PIMCO: A CRE Storm is Brewing

Factors including capital flow volatility, tightened regulations and maturing loans could lower commercial real estate prices by 5 percent over the next year, reported PIMCO, Newport Beach, Calif.

But the investment management firm noted that the “swirling winds” could create attractive opportunities for nimble investors.  

In a special report, A Storm Is Brewing, PIMCO Managing Director John Murray and Portfolio Manager and Vice President of Portfolio Management Anthony Clarke said U.S. CRE has enjoyed growth with solid fundamentals as rents have steadily increased and demand has generally exceeded supply. But they noted that the primary price driver for commercial assets has been capital flows rather than improving fundamentals.

“Since the fourth quarter of 2009, overall office prices have doubled as have general CRE prices, yet national office rents have risen only about 15 percent. But capital flows have grown unstable over the past year due to fears over interest rate hikes and, more recently, events such as political and economic uncertainty in China,” the report said.

Increased regulation could also lead to more clouds ahead, the report said, noting that CRE liquidity has declined in recent years due to post-financial crisis regulations such as Dodd-Frank and the Federal Reserve’s Comprehensive Capital Analysis and Review. “This has intensified volatility for the sector during periods of broader public market sell-offs,” Murray and Clarke said. In February, for example, oil-induced fears led to debt-market redemptions that forced several hedge funds to unload some commercial mortgage-backed securities.

The confluence of these forces comes as the U.S. CRE market is set to experience a surge in forced liquidations, Murray and Clarke said. More than $200 billion of 10-year CMBS loans will mature over the next three years and more than $50 billion of 10-year CRE debt and equity funds will wind down. “In many cases, these legacy funds have held on to sub-performing assets to retain fees; however, at the 10-12 year point, investors typically have the right to force liquidation,” they said.

The combined pressure from these events suggests that CRE prices could slump over the next 12 months, with a disproportionate impact on secondary and tertiary markets, Murray and Clarke said. “However, this dynamic could create opportunities across U.S. CRE debt and equity markets, both public and private…for flexible capital, this storm might be a welcome one indeed.”