Investors have seen mixed messages about the health of the commercial real estate market recently.
On Oct. 19, Moody’s reported that commercial property values had dropped 3.3% during August to a new low, 45.1% below the October 2007 peak.
But CoStar Group countered on Nov. 3 that investment-grade property values had recovered by 5.5% in Sept., while Green Street Advisors reported on Nov. 2 that property values remained stable in October.
The numbers point to two dominant themes.
First, property values will continue to bounce along a bottom for some time until either a positive or a negative force begins to dominate.
Second, both the positive and negative forces are already operating in what is now a “trifurcated” market.
Ironically, both the positive and the negative forces represent good news for investors in publicly traded REITs.
Professor David Geltner of MIT’s Center for Real Estate, focusing on the market “trifurcation,” reported that values of “trophy” properties values actually increased by 5% in August and are now only 17% below their peak.
Meanwhile, distressed properties plummeted by 10% to a new low 62% below their peak. (The middle part of the market went down, too, but only by 2.4% and is still 8% above its low point.)
The positive force, then, is the strong recovery already underway in the higher-quality, non-distressed part of the CRE market.
For example, Green Street Advisors—whose index measures only properties owned by publicly traded REITs, which tend to be the high-quality end of the market—cites “a quicker-than-expected rebound in fundamentals in some major property sectors.”
The negative force is the tidal wave of distressed sellers, many of whom may be forced to put their assets up for sale in the next several quarters.
Whether an index like those from Moody’s/REAL or CoStar goes up or down in a given month will continue to depend mostly on whether the distressed sales outweigh the non-distressed sales.
REIT investors need to understand that both forces are good news for REIT earnings.
When Green Street reports that the values of REIT-owned properties have recovered 30% from their low point, it’s because occupancy rates and rent growth have already started to improve.
Conversely, when Professor Geltner notes that distressed properties are at a new low, it means that publicly traded REITs—which have an advantage over other CRE investors in the form of better access to capital—are increasingly acquiring quality properties at bargain prices, which means adding to future earnings growth.
