Commercial Real Estate: Bubble Not Likely

A report by Global Real Analytics (GRA) offers a new perspective on fears that the price increases of the past three years is leading to a "bubble" similar to the one in the late 1980s. Said Richard Wollach, CEO of Global Real Analytics, "Using a base year of 1985, prices are not overblown by historical standards….For three or more major property categories, inflation-adjusted values were below those in 1985 and even lower when compared to the peak year for each asset type in the late 1980s real estate bubble."

Specifically, CBD office properties are currently 10.8 percent below 1985 levels (and 14.1 percent below their peak price of 1987). Warehouse properties show a decline of 3.5 percent since 1985 (7.0 percent from the 1988 peak). Retail is down 5.1 percent from 1995 (9.0 percent from the 1987 peak). Only apartments gained in real terms over the past two decades, with an inflation-adjusted appreciation of 43.6 percent.

Positive Features
For several reasons, prices could surpass the previous highs, says Wollach. First, the much greater degree of transparency and discipline in the capital markets has so far prevented unchecked new construction. Second, debt is cheaper, making investments more rational even at current low cap rates. And because of the amount of capital seeking investment, illiquidity risk is lower than in the past. Fourth, commercial rents have been rising across the board at more than five percent annually since early 2005, offering the best evidence of lack of supply, which could mean higher rent increases and rising net operating income over the next year or two.

Global Perspective
Finally, U.S. commercial real estate prices are lower than those in many foreign nations, one reason why so much foreign capital is coming here. According to Daniel O'Connor, GRA's Managing Director of Global Forecasting, office properties may fetch $600 to $700 or higher per square foot in leading office centers around the world. In the West End of London, office prices reached $1,601 per square foot, compared to $552 in mid-town Manhattan and $474 in Washington, D.C.

What About Apartments?
In contrast to the other sectors, apartment prices are at record highs, having appreciated by just under 44 percent since 1985. The GRA report suggests several reasons why this does not suggest a bubble in the near future. One reason is that apartments in the 1980s were considered less desirable than other sectors, with a result that apartments were undervalued. Only since the 1990s has this sector been recognized for its investment potential, with a result that much public and private capital has been flowing into that sector.

A second reason why apartment prices are so high is evidence that inventories have not kept up with the growth of U.S. population. While the population has grown by 25 percent since 1985, apartment completions in 2005 were only 60 percent of those in 1985. In addition, much greater mobility in the labor market and continuing high levels of immigration stimulate the demand for rental apartments. Finally, the two largest population groups-aging baby boomers and 18-34 year olds-are key sources of demand for apartments.

Global Real Analytics LLC provides information to real estate investors and investment managers. For more information, contact Paul Wildes, Director of Marketing and Client Relations, at 415-733-5351 or e-mail to pwildes@global.com.

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