Are Boston and New York’s Real Estate Markets Overvalued?

Northeast Private Client Group has reported throughout 2016 that assets in New York City and Boston are trading at record-high valuations for this cycle. In New York City, deal flow has slowed considerably since Q1-2016 and value-added investors are exploring opportunities in submarkets outside the City including Connecticut and the Hudson Valley. Similarly, in Boston, ranked as the third most expensive U.S. market for multifamily rents at the end of last year, valuations for income properties have hit historic highs for this cycle, as investors are increasingly less likely to bid down capitalization rates any further. Despite strong demand for multifamily and commercial assets in both markets, one is left to question if either or both of these markets may be “overvalued.”

An influx of new Class-A assets limits occupancy rates and rent growth

New York’s and Boston’s current high valuations in and of themselves do not necessarily indicate that these markets are “overvalued.” A more meaningful indicator than current sales prices may be found in occupancy and rent growth data. With regard to Class-A product, it is clear that new construction in both New York and Boston is in fact putting downward pressure on rent growth and occupancy figures. To this point, the Office of the Comptroller of the Currency (OCC) earlier this year asked lenders to tighten up lending terms for property developers, due in part to an influx of new multifamily assets entering the market in four major metropolitan areas – Boston, New York, San Francisco and Washington D.C. As an example at the submarket level, the supply of new multifamily units in Boston’s Beacon Hill/West End resulted in an 8 percent increase in vacancy rates from Q2-2015 to Q2-2016, according to CoStar Portfolio Strategy. As a whole, Boston multifamily properties currently average a 5 percent vacancy rate, which is .6 percent above the national average of 4.4 percent.

Lower occupancy is typically accompanied by softness in rents, which is particularly acute after several years of record rent growth in both markets. On average, New York City rents are 50 percent higher than they were 10 years ago. The average rent in New York City is $3,441 per month. However, 20 percent of the new rental leases in Manhattan are currently offered with concessions. Similarly, real estate research firm Reis Inc.’s third-quarter apartment sector survey found Boston’s apartment rents average the third highest in the U.S. coming in at $2,072 per month. With the amount of new Class-A development being delivered, little rent growth is anticipated in 2017.

“One of the biggest mistakes for an investor to make in an overvalued market is to assume that rents will continue to rise, especially in rent stabilized environments,” Anthony Watkins, Senior Associate in Northeast PCG’s New York office, said. “The inability to push rents, coupled with a healthy stream of newly-constructed multifamily units, creates the perfect whirlwind for increased rent competition, higher vacancy rates and decreased valuations. These are some of the strongest drivers for the falloff in sales velocity, as well as the overall sentiment in the New York metro market.”

Class-B and Class-C markets offer opportunities for investors

For investors who are willing to add value through capital improvements and management, Class-B and Class-C multifamily and commercial assets remains an attractive investment. In New York City’s neighboring Hudson Valley, and as with submarkets along Boston’s 128 corridor, there are opportunities for investors to reposition assets and create the conditions to increase occupancy and raise rents.

In addition to making improvements to undervalued assets in the Class-B and Class-C markets, the rise in vacant suburban office properties offers investors an opportunity to repurpose these buildings for new uses. Similarly, mixed use properties can often be converted to house an increased number of multifamily units.

In the Boston area, Northeast PCG currently has a 23-unit multifamily property located in close proximity to the North Quincy “T” Station available for $4.6 million.

“With the proper management and repositioning, this building has the potential to command higher asking rents and for its new owner to create value in an otherwise overvalued market,” Drew Kirkland, Senior Associate in Northeast PCG’s Boston office, said.

While increased vacancy rates and rising inventory indicate multifamily asking rents are poised to decline in both Boston and New York City, exploring opportunities in the Class-B and Class-C markets offer greater opportunity for investors.

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