Is Cash Looking Better Than Commercial Property?

NEW YORK CITY—A new chart from Situs RERC illustrates trends in investor preferences over the past eight years. Of note is what the chart says about views of investment alternatives as the second quarter of this year ended: bonds rose slightly in the rankings, cash rose sharply and commercial real estate continued a sharp downward curve.

That dovetails, says Situs RERC, with the Federal Reserve's assessment of commercial property pricing in its semiannual report to Congress earlier this week. The company issued preliminary results from its Q2 investors survey on Thursday.

“Valuation pressures in commercial real estate are rising as commercial property prices continue to increase rapidly, and underwriting standards at banks and in commercial mortgage-backed securities have been loosening,” according to the Fed's report. “For residential real estate, prices have risen most rapidly in areas where they fell most in the wake of the financial crisis, and aggregate valuation measures remain close to historical norms. In addition, dealers' responses to the March and June Senior Credit Officer Opinion Survey on Dealer Financing Terms suggest that client demand for secured funding of commercial and residential mortgage-backed securities has been increasing in recent quarters.” 

The Fed's concerns are also reflected in the Situs RERC survey data on investors' assessment of current investment conditions by property sector. Compared to a year ago, apartments have lost a little of their luster, with survey respondents' average rating of investment conditions for multifamily slipping from 6.3 to 5.9 on a scale of 1 to 10. In Q2 2013, the average for apartments was 6.9. The highest rating for investment conditions at the moment is for warehouse industrial product, at 7.6.

According to Kenneth Riggs, president of Situs RERC, this is likely the first key sign among survey respondents about the future performance of CRE from a price vs. value perspective. Investors perceive that prices have peaked relative to the underlying valuations, he says, and CRE will be challenged to maintain these price levels going forward, given the future market for cap rates and prices. “Even though these institutional players/portfolio managers are obligated to invest in CRE, they are voicing their opinions that CRE is generally priced for perfection,” says Riggs.

Survey responses suggest that institutional players see cash as a more attractive as investment alternative now because CRE is fully priced—that is to say, priced for perfection. The bond market is riskier because of anticipated increases in interest rates, and the stock market is particularly volatile at present. According to Situs RERC's historical data, the last time that survey respondents rated cash as higher than the other alternatives was at the beginning of the credit crisis that began in the fall of 2008.

Even if CRE prices have peaked, conventional wisdom suggests that there should be about six to 12 months yet of good returns for the sector, according to Situs RERC. Historically, the lag time for CRE to be affected by a correction in the economy has been about 12 months.

It's also important to note that even with price pressures, global pressures—such as the situations with Greece, China and Iran—nonetheless may cause a ripple effect for increased investment in CRE. Furthermore, says Situs RERC, the Fed may be pressured to be even more accommodative and keep rates down for a longer period of time, which could help push CRE prices and values to higher—albeit possibly unsustainable—levels.