Across the globe, investors are on a scavenger hunt for yield. As Central Banks continue to distort the money supply, yields in the traditionally safe segment of the market are effectively zero, after accounting for inflation.
This has in no doubt helped fuel the rise in the U.S. equity and corporate bond markets. And commercial real estate is getting a big shot in the arm from the hunt for yield and the distortion of low interest rates. But is appetite to find yield, along with arbitrarily low interest rates simply placing a band aid on the commercial real estate market and creating the illusion that things are returning to heath. Is all the optimism warranted?
As investors can’t find a decent yield in Treasuries, they are seemingly all too happy to accept yields in the commercial real estate space that are comparable to pre-bust days. Yield requirements is expressed in the form of cap rates. And in many segments of the commercial real estate market, cap rates are being driven down to possibly insane levels. This is probably no more evident than in the apartment market, as more and more money vies for deals. The apartment market illusion is further enhanced by Agency debt at very low interest rates. But what happens when the music begins to slow or stops all together?
The question that must be asked by investors and lenders is: beside low interest rates and the desire to find even a nominal yield – what market fundamentals for commercial real estate has significantly changed to cause all the optimism? Are companies hiring all that many new people, therefore requiring more space? Are the big-box retailers all of a sudden immune from the shift of on-line buying from consumers? What’s really driving the growth? Clearly apartments are benefiting from those exiting the home ownership market due to foreclosure, but is this demand enough to drive values to these lofty levels for the long term without the benefit of low rates.
It’s inevitable that rates are going to move up – pushing cap rates up and values down.
Are your accounting for this risk?
Brock Andrus is a managing director with 1st Service Solutions.