Should you follow the big dogs out the door on commercial real estate?

by 09 Mar 2017
by Glen Weinberg

In 2016 commercial real estate deal volume fell by 11% for the first time since 2009!  According to a recent Wall Street Journal report, some prominent real estate investors are reducing their holdings and taking money off the table.  Who is pulling back?  What are the 4 reasons investors are selling now and what can you learn from them?  Has the bull market finally run its course?

Asset managers at pension funds, hedge funds, private equity firms and other big investors are selling more assets and shifting to less risky strategies to protect against losses before the next downturn.  This has driven the volume of closed real estate loans down by 11% in 2016 and signifies the first drop since 2009.

Why are the big dogs pulling back?

Many asset classes have gotten ahead of themselves; here are 4 reasons larger investors are selling:
1.    Cap rates: Certain sectors have gotten very lofty in value with extremely low cap rates. In Colorado I have seen apartments trade as low as a 3 cap.  This is insane and well below historical norms for cap rates.  Many institutional and larger investors are taking money of the table to reduce risk since it is unlikely cap rates will continue declining.

2.    Rising interest rates: As rates rise commercial property in many cases doesn’t look as attractive. With the recent spike in rates other less risky assets can now provide good returns. Many institutional are using this as an opportunity to reposition themselves into less risky assets with comparable returns.

3.    Supply coming online: Commercial building is radically different than residential building.  It can take years for commercial buildings to come online.  The new supply coming online now was planned 3-5 years ago.  This new supply will put pressure on existing properties lease and vacancy rates.  This will ultimately put downward pressure on the prices.

4.    Near the end of the cycle? The rapid increase in commercial properties could be showing its age. For example, according to a REIS report, retail space showed “signs of a correction” with 30 metro areas showing signs of increases in vacancy. In the office market, the absorption rate has also dropped from 2015.

What should you do?

It depends on the particulars of your situation.  We all know that real estate is local and what happens in one market might not be occurring as much (or at all) in another market. The first question to ask, are the above 4 items. Based on your market, it could be a good time to think about taking profits off the table as cap rates are at historic lows.
 

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