CRE Headed for a Pause?

Commercial real estate has (in many places) had a good run in recent years, so is it reasonable to assume that some kind of slowdown is ahead?

Commercial real estate has (in many places) had a good run in recent years, so is it reasonable to assume that some kind of slowdown is ahead? Or at least a pause in its upward trajectory? Some indicators seem point that way. Just before the Labor Day holiday, Green Street Advisors reported that its Commercial Property Price Index increased by 1 percent in August. As long as it isn’t part of a bubble expansion, any increase is good news, but in this case it shows that the pace of CRE appreciation has slowed down compared to earlier this year. Also, during June and July, growth had been more-or-less nil.

Green Street senior analyst Peter Rothemund posited that cap rates have leveled off during the last few months, and he doesn’t expect them to move any lower, considering the state of the capital markets. “Real estate is looking increasingly expensive versus corporate bond yields, which have been on the move higher,” he noted. Also, pricing in the market for publicly traded REITs seems to show that investors “share the view that property values are stretched.” So it’s possible that the drop in the rate of CRE appreciation is reasonably good news—no one wants a bubble, after all.

Separately, the National Federation of Independent Businesses reported on Tuesday that its Small Business Optimism Index gained 0.5 points in August to end the month at 95.9,  as five of the index’s components posted gains, three dropped and two didn’t change. That too was not much of a gain. At the least various big-picture upsets in August — such as the prospect of a China in recession or the yo-yoing of the stock market — didn’t seem to have much of an impact on small business optimism.

Such optimism has an indirect impact on CRE. Small businesses employ a lot of people, and as optimism rises, they tend to hire. Some 13 percent more small businesses planned to hire in August as did in July, a positive-moving component of the index. Small businesses use commercial space across the spectrum, and sustained hiring eventually translates to an increase in demand for office, industrial and retail space as businesses of various types, along with retailers, expand. But overall, the increases in small business optimism have been only OK lately, thus being another indicator that might also point to a cooling down of CRE.