Finding Safety in a Confused World

By Ken Riggs, President & CEO, Real Estate Research Corp.

Just when we thought the financial markets were gaining some sanity, the world careened into a level of chaos that has completely overtaken the investment arena.

By Ken Riggs,
President & CEO, Real Estate Research Corporation

Just when we thought the financial markets were gaining some sanity, the world careened into a level of chaos that has completely overtaken the investment markets. Call it fear, or uncertainty, or the conviction that the economy is going in the wrong direction—regardless, this unexpected chaos of the past few weeks has caused us to pull out a few instruments from past recessions that we used to measure economic and financial damage. Whether one looks at the Misery Index or the VIX Index (see below for an explanation of these measures), it is clear that the onslaught of second-quarter 2011 negative economic reports, the nation’s political paralysis and debt ceiling debacle, Standard & Poor’s downgrading of U.S. credit from AAA to AA+ status and the sovereign debt contagion in Europe, have damaged the psyche of large and small investors alike.

As a result, investors are seeking “safe” paths away from the insanity and toward investments that are tangible and that have less volatility than other investments. Cash may be king in this environment, but one of the most attractive safe harbor investments is Class “A” institutional commercial real estate because of the returns that are available with this asset class. In fact, according to RERC’s recent institutional-investment survey results, among the various major investment alternatives, commercial real estate was the top-rated investment, with a score of 6.2 on a scale of 1 to 10, with 10 being high, outperforming stocks, bonds and cash during second-quarter 2011 (this rating for commercial real estate was earned before most of the recent gyrations in the stock market — if these surveys were being submitted now, it is likely the score would be much higher).

As noted in the summer 2011 RERC Real Estate Report, “Search for Safety,” RERC’s return versus risk rating for commercial real estate continues to increase and is now the highest it has been since before the beginning of the Great Recession. Investment survey respondents gave commercial real estate a rating of 6.1, indicating that they believe that the return for this asset class certainly outweighs the risk. This certainty is not as strong for the individual property sectors, however, except for the apartment sector, which received a rating of 6.6 on the same scale. The other major property types received scores closer to the midpoint of the scale, with the industrial and hotel sectors at 5.8, the office sector at 5.5, and the retail sector at 5.4, and although these ratings are not quite as strong as for the apartment sector, the returns for all the property sectors are perceived to be greater than the risk associated with them.

Even though this stormy period is likely to interrupt the commercial real estate recovery temporarily, the transparency of this asset class, the stability of the investment, and reasonable income returns make commercial real estate one of the safest ways to balance an investment portfolio. As the second half of 2011 continues, I anticipate:

  • The enhanced focus on the best commercial real estate assets in the best locations (flight to safety) will continue.
  • Downward pressure on required cap rates will continue for premium properties.
  • The market will re-adjust expectations for economic growth and its impact on the fundamentals.
  • Higher-risk properties face renewed concern for pricing and returns.
  • Commercial real estate is poised to weather the insanity as well as any asset class.

The Misery Index: Initiated in the 1960s, the Misery Index is the unemployment rate added to the inflation rate. The Misery Index reading has been rising, and is currently 12.76, which is higher than it has been since the early 1980s, and is demonstrating deteriorating economic performance.

The VIX Index: Commonly known as the financial fear factor, the Volatility, or VIX Index, shows stock market volatility in the U.S. on a daily basis. The VIX Index spiked 50 percent to 48.0 one day last week, its biggest one-day jump since 2007; thus far this week, the VIX Index has declined to 33.8.