Investor Sentiment: Increase in CRE Risk-Rated Returns

Commercial real estate has grown slightly more attractive than alternative investments on a risk-adjusted basis, reported RERC, Houston.

But RERC’s quarterly Real Estate Report found investors’ sentiments about returns vary significantly by property type.

RERC surveyed institutional investors, asking them to rate various investments including cash, stocks, bonds and real estate on a 10-point basis with 10 indicating returns far exceed the risk associated with that investment.

Investors rated CRE’s return vs. risk measure a 4.9 in the second quarter, up slightly from 4.8 in the first quarter. RERC noted CRE risk has outweighed its return every quarter since third-quarter 2017 except for a blip in third-quarter 2018. The return vs. risk rating was near or above average for more than seven years prior to second-quarter 2017. “The current quarter’s [CRE] return vs. risk rating is on the cusp of equilibrium but remains below the post-recession average [of 5.3],” the report said.

The return vs. risk rating for the office sector increased from 4.4 in the first quarter to 4.7 in the second. Office represented the only property type to see a quarterly increase in the rating, but the sector’s ratings have generally been at or below 5.0 over the past two years, indicating returns do support the amount of risk that investors are taking, RERC said.

Though the industrial sector’s rating declined slightly quarter-over-quarter, it secured the best return vs. risk rating by far among property types in the second quarter, RERC said. The sector’s rating decreased from 5.9 in early 2019 to 5.8 in the second quarter, up from 5.6 in second-quarter 2018. “The industrial sector rating has been at or above equilibrium in every post-recession quarter; the current quarter’s rating is slightly lower than the post-recession average,” the report said.

Risk continues to overshadow retail sector returns, RERC noted. The sector’s return vs. risk rating tumbled from 4.7 to 3.8, the lowest among property types. “Risk-adjusted returns in the retail sector are now the lowest they have been since the Global Financial Crisis,” the report said. “Risk has outweighed return in the sector for two years.”

In the apartment sector, the return vs. risk rating declined from 5.4 in the first quarter to 5.1 in the second. “The rating has stabilized over the past two years, but returns have generally been declining relative to risks since 2011,” RERC said. “Returns have outweighed risks for seven consecutive quarters.”

The hotel sector’s return vs. risk rating decreased from 4.9 in the first quarter to 4.8 in the second, indicating greater risk relative to return quarter-over-quarter. Hotel ratings have remained at or below equilibrium for the past two years, RERC said. In a separate report, CRE Investors Need to Sift Through the Chaos, RERC said commercial real estate can provide better opportunities for investors during an economic downturn than stocks and bonds.

“Historically, commercial real estate has also been more resistant to external shocks and less volatile than other investment alternatives,” the report said. “As a physical asset, commercial real estate provides relatively stable, predictable and recurring income as rents are contracted under lease terms. This coupled with increasing albeit measured growth in commercial real estate fundamentals over the next year continues to make commercial real estate the best positioned investment alternative as we head into the next recession.”