Investors Eye CRE for the Long Haul
It is clear that long-term investors are starting to experience fatigue with the lack of building wealth and are itching with the need to take on more risk in order to earn higher returns.
- Feb 22, 2012
By Ken Riggs,
Chairman & President, Real Estate Research Co.
Whether it is the assurance from Ben Bernanke that the Federal Reserve plans to keep short-term rates at low levels through late 2014, or the frustration with the paltry returns that cash investors see on their bank statements month after month, or the recent headline advice from BlackRock CEO Larry Fink when he stated that “when you look at dividend returns … it is an easy decision to be heavily in equities,” it is clear that long-term investors are starting to experience fatigue with the lack of building wealth and are itching with the need to take on more risk in order to earn higher returns.
As a result, investors who turned to commercial real estate for stability are now scanning the landscape to seek higher returns. With the world more willing to venture into riskier alternatives, especially in the U.S. in the wake of Europe’s difficulties, it is time for us to revisit our objectives, re-evaluate the return environment, and revise our investment strategies. As noted in the winter 2012 RERC Real Estate Report, “As the World Turns from Fear to Caution,” RERC’s institutional investment survey respondents continued to give commercial real estate their highest rating among the investment alternatives (6.3 on a scale of 1 to 10, with 10 being high), but this rating was down slightly from the previous quarter. Meanwhile, as shown below, their rating for stocks increased to 5.4 from 4.7 while the rating for bonds increased to 4.4 from 3.8, showing how risk tolerance has increased as returns grow for these asset classes.
It is also important to note that the investment ratings for commercial real estate have changed only slightly over the past year, indicating the relatively reasonable returns and the stability of this asset class as an investment, which is key to core investors who are focused on measured, long-term decisions (versus speculating or hedging opportunities). In looking at the ratings of the individual property types, however, even those investors sticking with commercial real estate are looking beyond the least risky property types and toward opportunities with slightly more risk (and with possibly higher returns).
RERC’s research also shows that the fourth quarter 2011 return versus risk rating for commercial real estate overall declined from the third quarter 2011 rating, but at a rating of 5.9, investors still maintain that the return on this asset class overall outweighs the risk. In addition, the return versus risk rating for the apartment sector — the least risky sector — declined from the previous quarter, although it was still the top-rated property type. Interestingly, the return versus risk ratings for the industrial and retail sectors increased during fourth quarter, as investors become more confident in the return potential associated with these sectors compared to the amount of risk. (However, the ratings for the office and hotel sectors declined to 5.1 and 5.4, respectively, indicating that these sectors may be a little riskier in comparison to potential returns.)
Given the growth of the economy (despite the still serious headwinds), it is not surprising that momentum is building in the stock and bond markets as investors climb out of the pit of fear that has dominated investor behavior for the past few months. If ever a market looked like it was ready to take off, it is this one.
However, given that uncertainty increased and transactions slowed quite significantly in fourth quarter, we expect that the commercial real estate recovery will exhibit more caution, will be more methodical in its approach as real estate fundamentals are taken into account, and will generally take more time to re-ignite. Although returns remain relatively attractive now and for the long haul, we need to remember that the commercial real estate recovery for the fundamentals of space demand generally lag the economy, and patience will be required in this cycle much like it has in previous cycles.
At least we should be able to come through it with less of the volatility investors will experience in the stock and bond markets — it is a world in search of Beta!