CRE Participants Increasingly Believe Risk Outweighs Return

Commercial real estate investors increasingly believe the risk involved outweighs CRE market returns, reported Situs RERC, Houston.

Situs RERC surveys pension funds, insurance companies, financial institutions and private equity firms each quarter about their perception of risk-adjusted returns vs. risk in commercial real estate investments. The responses range from one, meaning the risk far exceeds the return, to 10, meaning the return far exceeds the risk involved.

In the first quarter, respondents gave commercial real estate a 4.7 rating, meaning investment risk slightly outweighed potential returns. The figure deteriorated slightly from a 4.9 rating a year ago, meaning investors perceive that risk has increased relative to returns over the last year.

“This quarter’s rating stands out because it was the third survey in a row in which respondents expressed their belief that risk outweighed return in the CRE market,” the report said.

The industrial sector earned the highest rating among individual sectors with a 5.2 rating, meaning the return slightly exceeded the risk involved. Industrial remains investors’ favorite asset class due to increasing demand for warehouses and distribution centers spurred by growing e-commerce.

On the other side of the e-commerce coin, “the retail sector experienced the largest quarterly drop among the property sectors in the return vs. risk ratings, likely due to the disruption stemming from e-commerce and changing consumer preferences,” the report said.

Though commercial real estate’s overall return vs. risk rating has been on a declining trend since third-quarter 2016, the report said CRE remains among the best performers from a risk-adjusted return perspective compared to stocks, bonds, cash and other alternative investments.

Situs RERC also forecast total returns for the NCREIF Property Index for unleveraged, institutional-grade commercial real estate assets. Although NCREIF Property Index returns remain strong, annual returns have been decreasing since 2015. The firm’s most likely forecast scenario predicts the NPI annual total return will remain “somewhat steady” near 7.00 percent this year then decline to 4.00 percent in 2019.

The firm said its predictions regarding total returns have changed little from last year. “The economy is in one of the longest expansions in history, continuing to operate near full employment with low inflation and steady GDP growth,” the report said. “As the cycle moves through its ninth year and into a rising interest rate environment, commercial real estate returns are expected to slowly retreat from their peaks. With capital appreciation forecast to eventually turn negative and cash flow hitting a steady but slow level of growth, commercial real estate will rely on income to drive total returns moving forward.”