Amid Record Deal Flow, Investors Lower Sights

NEW YORK CITY—The first quarter of 2015 saw dollar volume of significant commercial property sales climb 45% from the year prior, according to Real Capital Analytics. However, the same quarter also saw respondents to Situs RERC's institutional investment survey lower their investment rating for commercial real estate as an asset class.

Among the investment alternatives, the rating for commercial real estate declined to 6.7 on a scale of 1 to 10, with 10 being excellent, during Q1. It's CRE's lowest investment rating since Q3 2013, but even so, it is the highest rating among the investment alternatives during Q1 of this year, as respondents noted that strong fundamentals continue to generate investment demand and higher prices. In comparison, the rating for stocks increased to 5.5, the rating for cash declined to 3.8 and the rating for bonds was unchanged at 3.6.

“Although commercial real estate is still attractive as an asset class,” according to Situs RERC's spring report, “it is losing a little luster. Situs RERC's institutional investment survey respondents lowered their recommendations to buy, sell and hold commercial real estate” in Q1.

Given continued demand, coupled with the fact that CRE sales continue to generate record high prices in many areas, the “sell” recommendation received a rating of 7.3 on a scale of 1 to 10, with 10 being excellent, only slightly lower than the previous quarter and still the highest-rated recommendation. However, Situs RERC says the “buy” recommendation rating fell to 5.2—the lowest since Q2 2008.

“As a result, the spread between the recommendations for buying and selling commercial real estate was comparable to the spread in early 2007,” the report states. Meanwhile, the rating for the “hold” recommendation was its lowest in over four years at 6.5.

Q1 also saw a decline in the investment conditions ratings for nine of the 11 property sectors Situs RERC covers on a regular basis. The only property type in which the investment conditions rating increased was the hotel sector, where the rating increased to 6.6 from 6.5 in Q4 2014. In addition, the student housing sector was stable with a rating of 6.7.

These lowered expectations go hand in hand with elevated concerns about macroeconomic conditions—not only global, but domestic as well. Among them, according to Situs RERC: the Federal Reserve hiking short-term interest rates more quickly than it plans, a geopolitical catastrophe, an unexpected need to add significantly to the national debt and the economy slipping into deflation.

Even so, institutional investors continue to see the return on CRE as generally higher than the amount of risk involved. Situs RERC's return versus risk rating for commercial property overall was stable at 5.5 on a scale of 1 to 10, with 10 indicating “excellent” return compared to the amount of risk. However, the report states. “Although institutional investment survey respondents maintained that commercial real estate returns outweighed the risk for investors, the 5.5 rating for the most recent quarter is the lowest in three years.”

That being said, Situs RERC notes that as value and price continue to push against each other, “it is good to see” that in Q1, survey respondents' overall value-vs.-price rating for CRE increased to 5.2 on a scale of 1 to 10, with 10 indicating that the value of commercial real estate greatly outweighs the price. “Our institutional investment survey respondents generally felt that commercial real estate prices still had a ways to go to catch up with values, though the first quarter 2015 overall value-versus-price rating was a little low compared to the ratings in the past two years,” according to the report.