Two stories with apparently conflicting narratives made headlines in the commercial real estate world last week. Prices in national CRE markets fell again last month, marking the ninth consecutive month of decreases. At the same time, outgoing Federal Reserve Chair Janet Yellen told CBS’s “Sunday Morning” that commercial real estate prices were very high, though not in an outright bubble.
That’s an interesting contradiction. If prices have been falling for the last three quarters, how are they still overvalued?
Ten-X Senior Quantitative Strategist Muoio told Bisnow that we’re at the top of the market rally that we’ve seen since the great recession and that the current decreases are mild enough to be interpreted as a plateau, rather than an outright drop. That tracks well with the drop experienced last month of 0.3 percent.
“We edged off historic highs,” said Muoio. “The declines over the last three quarters have been mild and more of a stagnation than a decline.”
Why the market has plateaued now, and what will happen next, are anybody’s guess, but several factors make this an interesting spectator sport. Had Lev Tolstoy been a real estate economist in the 21st century, he might have said that happy markets are all alike, but every unhappy market is unhappy in its own way.
Factors peculiar to this turning point include a glut of dry powder. Bisnow cited Prequin findings that global real estate funds had $249B in cash reserves set aside for investments as of December. Recent slowdowns in attractive opportunities to invest in - especially in North America - have led to the buildup.
Another factor is the Fed rate, which has been cautiously increased over the last few years but remains low. Recent remarks by Dallas Fed President Robert Kaplan suggest that this slow and steady course will continue. Most economists agree that this is the right strategy; some are even blaming the recent stock market hiccup on investors’ fears of a larger hike in response to rising wages. Only a few voices are talking about the threat of a real crash, but if one were to hit the CRE sector, the Federal Reserve would have precious little slack to play with.
What Janet Yellen seems to be suggesting - couched in language that is as careful as possible to avoid spooking the market - is that commercial real estate is at least somewhat overvalued. If that’s the case, the market could be due for a reasonable downward correction.
If that’s the case, all that dry powder might come in handy as a buffer for falling prices. Yellen also noted that the banking and financial systems in the U.S. are better capitalized and more resilient thanks to Obama-era reforms put in place after the recession. Part of her job is to reassure markets and maintain stability, but she makes a compelling argument that the U.S. economy is safe from another 2008-style shock.
In contrast to Yellen’s warning, some real estate experts think that we might be experiencing a temporary reprieve and that the sector will continue expanding. Ken McCarthy, the principal economist for Cushman & Wakefield, told Bisnow that he expects a mixed market across different CRE verticals, but that this may end up being the longest expansion in recorded history.
“We do not see any signs that the economy is nearing a turning point,” said McCarthy. “Pricing is holding firm for the most part and as long as the economy continues to grow the market should remain firm.”
Looking across a range of opinions, there seem to be two major camps: those who see strong fundamentals in the data now, and those who think that we’re due for a bust. Both points of view muster a strong argument, and it’s always worth pointing out that economists aren’t the augers that they’re often made out to be. We’ll just have to wait and see.