Time for Turnaround?

Has CRE reached an inflection point?

Paul-Fiorilla-2In 2007, the catastrophic downturn that hit the commercial real estate market came almost like a bolt from out of the blue after several years of euphoric activity. Few saw the bear market coming, and those who expressed concern in advance certainly didn’t predict the depth of the downturn.

The real estate market has since seen several years of steady—some might say heady—growth, highlighted by an influx of capital and record property prices. Market players, though, seem eager not to get caught unaware by the next recession, and the discussion in industry forums has turned to whether the bubble is about to burst. One warning sign is that the Moody’s/Real Capital Analytics Commercial Property Price Index (CPPI) dropped in February, its first negative month since the recovery began in January 2010. Other market analysts are saying that real estate is in the “ninth inning” of the cycle.

Click on image to enlarge.

Click on image to enlarge.

Is it time to head for the exits? Concerns are not unwarranted, as there are many similarities between today’s market and that in 2007. Among them:

  • The economy has expanded in the seven years since the last recession ended in the second quarter of 2009, one of the longer periods of growth in the post-war period. Signs that investors are nervous about the future include capital markets volatility and widening bond spreads, which also happened in the lead-up to the global financial crisis.
  • Property fundamentals and rents have improved for several years, particularly in the multifamily sector, which has seen an increase in rents of 20.3 percent between 2011 and first quarter 2016, according to Yardi Matrix. Construction activity is back to historical averages in the multifamily and industrial sectors, and is growing in other sectors.
  • Property yields, or capitalization rates, have reached record lows and asset values are at record highs, just as they were in 2007. Transaction volume is once again peaking at $492.4 billion in 2015, the most since $573.4 billion in 2007, according to Real Capital Analytics Inc. Sales volumes rose 236 percent between 2010 and 2015, which is not quite as much as the 440 percent growth between 2002 and 2007 but aggressive nonetheless.
  • Debt is flowing easily, and the total amount of commercial mortgages outstanding is at a record $2.8 trillion, well above the $2.5 trillion at the 2007 peak, according to the Mortgage Bankers Association. Plus, loan spreads are rising and lenders have to deal with a spate of frustrating new regulations that adds to the cost of debt.

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