The price of commercial real estate is beginning to gain ground on the value of this asset class, according to new information released in the summer 2014 issue of the RERC Real Estate Report.
The quarterly report issued yesterday (Tuesday) by Real Estate Research Corporation (RERC), predicts that, given the increased demand for commercial real estate as a safe haven in the current volatile investment environment ,and the competition for high quality assets, the will overtake property values in some situations.
Ken Riggs, president and CEO of RERC, said, “The relationship between the value versus price of commercial real estate is precariously balanced. Our analysis showed upward pressure on pricing without a corresponding increase in value, and when this happens, investors may be forced to accept lower returns for assets with added risk.”
Although the majority of valuation experts who responded to RERC’s investment survey maintained that on average, the price of real estate was rational compared to the value, respondents also noted that some property types — particularly apartment and retail properties — were fully priced or even overpriced in some areas.
One respondent noted the “continued performance divergence between the coastal and interior markets,” but values are expected to continue to increase, and, over the next year, should be stable, or two percent to three percent higher on average.
In addition, respondents noted that capitalization and discount rate spreads remained reasonable, given 10-year Treasury rates at 2.6 percent, although they are approaching a nervous level.
RERC’s required going-in capitalization rates continued to compress in second quarter 2014, decreasing 10 basis points on average, for unleveraged properties.
RERC’s value versus price ratings also declined for most property types during second quarter 2014. Specific findings include:
The apartment sector value versus price rating declined to 4.6 on a scale of 1 to 10, with 5.0 meaning that value versus price is equal;
Office and retail sector value versus price ratings declined to 4.9 on the same scale;
RERC’s value versus price rating for the hotel sector increased from 5.5 in the previous quarter to 5.7 in the second quarter;
The rating for the industrial sector declined from 5.8 in the previous quarter to 5.7 in the second quarter.
“In short, we are seeing pricing in most property sectors increase enough such that investors worry that a market correction is looming or that a bubble may be developing. The exception to this appears to be the industrial sector and the hotel sector, whose ratings indicated that the value of these sectors is greater than the price,” added Riggs.
Patrick D’Sa, director at Situs, a leader in CMBS underwriting due diligence, agreed.
“When looking at the fundamentals, the hotel sector value is very positive. Potential returns appear strong, as shown by RERC’s required capitalization rates for second quarter, which closely mirror requirements before the credit crisis in 2007,” he said.
According to RIggs, evidence is mounting that long-term interest rates may stay low for quite a bit longer than anyone thought, and could go even lower.
He said, “The 10-year bond in Germany was at a record low of 1.08 percent this week — conceivably U.S. Treasury notes could drop more from their current level of 2.38 percent. If 10-year interest rates keep going down in the U.S., we can expect continued downward pressure on cap and discount rates, and thus property prices to keep going up.
“Even if prices continue to increase from current levels (which are viewed high), in the face of lower rates, pricing for properties would still be considered fairly rational.”