NYC Investors: Don’t Chase Yield
Baseball season is upon us, so you sit down to watch your favorite team. The star player is at the plate, and he is ready to hit the ball with a cricket bat. Of course, this scenario is ridiculous, but we equate this to New York City real estate investors playing the wrong game. Instead of hunting for yield, capital appreciation is the main game in the city.
Historical yield
The yield, or cap rate, is your net cash flow divided by your purchase price. In this city, it has historically been 3%-4%. This is much lower than yields across the country. For instance, multi-family properties in Atlanta and Chicago are about 4.75% at the low end and over 6% in Indianapolis, according to a study done by Cushman in 2013.
Image by Philip Taylor / Flickr
There are many cities that offer a higher yield, making rents an attractive source of steady income. However, despite the high rents commanded in New York City, this is not the major factor generating returns. This naturally leads to the question: why invest in New York City? After all, an investment in the 10 year Treasury note currently has a 2.3% yield, but this has been an unusually low period for rates. Since it is backed by the full faith and credit of the United States government, repayment of the principal is considered risk free. Unlike real estate, it is a passive investment that does not involve inconvenient calls for emergency repairs and unruly tenants.
Since real estate involves more risk, there must be a higher potential return. There is a missing piece to the return equation.
Capital appreciation
The answer is that investors have generated a large portion of their gains from rising prices. For instance, real estate appraisal and consulting firm Miller Samuel examined Manhattan prices for 100 years, from the 1910s through 2010s. In the 1970s, the sale price was $45 per square foot for luxury properties, rising to $1,200 in the 2000s. In a narrower period covering 2004 to 2013, the median sales price for Manhattan rose from about $606,000 to $855,000. This is a 141% rise or a 3.5% compounded annual growth rate.
There are a couple of things to note. The 2004-2013 includes part of the build-up during the bubble and sharp contraction during the recession. But, over a decade, these large swings balanced out to a 3.5% annual gain. While this is about equal to the historical yield, it includes data across the entire borough. Doing some homework would have helped you outpace this gain. As an investor, you are going to be more discriminate in examining trends. For instance, if you invested when you noticed gentrification in certain Brooklyn and Queens neighborhoods, your appreciation was notably higher.
To see how much it varies, StreetEasy is predicting the median price will rise 4.4% in Queens this year, 3% in Brooklyn, while Manhattan trails these two with a 0.6% increase.
New York City is also a liquid market compared to other parts of the country, which is appealing for investors. There is demand from global buyers, meaning it is not solely dependent on the local economy. This provides a measure of support in a recession as foreign buyers step up to bargain hunt.
Putting it together
We do not mean to dismiss rent collection. Hopefully, it provides you with a steady annual cash flow. However, for those that are patient and astute, capital appreciation can be the real wealth generator.
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