The squeeze on cap rate spreads remains of some concern for real estate investments should rates rise more rapidly than expected, especially with the “frothiness” we have seen in certain gateway class-A markets.
Real estate has been a star performer over the last five years, delivering high returns on the back of strong and improving fundamentals and a gradually recovering economy. Real estate fundamentals continue to improve. Balance sheets of most firms have been steadily strengthening, with increasing margins, profitability and top line growth. Most households have recovered their lost wealth and are attaining new highs. Unemployment dropped to a new low. Commercial real estate supply still remains quite low by historical standards with only a few pockets of oversupply in the multifamily sector. So let’s look at some of the factors comprising my optimistic viewpoint.
With this bull market in commercial real estate now five years old (six for public real estate securities), isn’t it time to be cautious? The bull market’s duration does not, by itself, indicate how long it may last.
Country risk is the risk that cross-border cash flows will not be realized because of disequilibrium between the domestic platform and that of another country. Given this potential concern, one may require higher returns from an investment as an offsetting factor.
In the main global gateway markets—New York, London, Tokyo, San Francisco, etc.—metrics save average spreads indicate that the assets in these markets may be overpriced and headed into bubble territory.
With most institutions, not to mention high net worth investors, still under-allocating their capital to real estate, combined with the strong performance of both NCREIF and NAREIT, we can expect more investment capital to come into commercial real estate.
Major shifts have taken place in the commercial real estate industry, which is transforming from a highly localized, deal-driven business to an international market characterized by lower transactions costs, abundant information, lower risk premiums and increasing sophistication.