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Three Cents Worth: A Luxury Spread You Can't Afford

[Who said market appraisers sit on the beach all summer? This week, Jonathan Miller plots the relationship between the Manhattan luxury market and the overall market versus adjustable mortgage rates. The full rundown below. Click on the image to expand.]

One of the more active segments of the Manhattan real estate market in the first half of 2006 has been the luxury market which I define as the upper 10% of all co-op and condo sales. We are not seeing appreciation in the sector, only steady transaction activity, unlikely many other segments of the market, which has seen a drop in transactions.

A large portion of the luxury activity was likely stimulated by Wall Street bonus income, which was at record levels this year and the real estate portion will likely be spent by the mid-point of this year. There are many who say that the demographics of these buyers are less affected by changes in mortgage rates than other segments. This got me thinking about rates and the behavior of the luxury market.

This week's chart may be simply an exercise in futility (it was fun anyway) but I found it curious that the price per square foot spread between the luxury market and the overall market changed as adjustable mortgage rates changed. I started breaking out the luxury market for the current incarnation of the Manhattan Market Overview in 2000 so I don't have deeper historical data readily compiled for the luxury segment. The relationship between the rates and the spread may simply be a correlation and not causation. There are three phases outlined in the chart defined by the vertical blue dotted lines.

My apologies in advance - there's a lot going on in this chart so grab a cup of coffee first.

The fun continues after the jump with Phases 1, 2 & 3 and the grand finale.

Phase 1. in late 2000, as the economy was drifting towards recession (arrived in 3Q 01), the price spread contracted as adjustable rates fell which occurred as the Fed tried to stimulate the economy. The luxury sector saw about a 10% price drop during this period.

Phase 2. By mid-2003 adjustable mortgage rates were generally stable and the spread began to climb again, in other words, the luxury market distanced itself from the overall market in terms of price.

Phase 3. Since 3Q 2005, adjustable rates have risen sharply and the spread between the luxury market and the overall market has been volatile with a sharp drop in the most recent quarter. Despite recent comments by the Fed and later, David Lereah, NAR's chief economist, which seemed to infer that 2Q 06 was the end point. I believe the demarcation line was actually the beginning of 3Q 2005.

The consensus now is that rates will level off in the next 2 quarters after one more rate increase by the Fed this month. In the gloom and doom scenario, if the economy slips into a recession or nears one in late 2006 or early 2007, we may see the spread contract if rates are eased to stimulate the economy. Luxury prices either trend downward as the overall market remains stable or luxury prices remain flat as the overall market improves.

If the economy does not weaken significantly later this year and rates level off, I suspect that the luxury sector is still vulnerable because it seems to have more than its share of listing inventory, but thats for a future chart.
· Luxury Spread Versus Adjustable Rate Trend [Miller Samuel]