Economy Watch: More Evidence That CRE Values Might Drop Next Year

The conventional wisdom, it seems, is fast becoming wedded to the idea that the peak is here for commercial real estate values, and 2016 will be the time for some kind of correction.

cre-imageThe conventional wisdom, it seems, is fast becoming wedded to the idea that the peak is here for commercial real estate values, and 2016 will be the time for some kind of correction. This week Green Street Advisors weighed in on the question, positing that various indications point to a slowdown. “Green Street’s Commercial Property Price Forecast sent very bullish signals for real estate values from 2009 up until the first quarter of this year,” said Andy McCulloch, managing director of real estate analytics for Green Street Advisors. “Since then, however, the signals have become notably more bearish, and there is now a good chance that commercial real estate prices will be lower within the next 12 months.”

The company isn’t predicting a massive drop, however. In its most recent quarterly Commercial Property Outlook, Green Street forecasts a modest drop for CRE values across the year. The company’s Commercial Property Price Index, which focuses on major assets in larger markets, has tracked asset values as they’ve recovered robustly over the last six years, passing pre-recession peaks some time ago. In fact, that’s been the case even in recent months, but now CRE appreciation is slowing, with cap rates flattening out in most sectors. Class A malls and Class B apartments are exceptions to this, with their cap rates continuing to drop.

The lone sector in which cap rates have moved up over the past three months, according to Green Street, is senior housing, a trend that seems to be based on fears that too much new supply is entering some markets. Also, while cap rates are still inching down in most major MSAs, a few places are seeing rises, such as DFW, Houston and Denver. These markets have been adversely affected by the energy slump over the last year, so that’s little surprise.

Despite the projection for valuation declines, McCulloch stressed that the company isn’t predicting weakened fundamentals in most markets or for most property types. On the whole, occupancies and rents will continue to grow somewhat over the next few years, though maybe at merely a good pace rather than a great one. Even so, these fundamentals won’t be able to sustain even higher valuations. Various signals—from the bond markets and REIT markets, for instance—mean that investors consider real estate prices too high, and they aren’t inclined to bid prices up any higher.