Mortar Reports: Summer Market Update

July 12, 2021
The Covid Cap Rate Flip...

For years, New York has long been recognized as one of the safest and most competitive markets for real estate investment in the world. After over a year of navigating the pandemic, it seems some investors may have forgotten this fact, creating rarely seen opportunities for local investment.

The flight of both residents and investors to warmer weather during Covid created a rush and demand in states like Florida and Texas.  This demand sent investment managers and real estate professionals from all over the country to these new ‘hot’ markets, purchasing real estate assets, raising rents, and driving up prices in each market. During this time, Northern cities – like New York, Chicago and Los Angeles, were greatly impacted by Covid, and forced to reduce rents and greatly driving down prices.

Now almost 18 months later – markets in Northern cities like New York have come back with great eagerness as the world continues to open back up. The result has created a void of inventory for residential assets, where rent prices are climbing, while the prices for multi-family assets still remain historically low.

Some Background

Cap Rates: While often the subject of confusion, Cap Rates are a simple measure of pricing investments. If an investment with a $100MM market price yields $5MM in net operating income annually, it is said to have a 5% cap rate ($5M/$100M=.05). If the same investment of $100MM yielded $6MM annually, it would have a 6% cap rate, and if it yielded $4MM, it would have a 4% cap rate. Thus, the higher the cap rate of a deal, the cheaper the deal is, and vice-versa.

Cap Rates and Covid-19: New York has historically enjoyed the lowest cap rates of any market in the world, and for good reason: New York’s strong and diverse job market, and status as an international travel and business destination have cemented its reputation as being the world’s most attractive place to invest in real estate with minimal risk.

However, as the pandemic shut down cities across the country, and doubts were cast on the continued feasibility of investments in places like New York City, institutional investors turned en masse to secondary markets such as Austin, Miami, and Raleigh, seeking to take advantage of their higher cap rates (cheaper deals) and forecasted population growth. While this shift in investor focus made sense given the uncertainty that prevailed regarding large, dense cities in the depths of 2020, as swings of investor sentiment often do, this one may have swung too far, causing an overcorrection to market prices.

A Market OVERcorrection

As investor attention shifted to the Sunbelt and South Florida, cap rates have predictably fallen as a result. This means that investments in Raleigh or Ft Lauderdale today are more expensive (lower cap rate) than they were at the beginning of the pandemic. Now this is where things get interesting. As cap rates have been falling dramatically in these secondary markets due to the Covid frenzy, the shift in investor attention away from New York City has caused precisely the opposite effect. New York City is trading at a discount to some of these markets.

According to Forbes, as of May 2021, Manhattan, Brooklyn, and Queens residential properties were all trading at cap rates higher (cheaper) than they were 6 months prior. The change was especially dramatic in Brooklyn and Queens, where rates rose more than 20%. (Brooklyn is up to 5.89% from 4.85%, and Queens is up to 6.23% from 5.09%). In Manhattan, the increase was smaller, but still substantial, at 4% (up to 4.43% from 4.26%). On the contrary, Raleigh-Durham properties were trading at cap rates of 4.25%-4.75%, and Miami properties at 4.25-4.5%, according to the latest data from CBRE. This means that overall, investments in New York City are actually trading at a discount to investments in these other cities.

What does this say about the current investment climate? Are sellers in New York right to price properties cheaper than sun belt cities, at more than a 20% discount to New York prices only 6 months earlier, or is the market being mispriced due to the temporary effects of the COVID pandemic?

A Rare Investment Opportunity

At Mortar Group, we view this short-term jump in cap rates as an opportunity to invest in quality real estate assets at a significant discount to normal prices. We continue to be confident in the forward growth of the New York residential real estate market, and with such dramatic recent increases in cap rates, particularly in Brooklyn and Queens, we see the current market conditions as a rare and unique investment opportunity for investment.

Mortar’s expertise with acquiring assets in growing, established neighborhoods, coupled with years of experience building and managing real estate projects in these currently undervalued boroughs, has positioned us excellently to identify and execute projects in high-growth locations with superior risk-adjusted returns for our investors.