The Locked-In Effect
I’m thinking about the different reasons why people don’t want to sell their apartments in New York City right now. The New York Times is looking across the US for answers. Their argument is that homeowners who have low mortgage rates on their home- and the option of renting out their home- are making money as landlords. So they won’t sell.
While that may be happening elsewhere, that is only a tiny subset of what’s going on in New York.
So something else is keeping inventory down in New York.
Everyone is expecting more inventory this Spring, but it is creeping up ever-so-slowly (see our February Inventory Report here). From my perch, we’re not seeing any issues with demand for property- just issues with supply.
Let’s consider the reasons, as they are worth looking very closely:
Yes, People Have Super Low Mortgage Rates and Don’t Want to Lose Them
If someone has a sub-3% mortgage rate, and wants to downsize, they can’t take their rate with them.
Let’s take an example: Someone with a property worth $3mm with a $2mm mortgage @ 2.8% and $4500 monthly costs wants to downsize to a $1.5mm property with $2500 monthly costs and take a $1mm mortgage at 5.5%.
In this scenario, their total costs would go from $12,717 to $8,177. It’s a savings of roughly $4500 per month, or $54,000 per year. That sounds nice, right?
It does. But more likely, what they want is going to cost them $2mm. If they are still only putting $500,000 down, their monthlies may only drop to $11,266 (which is a $1.5mm mortgage @ 5.5% with $2750/month charges- see for yourself). In this situation, would it be worth all the hassle of moving to save $1500/month? You know the answer. A resounding “heck no!”
Even if someone wants to sell and move into a rental apartment, the prospects are pretty dim, too. A nice two-bedroom rental can easily run into the $8000-10000/month range. That won’t be palatable, either.
But let’s say that they are committed to selling and finding the $1.5mm new home. They start looking- and see nothing worth moving for. What then? Will they still sell?
Why Can’t They Find One?
Who is going to sell to them? That is, what about the people who are looking to do the opposite? Going from the $1.5mm property to the $3mm one? Their costs would go from $6608 per month for their $1.5mm property to $15,855 for the new one. That’s a pretty big leap.
If neither sells, there isn’t enough inventory. The $3mm can’t move down and the $1.5mm won’t move up. It’s messy. One result is that the prices haven’t fallen on a per square foot basis. And renovated properties are getting renewed interest from buyers who see a sliver of hope in mortgage rates that are softening from recent highs. But there isn’t enough renovated property yet.
No One Wants To Renovate
Yep. Too many Sellers in New York City Are Estates, and renovation is expensive. Darned expensive. One high-end contractor I spoke with last week told me his starting number is $1000 per square foot. That is, $2mm to renovate a 2000-square foot apartment. Now, that’s at the far end of the spectrum. But if typical renovation costs are $400-500 per square foot, where does that leave move buyers? They just don’t have the combination of:
downpayment + renovation costs + post-closing liquidity + costs of renting elsewhere
So the renovated units sell, and the unrenovated units sit. This means that the inventory that is on the market is largely full of properties that people don’t want to renovate.
No One Wants to Lose Money
A large swath of sellers who bought between 2014-2019 are facing the reality that if they sell today, not only will they have a higher mortgage rate when they buy something else. They will also lose money on their sale. That’s right- our market is still below the peak of 2014-2016. I would say between 30-50% of sellers I speak to today are going to lose money if they sell. The big question is how long they might have to wait to break even. Is it worth waiting? If they can make 4% risk free on their equity today, it may be worth losing a little, rather than becoming a landlord or staying where you do not want to be anymore.
I’m just saying.
What Breaks The Dam?
Lower mortgage rates. Until rates start to move down, buyers upgrading may sit on the sidelines and stay in the apartments they have today. It’s a locked-in effect that was real in 1979-1981 (see article here), and it’s happening today, too.
What Does This Mean For Buyers?
As a buyer, you need to be more prepared than ever to act quickly when you see the right space. You need to find every option to get the lowest mortgage rate possible. And you need to be looking for that seller who is ready to move yesterday.
It takes a village to get it done in the best of times. It’s more true now than ever. -Scott