What does vacant retail mean for New York City residential prices?

Thanks to Amazon and shifting consumer habits, Manhattan retail vacancies are at all-time highs. This report from Cushman & Wakefield shows that nearly one out of three storefronts on Madison Avenue, Times Square and Herald Square are sitting empty, and more than one in four are empty in Soho. This is no bueno.

What does any of this have to do with residential real estate?

Take a step back, and think about the mosaic of New York City real estate. Almost none of the city’s buildings are single-use. More typically, buildings have retail space at the street level, and then residential, office or hotel above. That means that most “residential” buildings derive some rents from retail storefronts.The banks who lend money on New York City buildings have historically attributed a large share of building value to the retail space. Their cash flow assumptions typically take those retail rents into account. Without them, the buildings may not generate enough cash flow to cover interest and principal payments.

In the parts of Manhattan where retail rents have been very high, these shortfalls can wind up costing apartment owners lots of money every month that they have not budgeted for. For example, the very posh apartment buildings that line Madison Avenue are accustomed to letting out their retail spaces (to tenants like Chanel, Gucci, etc) at some of the highest rents in the world. Those buildings count on that juicy cash flow stream from storefronts to pay building expenses like maintenance and mortgage interest. In the past, the rents have been paid like clockwork. But when the retail tenants leave — as they have been doing — the rest of the building has to find the cash flow from somewhere else.

If the building is a co-op or a condo, the shortfall is covered through “an assessment” which means apartment owners must pay additional money every month. By definition, these assessments make the apartment units less valuable.

This retail trend has been playing out for awhile, so this is not really news.

The ripple effects of these retail vacancies have not yet been priced into apartments. In most cases, an apartment listing will have tiny fine print in a listing that says something like “There is currently a $___ assessment in place.” But sellers still expect to get prices that are in-line with historical comps — and historically retail spaces would eventually find tenants. Who knows what will happen going forward?

Uncertainty breeds opportunity, and at Compound, we are poised to strike. We are already finding interesting deals the likes of which have not been seen in the recent past.

It’s a buyer’s market. There is a glut of overpriced condos, apartment sales have slowed and apartment prices have been falling since 2015.

But it’s not all doom-and-gloom in Manhattan.

Apartment rental occupancies and rents remain at all time highs. Hotels are doing quite well, too, with market-wide occupancy approaching 90%.

New York City remains a place where people want to live and work.

And right now, New York City is on sale.

And that almost never happens.

There are deals to be had on Manhattan apartments. Meanwhile, there are tenants who need quality places to live.

At Compound, we’re focused on finding the best residential investment opportunities for these uncertain times. Be greedy when others are fearful!