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Real Estate Report 2007

A bubble’s destiny is to burst. Otherwise, it’s not a bubble. This year, however, the New York housing bubble—the ominously overinflated market that experts have been warning us about since the current run-up in housing prices began—has begun to seem more like a protective sphere. West of the Hudson, things are looking bleaker by the day: 180,000 homes fell into foreclosure nationwide in July alone, with up to eleven times that figure feared by the end of 2008. Sales of existing homes were down 17 percent in the second quarter; for the fourth quarter, Goldman Sachs forecasts a 15 percent nationwide price decline. “We’re in the worst housing recession in 40 years,” says Nouriel Roubini, professor of economics at NYU. “It’s an absolute disaster.” In our charmed city, meanwhile, the weather—for the moment, anyway—appears to be fine. In the second quarter, the price of an average New York apartment rose by 8 percent. The luxury sector went positively berserk, with four-plus-bedrooms in Manhattan going for 20 percent more than last year. And 15 Central Park West, “the new Dakota,” famously raised its prices nineteen times before finally selling every one of its 201 units for a combined, staggering $2 billion—including Sandy Weill’s $42.4 million penthouse.

The near-obscene disconnect raises the question: Is New York immune to the market forces presently shaving billions off home values in the rest of the country? Some say yes. A few years ago, economists Joseph Gyourko, Christopher Mayer, and Todd Sinai coined the phrase “superstar cities” and posited that some lucky areas—this metropolis very much included—are simply different, possessing the right combination of “inelastic supply” and near-bottomless demand to untether them from national trends. On the supply side, New York is geographically small and decidedly finite, and the red tape required to build here is staggering. (Gyourko has calculated that the inflated values created by artificial stifling of construction cost the average New York homeowner more than $7,500 a year—a de facto “preservation tax.” Others say that number may be closer to $10,000.) Even Michael Bloomberg and Dan Doctoroff’s pro-building agenda, which includes tax breaks for developers, aggressive rezoning, and a taste for neighborhood-altering megaprojects, hasn’t really done much to pump up inventory. Despite what our own eyes tell us (“I live in Tribeca and can count 40 separate construction projects in my neighborhood right now,” says Roubini), new construction is not adding nearly enough units to glut the market. Low crime, plentiful jobs, and the resurgence of big-city sex appeal, meanwhile, have led throngs of people to want to live here and, in a huge paradigm shift, stay even after they breed. To well-heeled newcomers, our enormous rents make our enormous mortgages a relatively sane proposition, and our international character, combined with the soft dollar, also make us one of the few American cities with a global buyer pool. “We have the Google effect,” says Brad Inman, the Berkeley, California–based publisher of the real-estate news service Inman News. “You got the Irish effect. They’re buying $10 million apartments!” (Inman is referring to upper-class Dubliners’ newfound longing for Manhattan pieds-à-terre, which is strong enough to have caused some developers to market whole high-rises exclusively to the Irish.) Brits, Japanese, Saudis, and other groups, of course, have all, at one time or another, developed mass crushes on New York as well.

All told, the city’s population is expected to grow by 200,000 in the next three years, and by half a million by 2020. It stands to reason that if enough “high-income superstar earners,” in Gyourko’s parlance, disproportionately file into New York and pay a premium for the privilege, home prices will continue to rise. As Gyourko’s colleague, Harvard professor Edward Glaeser, puts it, New York’s boom is “driven by the reinvention of the city as a center for idea creation in finance and a playground for the prosperous.”

But what if the prosperous stop prospering and don’t feel like playing? Though some experts believe that the current subprime-mortgage mess will be contained, it points directly to our Achilles’ heel: what Inman calls “the deadly marriage between New York City real estate and Wall Street.” Housing-wise, financial types are a dream demographic—they generate wealth for clients and snap up extravagant abodes for themselves—but it’s easy for the market to get addicted to yearly infusions of investment-bank bonus cash, and the withdrawal can be painful. After the 1987 stock-market crash, Manhattan median home prices plummeted by 26 percent. Should the current liquidity crisis spread, New York real estate could theoretically crash without a single subprime foreclosure in the five boroughs: Others’ grief could catch up to us via bad brokerage-house bets and the plummeting profits and pink slips that come with them.

There are other, wonkier, reasons to be afraid. If we look at the instruments economists use to take a market’s temperature, many point to an imminent bust. For one thing, we appear to be reaching the peak of a so-called Minsky cycle. In Hyman Minsky’s ingenious model of asset bubbles, economic stability breeds riskier and riskier investors: First come the “hedge borrowers,” who play with their own money; they are followed by “speculative borrowers,” who have enough cash flow to keep the lender at bay but not enough to cover the principal investment, and finally “Ponzi borrowers,” who are, as the name suggests, borrowing to refinance other debts they can’t meet, in the wild hope that the market will keep climbing. The Minsky model is remarkable for having been proved the way we like our economic models proved: recently, the hard way, and twice. We cycled through it in the eighties with junk bonds, and in the nineties with tech stocks. As it happens, the latter-day brownstone-flippers, financing each new property with the last one’s equity, are the dictionary definition of Ponzi borrowers. In fact, it’s almost unbelievable that the obvious junk-bond and dot-com analogies would ever pass us by. But such is the boom mentality. First you think the bust isn’t going to happen, then you think it’s not going to happen to you.

Another frightening omen: Glaeser has studied housing data from every metropolitan area in the country between 1980 and 2004. Based on his research, he has estimated that on average, for every dollar a city gains in prices over five years, it loses 32 cents over the next five years. It’s a simple and brutal equation. “New York City has had a great past five years,” he points out. “This bodes poorly for the future.” For someone who bought at the top of the market, seeing one-third of the value shaved off the purchase price is a potential disaster, especially if there’s a home-equity loan or second mortgage involved.

Scarier still, there are indications that the slump is already under way—there’s just too much of last year’s bonus cash coursing through the city, or so the theory goes, for us to notice. A closer look at the latest figures shows pockets of weakness. This summer, it was moneymaking Manhattan pulling up the stats for the rest of the city, with a few Brooklyn enclaves coming along for the ride. But Queens, the city’s leader in foreclosures (up by 92 percent this spring), and the rest of the boroughs went on a backslide that roughly mirrors the broader American slowdown. The wider the net, the worse the numbers: The S&P/Case-Shiller Home Price Index, for instance, which takes into account the entire metro area, shows a 3.4 percent year-over-year decline in New York since June 2006. The co-creator of the index, Yale professor Robert Shiller, has impeccable Cassandra credentials: He correctly predicted the tech-stock disaster in his 2000 book, Irrational Exuberance. Still, some economists argue that the index does not accurately reflect conditions in Manhattan because it includes parts of Connecticut, New Jersey, and Pennsylvania, and thus mixes co-op and condo data with single-family-home sales.

So, which is it? Irrational exuberance or irrational paranoia? Bubble or Biodome? We turned to some of the brightest minds in real-estate economics—Glaeser, Inman, Roubini, Tim Harford (author of The Undercover Economist), George Mason University’s Tyler Cowen, and founder Noah Rosenblatt—to come up with competing best-case and worst-case scenarios from now to 2010. Because economists are loath to utter concrete numerical predictions on the record, we mashed their guesses together; the results are composites of frequently divergent individual opinions and should be treated as such.

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