biggest positive. Gross domestic product rose by a seasonally and inflation-adjusted annual rate of 3% in the second quarter, above the first quarter’s tepid 1.2% growth and the economy’s average of a little more than 2% a year since the recession ended in mid-2009.
A combination of low inflation, geopolitical tensions and reduced expectations of a sweeping fiscal stimulus package from the Trump administration buoyed demand for safe-haven Treasury bonds this year. Nevertheless, Treasuries may come under pressure when the Fed, as widely expected, starts unwinding its $4.5 trillion portfolio of bonds. This move should put upward pressure on rates and eventually lead to higher borrowing costs on consumer and business loans.
For most of the past decade, historically low interest rates fostered ferocious demand for Queens real estate. However, echoing New York City’s trend, the borough’s investment sales market continued to cool off in the first half as investors focused on the new presidency, revisions to rent regulation, and the new iteration of the 421-a tax abatement, according to Ariel Property Advisors’ “Queens 2017 Mid-Year Sales Report.”
Sales of development sites slumped in 1H17, partly due to the lack of 421-a, which was reinstated in April as “Affordable New York.” Rising expenses also played a role, with the cost of construction estimated to rise 3.5% in 2017, according to New York Building Congress.
Common indices that lenders used to price construction loans off of have risen between 0.5% and 0.75% over the past year. Fortunately, higher rates should “normalize” market conditions, and entice sellers to continue adjusting their price expectations for development sites downward.
Developers, due largely to their unfamiliarity with “Affordable New York,” are locked in a wait-and-see mode for the time being. This, however, should prove transitory and as acquisitions pick-up, financing activity should move in lockstep.
Construction remains one of the strongest business plans to create value in the current environment and developers will increasingly focus on the nuances of “Affordable New York,” which can make-or-break a project. As the NYC Department of Housing, Preservation, and Development (HPD) refines their interpretation of the law, lenders are sitting back, cautiously optimistic about how to underwrite the new tax exemption.
Competition Creates Conducive Climate
Using a 6-month trailing average, Queens capitalization rates are relatively attractive, standing at 4.24% in 1H17, above Manhattan and Northern Manhattan, which had cap rates of 3.55% and 4.08%, respectively. In pursuit of higher yields, investors, especially institutions, have turned to Queens.
As investment sales activity slid throughout New York City, so did dollar volume for Queens acquisition loans. According to Ariel Property Advisors’ research, mortgage origination volume fell 11% to $1.05 billion from $1.18 billion in 2015, and the number of closed mortgages slid 14% to 363.
This drop reflects a market slowing down from extremely busy years in the past, but is also indicative of caution on behalf of lenders. Traditional lenders have adjusted their credit criteria on multifamily mortgages due to concerns about overleverage, lack of diversification, increased cost of capital, and government regulation.
As participants of yesteryear stepped back, a fresh crop of lenders adeptly filled their void. These individuals and institutions entered a power vacuum, enabling them to leverage discretion over their capital to deliver optimal structures. Even if the Fed tightens monetary policy further, favorable terms will still be attainable because these lenders are competing for business.
For example, Ariel Property Advisors’ Capital Services Division recently facilitated financing for a 6-unit multifamily building in Astoria. Ariel structured a fixed-rate, 10-year, non-recourse cash out refinance at 3.97%, giving the borrower protection against future interest rate fluctuations. Ariel‘s team procured these favorable terms by bringing the borrower to an aggressive out-of-state lender.
Lenders are enamored with Queens due to its sturdy economy. New York State data shows employment in the borough leaped 13.7% in July from a year earlier to 1.21 million. The unemployment rate stood at 4.4% in July, mostly in line with the national average, but below New York’s City’s average of 5% and the borough’s year-ago level of 4.9%.
As more and more people work and live in Queens, institutional and private investors will likely continue to seek mortgage financing in the “World’s Borough.” Overall, the normalization of Fed monetary policy indicates a strong economy, and therefore we expect capital markets to remain active, allowing investors ongoing access to attractive and reliable financing.