Pimco sees a storm brewing in the $15 trillion U.S. commercial real-estate market that it thinks will cause values to fall up to 5 percent in the next year. Other investors have more dire estimates for a coming sell-off.
Their collective pessimism is underpinned by the fact that property loans are coming due, new regulations will most likely prompt building sales and less money will be coming from overseas investors because of slowing growth in China, the Middle East and Europe. And then there’s the basic fact that office-building prices have risen so much that they just seem due for a fall.
Even the Federal Reserve is worried, especially because office building prices have doubled since 2009 even as rents increased by only 15 percent.
It’s enough to prompt some to invoke the dreaded word “bubble.”
There are certainly signs this market is slowing and may have peaked for the near term. Deals in New York are drying up. U.S. malls are facing tighter lending terms as investors question their future. A rash of building in the nation’s hottest markets have left a glut, particularly among the more-expensive properties.
But a widespread crash is improbable. While commercial property values have certainly climbed, this cycle looks a bit different from the one leading up to the 2008 credit crisis. Less leverage is being deployed. Property prices are high, but so are values for everything else. There’s still a lot of money sitting around looking for something to do, and a building at the right price could be just the income-producing ticket many investors are looking for. Furthermore, many owners of new buildings aren’t in a hurry to sell.
So more than likely there will be a cooling-off period for commercial property values, which would be a best-case scenario for a lot of buyers and possibly the market as a whole. It would pause a rally that’s produced annualized returns of 12.6 percent since the end of 2010, according to data compiled by the National Council of Real Estate Investment Fiduciaries. And it would allow cash-flush investors to justify buying office properties that still look appealing to them, albeit incredibly expensive at the moment.
“Buyers are expecting a dip in prices,” said Jim Costello, senior vice president at Real Capital Analytics. “Those currently invested are not expecting a dip. So the impasse creates a hung market, falling volume.”
But investors who are salivating over the idea of snapping up deeply discounted buildings will most likely be disappointed. Commercial real estate is increasingly becoming a substitute for bonds for many investors, particularly those coming from overseas, because they typically provide a steady source of income from building occupants. And as bond markets in Japan and Germany have demonstrated, fixed-income prices can keep going up past the point of rationality.
Foreign buyers, who own a growing proportion of commercial real estate in the U.S., are still flooding in, and these investors are more likely to hold onto their assets for longer as a way to diversify and gain a steady stream of income.
Meanwhile, many U.S. investment firms still have money sitting around looking for some sort of return, cash that would most likely buffer any prolonged downturn or even prevent it all together as buildings became slightly more attractive.
The condition of the commercial real estate market is starting to resemble that of the stock and bond markets: jumpy, with relatively thin trading and a complete lack of conviction. A sell-off would be welcome for hungry investors who can’t find their place in historical investment maps.
But there are too many forces deflecting a steep downturn, leaving it in much the same place as many other markets: Lofty and buoyed by too much cash looking for a place to land.
Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.