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CRE Market May Be Reaching Bubble Territory

The market valuations of office buildings sold in some of the world's largest cities reached record highs in the second quarter.
Katie Kuehner-HebertAugust 13, 2015
CRE Market May Be Reaching Bubble Territory

Historically low interest rates and “a flood of cash being pumped into economies” by central banks have made commercial real estate look attractive compared with bonds and other assets — causing prices to soar and the global property market to overheat, the Wall Street Journal said Thursday.

For example, New York commercial real estate has an average capitalization rate of 5.7%, according to industry tracker Real Capital Analytics, compared with a 2.2% yield for a 10-year Treasury note. (The capitalization rate is defined as net operating income divided by the current market value of the asset.)

As a result, the valuations of office buildings sold in London, Hong Kong, Osaka, and Chicago hit record highs in the second quarter of this year, on a price-per-square-foot basis, and reached post-2009 highs in New York, Los Angeles, Berlin, and Sydney, said Real Capital.

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Deal activity is also soaring, with the value of U.S. commercial real-estate transactions in the first half of 2015 jumping 36% from a year earlier to $225.1 billion, ahead of the pace set in 2006, according to Real Capital. In Europe, transaction values shot up 37% to €135 billion ($148 billion), the strongest start to a year since 2007.

“We’re calling it a late-cycle market now,” LaSalle Investment Management’s head of research and strategy Jacques Gordon told the WSJ. “If too much capital comes into any asset class, generally not-so-good things tend to follow.”

Property values could fall if interest rates rise sharply, which could trigger a wave of defaults on mortgages, analysts told the WSJ.

“But bulls counter that even if interest rates rise, property values might not necessarily be hurt if higher interest rates are accompanied by higher inflation, which typically allows landlords to raise rents,” the WSJ wrote. “They also point out that so far this cycle hasn’t seen the kind of overbuilding that has destabilized real-estate markets in the past.”