INSIGHTS

On April 04, 2012

An Attractive Entry Point for the Commercial Real Estate Asset Class

By Casey Frazier, CFA, Chief Investment Officer - Versus Capital Advisors, LLC

Given the great start for the equity markets in 2012 with the Dow Jones Industrial Average and Standard & Poor's 500 Index delivering their best first quarters since 1998, I have been asked “What are your expectations for the real estate sector over the next 12-18 months?” 

I expect commercial real estate fundamentals to remain solid and to continue to improve over this time period as economic fundamentals continue to improve.  Unlike the equity markets, where improving economic conditions (lower unemployment, increased consumer spending and higher consumer confidence reported during the quarter) and record profits (U.S. corporate operating earnings were up 15 percent in 2011) have had a swift and positive impact on the market, commercial real estate fundamentals should be slower to react.

An improving economic climate has led to occupancy growth in the commercial real estate sector, but has yet to lead to rental growth in most property types and most markets, in my opinion. I expect the demand for commercial real estate to grow over the next five years, and as demand growth increases, revenues in this sector should also increase.  New supply in commercial real estate has been at historic lows for the last three years.  I anticipate the new supply of real estate will stay muted over the next five years because of the dearth of financing available for commercial real estate development projects as well as occupancy and rental rates that do not justify new development projects in most property types and markets.  With demand for commercial real estate improving and limited new supply for the foreseeable future, I believe that the current environment represents an attractive entry point for investors with a medium to long-term view (also outlined in AAM’s blog post, The Strategic Times: Year in Review & Looking Ahead). In addition, I believe that the real estate sector is attractively valued relative to most other asset classes for long-term investors. The current low-interest rate environment can make commercial real estate, with its significant income component, appealing. In addition, while many other asset classes have rebounded to peak or near peak levels, direct real estate is still below peak prices. If you combine these attributes with the tangible nature of the asset class, which historically has been attractive in times of capital market and economic uncertainty, I think you end up with a solid case for investing in commercial real estate for the appropriate investor.  

My view on the sector is echoed by a recent Urban Land Institute (ULI) survey of 38 leading real estate economists and analysts from across the United States that projects broad improvements for the nation’s economy, real estate capital markets, real estate fundamentals and the housing industry through 2014.

The following excerpts were taken from the press release on the survey, to read the entire press release please click here: (March Real Estate Consensus Survey)

“The survey results show reason for optimism throughout much of the real estate industry. Over the next three years:

• Commercial property transaction volume is expected to increase by nearly 50 percent
• Issuance of commercial mortgage-backed securities (CMBS) is expected to more than double
• Institutional real estate assets and real estate investment trusts (REITs) are expected to provide returns ranging from 8.5% to 11% annually
• Vacancy rates are expected to drop in a range of between 1.2 and 3.7 percentage points for office, retail, and industrial properties and remain stable at low levels for apartments; while hotel occupancy rates will likely rise
• Rents are expected to increase for all property types, with 2012 increases ranging from 0.8 percent for retail up to 5.0 percent for apartments;
• Housing starts will nearly double by 2014, and home prices will begin to rise in 2013, with prices increasing by 3.5% in 2014

These strong projections are based on a promising outlook for the overall economy.”

“While the ULI Real Estate Consensus Forecast suggests that economic growth will be steady rather than sporadic, it must be viewed within the context of numerous risk factors such as the continuing impact of Europe’s debt crisis; the impact of the upcoming presidential election in the U.S. and major elections overseas; and the complexities of tighter financial regulations in the U.S. and abroad, said ULI Chief Executive Officer Patrick L. Phillips. “While geopolitical and global economic events could change the forecast going forward, what we see in this survey is confidence that the U.S. real estate economy has weathered the brunt of the recent financial storm and is poised for significant improvement over the next three years. These results hold much promise for the real estate industry.”


More information on the survey can be found at:  http://www.uli.org.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com

The information contained herein is written by Versus Capital Advisors, LLC and is believed to be reliable. The information is not warranted as to completeness and accuracy and is subject to change without notice. The foregoing has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security.