As part of our quest to collect as many New York no-fee apartment listings as possible, we end up sifting through a lot of data about neighborhoods, buildings, and most interesting of all, changes in rent levels. The question everyone asks us is, how far will Manhattan apartment rent levels fall?
Of course, the honest truth is no one really knows for sure. However, can we do our best to infer the future given what we know today? There is, potentially, a trick we can take from the seemingly unrelated field of fixed income relative value trading! For the die-hard Wall Street skeptics out there, you should stop reading now.
And for those still remaining, I present the question we’d like to explore:Â Is it possible to bootstrap a Manhattan rent curve using varying tenors of lease offerings?
Most of you have probably opened a Certificate of Deposit account with a bank at one point in your life, aka a CD. As you know, CDs come in various maturities. On ING Direct today, you can get a 6 month CD paying 1.25% interest, a 12 month CD paying 1.75% interest, or a 60 month CD paying 2.00% interest. If those are the only 3 available CDs, could we guess today what interest a 6 month CD will pay, SIX MONTHS FROM TODAY? In fixed income jargon, we might call that the 6 month forward 6 month CD rate. The key trick in bootstrapping is to claim we know this 6 month forward 6 month rate, because there is only one interest rate that makes both today’s 6 month rate and today’s 12 month rate sensible propositions.
Imagine a few values that could not possibly be the correct 6 month forward 6 month rate. If in six months, the 6 month CD paid only 1.25%, then it would be a very bad idea to invest in the 6 month CDs when you can invest in the 12 month CD to get 1.75%. Similarly, if the forward rate was as high as 5%, then the 6 month CD is the better investment today. After all, if you open a 12 month CD today for $10,000 at 1.75%, then after waiting six months, you will have remaining a 6 month CD with balance $10,087.50 (to be honest, ING just changed their compounding policy so you’d get a little bit more). If indeed, the forward rate was 5%, then you’d end up with $10,175 with the 12 month CD vs. over $10,314.06 (ignoring the fact that ING quotes in APY). You will find the only way to make both investments equal would be if the forward rate was approximately 2.2236%. If the rate were any more, you’d always invest 6 months at a time. If the rate were any less, you could always invest in the 12 month and then sell it after 6 months.
Now, can we apply the same idea for leases of varying lengths, with the huge assumption that the curve can be bootstrapped and that inflation is negligible over the next few years? Clearly it is not possible to sell your lease halfway through to another tenant, but the fact that we’ve seen landlords give out stellar deals for 2 year leases would suggest landlords know that forward rents are on the decline (and the lease curve is for once quite inverted). Stay tuned as we gather 6M, 1Y, and 2Y lease quotes from a good mix of lease dealers.
On a similar note, we even saw a creative land lord who offered an free option: “Break out of your lease at month 14 of your 24 month lease, no penalty!” We’ll leave pricing of that option for another time…
