Search for Clarity, Relative Stability in a Dangerous World

By Ken Riggs, Chairman & President, Real Estate Research Co.

Despite the vagaries of the world's economy, real estate as an asset class still holds a relatively stable return and outlook.

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

As third quarter 2011 data started coming in, we were encouraged for the moment by the signs of improvement in the U.S. economy. GDP growth was up, interest rates were still low, and retail sales increased. We clearly knew that the ever-present challenges remained – unemployment and underemployment are much too high, the housing market is still in the ditch, and confidence is at near-record low levels – but at least consumers are starting to open their pocket books.

We then heard again words like “contagion,” “austerity programs” and “sovereign debt crisis,” and it wasn’t only Greece and Italy that these terms were applied to. The concern now is that any European failure will affect the rest of the European Union and their currency, and pull Europe and the rest of the world into a global recession. For that matter, the debt crisis in the U.S. has not been resolved either, with Congress still without an agreement for reducing the $14.9 trillion in debt over the next 10 years. According to World Bank President Robert Zoellick, “The world is in a danger zone.”

In a world of increasing financial danger, investors inevitably are looking for stability. For the most part, commercial real estate has traditionally served in that capacity. Commercial real estate does not usually offer the highest returns, but it has generally been a safe investment – it is tangible and transparent, returns are mostly reasonable in this volatile world, and investors have been able to add stability to their portfolios by expanding their exposure to commercial real estate.

According to the institutional investors that Real Estate Research Corp. surveys each quarter, there is certainly a flight to cash in this environment, but commercial real estate easily retained its top rating among investment alternatives during third quarter. In fact, while many commercial real estate investors continued to focus their attention on property performance and realistic deal underwriting, other investors have adopted a wait-and-see approach in their investment decision process. As a result, over the past few months, we have seen a decrease in deal volume and property values have begun to flatten.

However, even this drawback can be considered a positive step in that it should help prevent the market from getting too far ahead of fundamentals (particularly regarding venturing further out into the risk spectrum), which will be beneficial to the long-term success of real estate investment as a primary asset class. This outlook is substantiated by our third quarter institutional investors who, as noted in the fall 2011 issue of the RERC Real Estate Report, World Unhinged, increased their return versus risk rating of commercial real estate to 6.2 on a scale of 1 to 10, with 10 being high.

Although the third quarter increase was very slight (from a rating of 6.1 in second quarter), it indicates that the return for this asset class continues to outweigh the amount of risk involved. In addition, the apartment sector was regarded as even more stable, earning a return versus risk rating of 6.9 on the same scale. (The other major property sectors received a lower rating, although all possessed higher return potential than the amount of risk involved.)

With the financial world in danger and the investment markets filled with risk, no investment is totally stable or safe. But so far, commercial real estate has not been as susceptible to the major swings we are seeing with other investments, and with a little luck, it might remain that way as the financial crises unfold.