WASHINGTON, DC—Given some of the pricing for prime commercial real estate assets, especially those on the coastal markets, it is understandable that the industry might start wondering if the markets are getting too aggressive. Certainly capital is showing no signs of shyness, relative to underwriting, as it competes for the most profitable assets. In short, people are starting to get nervous, Kenneth P. Riggs, Jr., president and CEO of Real Estate Research Corp. tells GlobeSt.com.
The RERC is releasing its RERC Real Estate Report that it publishes four times a year on Monday and this uncertainty and nervousness is a theme running throughout the 76-page report.
According to RERC’s institutional investment survey respondents, there is still too much money chasing too few good investment opportunities. Compared to the previous quarter, in the first quarter of 2014 investors increased their rating for the availability of capital to 8.2 on a scale of 1 to 10, with 10 being high, while they lowered their rating for the discipline of capital—or underwriting criteria–to 6.2 in first quarter 2014.
This was the highest rating for the availability of capital since second quarter 2007 according to RERC’s records, and the lowest rating for the discipline of capital since second quarter 2011.
But let’s cut to the chase: ultimately investors have decided that commercial real estate remains the smartest tradeoff of risk and reward, compared to other capital sources. However, they will be watching underwriting that much more carefully.
“The Federal Reserve Bank is pushing everyone to take more risk and that includes commercial real estate,” Riggs says.
RERC has also come to that conclusion. Its view is that, despite the extreme activity on the coastal markets, “commercial real estate is reasonably priced and valuations are very rational.” Five-year annual compounded rates of return have been around 7% to 8 percent, which were more than reasonable, RERC says. “We expect total returns to perform slightly higher [in the coming year] making commercial real estate very attractive in the future,” it says.
Indeed, RERC’s institutional investment survey respondents seem to be taking the Federal Reserve’s forward guidance to heart, with the majority of first quarter 2014 respondents expect 10-Treasury yield rates to be only slightly higher over the next year and a half than the current 2.6% to 2.7%. For that reason alone, commercial real estate will be preferable over other investment alternatives.