Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
Issue link: http://cire.epubxp.com/i/443516
28 January | February | 2015 Commercial Investment Real Estate investors more capital than they know what to do with. With investors searching for a place to park this capital (with good risk- adjusted and safe returns), the result has been asset prices pushed to all-time highs — which is making the market nervous. We see this in the stock market, with record-high performance, and we see it with commercial real estate, which, with its attractiveness as an asset class, including return performance, ability to hedge against inf ation, and tangible nature, has attracted a great deal of capital. Put stocks and real estate together and you get an idea of just how much in demand these two asset classes are. According to Bloom- berg, investors are rewarding retailers' ef orts to spin their properties into real estate investment trusts. Sears Holdings recently announced plans to create a REIT for its properties, and shares increased 31 percent. RERC also examines the amount of capital available for investment and compares it to the underwriting discipline. As shown in Figure 2, investor ratings for capital availability have greatly outpaced the discipline (or underwriting standards) for capital in 3Q14. It is worth noting that the last time the availability of capital outpaced discipline to this degree was in 2Q07 — shortly before the credit crisis that preceded the Great Recession. T e comparison of the availability and discipline of capital shows that we are again at an inf ection point. T e f ood of capital chas- ing commercial real estate continues to pressure property prices to increase, especially for high quality assets in top markets. Some investors have noted that, given high prices, there is already too little product to invest in, which further drives prices higher and returns lower. However, RERC expects values and prices to continue to increase as long as interest rates stay low. If RERC's history of availability of capital versus the underwriting discipline holds up, this bull com- mercial real estate market has another 18 to 24 months to run. T is is not to say the market is right, but it is the market. It All Depends on Interest Rates Although the Federal Reserve has concluded its recent quantitative easing program, monetary policy remains accommodative, with the federal funds rate remaining at 0 percent to 0.25 percent for "a considerable period of time." T e Fed's target unemployment rate has been reached, but its target inf ation rate is elusive, and growth remains slower than expected. T e market and most investors anticipate that the Fed will raise short-term interest rates in mid-2015, stating that it is too risky for the Fed to leave rates at current record lows much longer (in case the rates need to be lowered again when there is another recession). Oth- ers believe that the Fed will leave the funds rate very low for several years due to global pressure, as troubled economies in the rest of the world would be forced to pay higher interest rates. As shown in Figure 3, risk-free rates in other developed economies have followed the U.S. trend to keep rates low, and as shown in Figure 4, 10-year Treasury rates have been declining for several decades. Despite the Fed's clear message about their intent to increase U.S. Treasury rates at some point, some investors have become compla- cent, expecting Treasury rates — as well as interest rates — to stay low for much longer. Continuing low interest rates will be another signif cant benef t for commercial real estate investors. Value vs. Price As long as Treasury rates and interest rates remain low, the global investment environment for commercial real estate will be very Figure 1. Historical Investment and Economic Performance Ratings Figure 2. Historical Availability & Discipline (Underwriting Standards) of Capital Cash Bonds Stocks Commercial real estate Economic performance Recession Source: RERC Institutional Investment Survey, 3Q 2014 Source: RERC Institutional Investment Survey, 3Q 2014 Ratings are based on a scale of 1 to 10, with 10 being high.