Investors chasing restless millennials

In a focus on the first quarter of 2017, James Nelson of Cushman & Wakefield sat down with Kas Sanandaji of Property Markets Group, Greg Kalikow of The Kalikow Group and Kaled Management, and John McCarthy from HUBB NYC to discuss their current projects and business strategy, and what they expect from 2017.

James: Please tell us about your company and your current projects.

Kas: Property Markets Group has been in business for about 25 years with offices in New York, Miami, and Chicago. We are currently developing more than $3 billion of projects. Our largest market is New York City. We focused on substantial redevelopment or ground‑up development, primarily residential however, we have also done about 1,000 units of hotels in the city as well.

Greg: I am fourth generation in my families management company, Kaled Management, I am also Vice President of The Kalikow Group. We are owners and operators in New York City, primarily in Queens, Brooklyn and Manhattan. Currently, we are doing a multifamily development in Prospect Lefferts Gardens.

Johnny: HUBB NYC was started a little over five years ago with the premise of investing in retail coops and condos, and multifamily in and around New York City. Currently we are only in Manhattan and hopefully in the next year or two we will head out to the outer boroughs and maybe Jersey City.  Our investment strategy is very long term.

James: Could you tell us how your companies are structured?  And what is your typical capital stack?

Kas: Property Markets Group is a private partnership. We oftentake on financial partners, and sometimes we will work with another developer, but we tend to want to have our hand on the wheel. Therefore, we typically run the development and then bring in money from outside.

Greg: Kalikow’s capital structure depends on the size of the deal.  We always prefer to manage as well, but based on the size of the deal it depends on how many partners we would bring in and the kind of partners we would bring in.  Typically, we will do a smaller deal ourselves and bring in individual investors, but for a larger deal we will look to either a publically traded or a larger investment group.

Johnny: HUBB NYC is privately held. Our investor is a large pension fund. We typically do not do partnerships because our problem is not capital. Our problem is finding an investment that actually makes financial sense.

James: What is your investment profile? What type of returns do you look for?

Johnny: When we were formed we structured our business to hold for generations. It is really tough to get money out of the first cycle, so we look for strong areas, strong location, maybe a little bit of inefficiency in a market that we can take advantage of in five to ten years.  Then we just buy hold to operate, lease, and position it for the future. Typically we buy value‑add, but we will happily buy stabilized deals as long as the price point is attractive.

Greg: As a primarily residential group, I think right now you have to have a longer investment horizon. I think the cap rate is coming up and price per square foot is going down.  Given the new rent guidelines and how much money you have to spend to bring units to market rent, you really have to be dealing with a long term horizon. We are typically longer term holders.  I believe that if you buy good bricks in a good area, value will go up. It may not be a year or five years, but the value is there.

Kas: PMG is typically a merchant builder so we build and we sell.  Therefore, we do not have very much that we are doing on a ten‑year term. Our value creation happens over the development process.  We look for opportunities that we can add value to.

James: Retail asking rents are down across the board in every single sub‑market, and availability is now at 20‑plus percent in pretty much every major sub‑market. How does this impact where you are looking for retail investments?

Johnny: Retail is undergoing a few changes right now.  People are changing their shopping patterns, and that is changing how retailers work in and around the city and how they are selling to people.

It is changing the retail make‑up and there has been a sales shift in New York City, and with that there have been some retailers that don’t survive, some that find it tougher to compete in the city and it has created some vacancy.

Looking a SoHo for example, how do you make money as a retailer paying rent over $1,000 a square foot? And on top of that, the dollar is really strong and that makes it tough for the tourism sales.

It is just about getting the market to come back down and find out where retailers have the sales to make money and be profitable in those locations. In terms of the rest of Manhattan and all of the other markets, I think the rental market is still there. It is just a little bit more of a process to get people in.

James: The new rent guidelines, the Altman Ruling, and the state weighing in with the tenant protection unit have made things very challenging for landlords.  Why do you continue to invest in regulated product and how do you navigate through those challenges?

Greg: It is definitely more challenging to acquire multifamily properties today.

If you have a tenant that is rent‑stabilized paying $500 a month and they leave, you get a 20 percent vacancy increase just on that tenant leaving.

Now in order to deregulate that unit, the vacancy decontrol amount is $2,700 a month, whereas it used to be $2,500, so you have to spend the difference between $2,700 and $600, or $2,100 ,and you have to multiply that by 60 for buildings that are over a certain amount of units.  Therefore, you are going to have to spend $127,000 to get that unit to the point where it can be decontrolled.

One strategy that we would use when underwriting properties is we would spend more than that amount to get the rent above $2,700 closer to market, so that even if we are collecting no increases, we are at market. And if you put in the work and you put the necessary language in the rent‑stabilized lease, you issue a preferential rent. At the end of the lease, we have the right to remove the preferential rent and increase the amount to legal rent. I also think there is a generational difference. Millenials live in more of a transient environment and people in their 20s and 30s move a lot. People in their 60s, and older don’t really move that much.

So when we see that the next tenant is stabilized, we are relying on the fact that the younger generation is a more transient generation and that they are not necessarily going to stay where they are for 20 to 40 years.

James: How do you view the overall stock of both condo and rental product in the city?

Kas:            I think that condos are going to have problems.  The issue is that it takes 36 months to get price feedback on a sale of a condo from the time that you make a decision to make an investment.

When people see an eye‑popping profit, all of a sudden capital rushes towards building condominiums and that is why the condo business has a tendency of being a very cyclical business. We saw a huge amount of capital go into the price of land, we have had very, very low interest rates, and financial services did incredibly well coming out of the downturn. As a result, a huge amount of supply got pushed into the marketplace.

James: Is it feast or famine for that very high end where only the best product is going to sell and then everyone else is going to suffer? What do you make of that super‑high end product?

Kas:            In good years with relatively low interest rates, Manhattan absorbs approximately 1,800 units a year of new product.  If we have roughly 5,000 units of product coming into the marketplace, either in the marketplace now or that commenced construction before the lending markets essentially shutdown in August of 2015, you have got about a three year supply of condos before you get to a place where you are starting to have under-supply issues.

I think that there is an exacerbating factor that may drag that out past three years because interest rates are going up, and I think people underestimate what that is going to do to both cap rates on existing assets and especially as it relates to the liquidation of condo inventory.

But there are many people who are just investing to keep their money safe because they believe in New York City over the long term, and because the supply/demand dynamics for residential in New York City are incredibly favorable.

So in summary, land prices are going down and liquidation is going to be slow.  But in my opinion, the smart developers are the ones who are looking right now because in 36 months you are not going to have supply anymore and there is very, very little financing right now so there is a direct inverse relationship between the amount of financing that is available for condo units and the time that you should be making the investments.

James: What kind of concessions does it take today to get an apartment rented?

Greg: The amount of Manhattan landlords that issued concessions two years ago was under five percent, and now it is somewhere in the 33 percent range.

I think it is difficult to compete with the existing product, however if you are offering concessions and you have good product in a good location, it will naturally be absorbed. The areas that typically get hurt most are your secondary markets and areas that may not be as desirable.

I think that there is more competition to find renters now, especially in the winter months. As an owner or someone looking to invest, it is important to anticipate the transient nature of the renter, which I think does make it more challenging.

James: Who are the active retail tenants out there today, and what kind of concessions are being offered?

Johnny: In terms of concession it really depends. If you leave the high rent districts and you get into the rest of Manhattan, we are not seeing a huge run up in concessions.  I think it is just typically white box, standard free rent to build out the space and maybe some building supplies.

But when you get into the high rent districts, it is a little bit different. There is always a little bit of buying up the rent, but you are not seeing a huge change in concessions. We are seeing change in rent, though, and that’s probably more meaningful.

In terms of the tenants in the market, it depends neighborhood by neighborhood, and the make‑up of the neighborhood.  A good example would be office services, residential. If you have a nice area with office and residential, office has the day time eating spots, quick service food and night time with residential you get a lot of restaurants. Therefore, I would say food tenants are really big in the market across all of New York City right now.

Beyond that, people’s shopping patterns are changing and gradually over the next five years, they will be more experienced tenants in Manhattan, like a showroom where you buy things.

Today it is less about buying your standard stuff that you can get off of Amazon and more about buying other stuff and experiencing something, and I think that is a change that will happen over the retail world, not just in Manhattan but everywhere over the next five or ten years.

James: How do you think the Trump Administration will impact New York City real estate?

Kas:    I think that the Trump presidency is probably going to be a good thing for real estate, especially for New York City real estate, because he has been very explicit about the fact that he wants to take the shackles off the banks, and in doing so will probably be a big boon to financial services.

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