The new chief economist of the National Association of Realtors says that low cap rates are making investment in commercial real estate a riskier proposition today and suggests the spillover of the housing credit crunch to commercial lending will leave many investors on the sidelines in the coming months.
Lawrence Yun, speaking to commercial brokers at NAR’s annual convention Tuesday in Las Vegas, says foreign investors are buying more commercial real estate than they did in 2006 because the weak dollar has made those investments attractive. But Yun says many nationally based investors may put off acquisitions in a market that has seen the rate of return decline between one and two percentage points in the last two quarters in the industrial, office and retail sectors and less than 1 percentage point in the multifamily market. Cap rates are hovering around 6.5% on average for each sector, he says.
“With the cap rates so low, people are questioning do you buy commercial property or buy a CD with a guaranteed 5% return, or an office property with a cap rate of 6.5%,” Yun says. “Because there is very little differential between CD returns and cap rates, there is a concern people may move away from investing in commercial properties.”
Yun warned that vacancy rates for retail properties may rise to levels seen earlier this decade and that rents may grow by as little as 1% in 2008. Only the multifamily sector will have rent growth in 2008, and Yun suggests that sector may not benefit as much from the downturn in single-family housing and rising foreclosures as expected. The reason: more people are doubling up and some children are even moving back with their parents for now, he says.
In a panel discussion that followed, two commercial brokers and John Tuccillo, a former NAR chief economist and now a consultant, expressed caution but suggested there are investment opportunities in this market.
Stan Mullin, a Southern California-based commercial broker, talked of a repricing in the industrial acquisition market that has been affected by the credit crunch. Half of the lenders are out of the market, and that has left buyers on the sidelines because more equity is required. That means those who have capital are in a great position over the next 18 months when opportunities come up, he says.
As for investment opportunities, Tuccillo says the hotel market has performed well and has seen tremendous growth. He also says he likes high-technology low-rise buildings in edge cities or the suburbs because that’s where the workforce is going. He said he’s not a fan of large malls, which he adds no longer fit a niche and how more people are shopping online.
Cynthia Shelton, director of investment sales with Colliers International in Orlando, says she wouldn’t tell anyone to buy a mall in an industry where only two were built last year. Their future is not as good because people prefer to shop, work, and be entertained, she adds.
Even though vacancies are rising, Shelton says there are opportunities in retail investments. “Even though it is down, that is the time you want to buy,” Shelton says. “You can get a better deal on it.” Mullin says he’s bearish on REITs that acquire industrial manufacturing property given the competition from China and its lower wages, but he says there continue to be opportunities in Silicon Valley.
Yun says investors should look for markets with a spurt in job growth in recent quarters because that will raise demand for residential and commercial properties. He says there are growing opportunities for commercial investments in San Francisco and Seattle because of solid job growth and a limited supply of land.