REIT Column: Will Property Prices Bull or Bear in 2016?

By Andy McCulloch, Managing Director, Real Estate Analytics, Green Street Advisors: Green Street Advisors' outlook for REIT and commercial property prices in 2016.

By Andy McCulloch, Managing Director, Real Estate Analytics, Green Street Advisors

Andrew McCulloch

Optimism regarding commercial property values has been entirely warranted over the past six years. Amid a backdrop of solid fundamentals, minimal supply concerns, very low interest rates and a flood of capital into U.S. property markets, values have doubled since the recovery commenced in 2009.

Green Street’s Commercial Property Price Forecast, which combines signals from the corporate bond market with signals from the REIT market, had been sending off very bullish signs for real estate over this entire time frame — until recently. Over the past several months, Green Street’s forecast has turned decidedly bearish, as REIT share prices have taken a turn for the worse and corporate bond yields have gapped out.

Green Street’s forecast, which is based on the firm’s proprietary time series of unlevered return expectations and REIT NAV premiums/discounts, has been very reliable in predicting changes in commercial real estate pricing. The tool is not precise enough to put much weight on the forecast magnitude of pending price moves, but it does help provide a sense of the directional changes that lie ahead.

Green Street CRE Forecast Track Record

CRE Forecast Track Record Chart 1CRE Forecast Track Record Chart 2

*Past performance cannot be used to predict future results. View our full track record and disclosures.

The shift from a “real estate is cheap” to a “real estate is expensive” environment has been abrupt. The cyclical nature of property prices means that they seldom settle near fair value but instead tend to overshoot in both directions. The process of overshooting on the high side is now clearly underway. Will valuations correct in the next few months? Don’t bet on it. History says there is a good chance they will be lower in a year, but the historic record is also full of alarms that went off too early.

Precise predictions are for fools, but it increasingly looks like a reasonable base-case forecast for commercial property prices in 2016 is a modest (less than 5 percent) decline, bounded by a good case that might consist of a similar-size uptick and a bear case that would entail a worse result. Each of the three scenarios probably has a roughly equal chance of panning out. That two of the three scenarios entail a directional move downward should come as no great surprise on the heels of an incredibly bull market in property, but it is nevertheless hard to overstate the extent to which this view is out of sync with today’s conventional wisdom.

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