‘Uncharted Territory’ for CRE
Real estate is widely known for its market cycles, but this is “a unique time” in the current cycle, which could be foundationally different from past cycles, a report said.
“We are entering uncharted territory,” Situs RERC, Deloitte and the National Association of Realtors said in Expectations & Market Realities in Real Estate 2019–Uncharted Territory. “If the current economic expansion continues through June 2019, it would mark the longest expansion in U.S. economic history since records started being collected in the 1850s.”
Economic expansions have averaged 58.4 months since World War II, but the current expansion phase is approaching 120 months, the report noted. “We have been crawling the ‘wall of worry’ for at least the past two years that a correction in both real estate and the overall economy is looming,” it said. “A future recession is inevitable, but there is no way of knowing when it will occur or how severe it will be.”
But with stock market volatility increasing since last year, commercial real estate represents an attractive investment alternative, the report said. “The attractiveness of a particular asset class is relative to the desirability of alternative asset classes, which can vary depending on the risk appetite of the market,” it said. “Comparing historical private commercial real estate returns to other investment alternatives, we find that private commercial real estate holds its own against stocks over the long term without having the added risk of volatility.”
Private commercial real estate total returns declined slightly in third-quarter 2018. But many institutional investors still prefer the “enduring stability” of commercial real estate’s income component compared to the wildly fluctuating returns seen in other asset classes, the report said. Comparing historical real estate yields to capital market returns shows that commercial real estate returns remain at “competitive and acceptable” levels, it said.
The 10-year Treasury rate declined more than 50 basis points in November and December and Treasury rates remain extremely low from a historical perspective. “[Treasury rates] appear to not be satiating investor appetite for yield,” the report said, noting commercial real estate expected yield spreads averaged 500 basis points year to date as of the third quarter. “While below the 10-year and 15-year average spreads…the cushion has still been enough to attract investors to the CRE asset class,” it said.
