Real Estate 'Envelopes' May Tear in 2003

CHICAGO-Commercial real estate may be on the verge of entering a year of lower expectations as investors have started to “push the envelope” on asset prices and expected rates of return. That’s the latest view from Real Estate Research Corp.’s most recent survey of investors.

“For the most part, the high returns of yesteryear are no longer available, regardless of the type of investment,” says Real Estate Research Corp. chief executive officer Ken Riggs. “Investing in real estate is not without risk and the returns may be less than in years past, but at least investors can understand how real estate fundamentals relate to their investment.”

By two measures, real estate returns may be peaking, Riggs suggests.

“As of this writing, 10-year government bonds are near 3.8% while expected real estate yields cling towards 11.5%, resulting in a yield spread of 7.7 (percentage points)—the widest gap ever witnessed over the 20 years that RERC has tracked this relationship,” he explains.

Additionally, expected returns dropped for all property types in the third quarter, led by hotels, where investors’ expected capitalization rate of 13.6% is down 50 basis points from the previous quarter; and retail power centers, where expectations are down 40 basis points to 11.6%.

Nonetheless, a fire hose of capital continues chasing after the relative trickle of deals. A change depends on Wall Street, and Riggs expects that to occur in 2003.

“Until the stock market re-establishes a positive upward trend, probably some time next year, RERC looks for real estate to attract a disproportionate share of investment capital,” he says.