Tuesday, April 19, 2016

The State of Commercial Real Estate

The NCREIF ODCE Index NOI growth is currently at its lowest point in the past decade (as shown in the graph on the top-right). 

Also known as the NFI-ODCE, the index consists of 30 open-end commingled funds, pursuing a diversified core investment strategy and primarily investing in private equity real estate, with $173.1 billion of gross real estate assets and $133.3 billion of net real estate assets. 

An important criterion for a fund to be considered for the NFI-ODCE index is that at least 80% of market value of real estate net assets must be invested in office, industrial apartment and retail property types. The decrease in net operating income growth is important to note, given that U.S. commercial real estate prices have been rising steadily since 2009 and are only now beginning to plateau; decreasing in some sectors and locations. 

Though one cannot be sure whether this bull market is finally coming to an end, one must consider that it is a possibility. 

According to deal tracker Real Capital Analytics, Inc., $25.1 billion worth of commercial property was exchanged in February compared to $47.3 billion in February 2015; a decrease of approximately 88%.

Commercial real estate valuations have been on the rise since 2009, with retail and apartment properties above 2007 levels. Though not quite as high, industrial and office properties have also surpassed values reported in 2009. 

One of the reasons for the appreciation is the increase in demand for commercial real estate, resulting in some of the lowest vacancy rates in the last 25 years. The apartments sector has the highest vacancy rate, relative to vacancy rates in the respective time period, when compared to the office, retail and industrial real estate sectors. If this data concerns you, you are not alone. 

Last week, Kansas City Fed President Esther George expressed her concern for the commercial real estate market by saying it is a potential asset bubble that “bears watching”. George encouraged the U.S. central bank to stay on the course and gradually raise interest rates. This has been a growing concern for many, with the U.S. central bank acting increasingly dovish in recent times.

Something else to consider is the beginning of the end of SIFI designations. The SIFI designation for non-bank companies and a similar designation for eight of the big banks were established to create safeguards to prevent or minimize the effects of another financial crisis by requiring financial institutions recognized as being too big to fail maintain high levels of capital reserves and liquidity, and be subject to extensive government oversight. However, both MetLife and GE have recently filed to have the SIFI designation removed. If successful, this may mean an increase in capital available. Though the effects may not be immediate, commercial real estate lending might increase for those firms with exposure to the industry.  

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