Thursday, December 29, 2016

Commercial real estate still booming

According to the folks at the CoStar Group, the commercial real estate market is registering annual price gains of more than 8%, as the rally in prices that began some six years ago continues to impress.


The chart above includes the latest (as of November) Co-Star data. Note that both measures of commercial real estate prices are at new nominal highs and have been increasing at annual rates of 8-10% for a number of years.


Moodys publishes a similar index (second chart above). As both charts show, prices have reached new all-time highs.


As the chart above shows, commercial real estate has been outperforming the residential market in the current cycle, whereas it lagged during the great housing market boom of the early 2000s. But both are performing quite well.

If anything, the action in the commercial real estate market would appear to be at odds with the very low rates of inflation and sub-par rates of growth that we have seen in the current business cycle expansion. My take is that this is evidence, at least in the past year or so, of rising optimism as well as declining demand for money, and both are precursors, in this age of Quantitative Easing, of rising inflation, as I've explained many times before. However, the bond market is still showing modest inflation expectations (e.g., 1.9-2.0%) for the foreseeable future, so it may be premature to sound a rising inflation call. Especially given the impressive strength of the dollar.

As a reminder, real estate is likely to benefit from a strong economy as well as rising inflation.

8 comments:

Andrew Ross said...

There are several measures of inflation and taxes are technically part of inflation.

So being on the eve of "major" changes to our tax rates, with the expectation that they will be lower, may temper one source of inflation.

Benjamin Cole said...

Great post. We see a collapse in commercial real estate exactly parallels the collapse in residential house prices. This tends to refute the idea that federal housing programs created a housing "bubble." Entirely forgotten is that there was also a commercial property "bubble."

At the risk of appearing like a Nervous Nelly we are seeing the same very low cap rates that we saw back in 2007-8. Also, the justification for buying a commercial property premised on a repositioning, and higher rents in the future.

My worry now is that real estate lending will contract in 2017, which will lead to a decrease in the endogenous creation of money and ergo a slowing down of the economy.

Benjamin Cole said...

Great post. We see a collapse in commercial real estate exactly parallels the collapse in residential house prices. This tends to refute the idea that federal housing programs created a housing "bubble." Entirely forgotten is that there was also a commercial property "bubble."

At the risk of appearing like a Nervous Nelly we are seeing the same very low cap rates that we saw back in 2007-8. Also, the justification for buying a commercial property premised on a repositioning, and higher rents in the future.

My worry now is that real estate lending will contract in 2017, which will lead to a decrease in the endogenous creation of money and ergo a slowing down of the economy.

Scott Grannis said...

The way I read the third chart in this post, commercial real estate began to collapse well after the residential housing market collapsed. If there is anything that links the two markets, it's the economy. The residential collapse helped trigger a severe weakening of the economy, and that in turn is probably what led to a collapse of the commercial real estate market.

It's interesting that the commercial market picked up much sooner than the residential market. That would suggest that the degree of overbuilding in the commercial market was much less than in the residential market, which had been fueled to bursting by misguided policies which strived to artificially increase home ownership. The residential market needed quite a few years to work off excess inventories. That was not the case with the commercial market, which began rebound about one year after the economic recovery started.

Benjamin Cole said...

Scott:

Yet…reading the chart, it appears commercial property had a steeper drop in value than residential.

By the chart you show residential values fall from about 200 to about 140, or a 30% fall.

Commercial property fell from about 170 to about 100, or a 41% tumble.

Of course, using national values when real estate markets are local is always an adventure. As we know, there are famously tight West Coast residential markets due to zoning.

BTW, as you probably can guess from my comments over the years, I am no fan of market intrusions, or government housing programs. I would be fine with total elimination of all federal housing programs, and the elimination of the home mortgage tax deduction, and elimination of property zoning.

Unfortunately, I appear to be a party of one, on these issues.

But something else caused the collapse of commercial property markets, and even steeper steeper drop than seen in residential.

Pat Filippelli said...

As the chart above shows, commercial real estate has been outperforming the residential market in the current cycle, whereas it lagged during the great housing market boom of the early 2000s. But both are performing quite well.

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