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DEADLY errors that CRE occupants
make
One of the more interesting replications of investment activity is demonstrated by RERC’s historical ratings for the availability and discipline (underwriting standards) of capital. We can see that the most recent time that availability outpaced discipline to the degree we witnessed in third quarter 2014, was in second quarter 2007—shortly before the credit crisis that preceded the Great Recession. Commercial real estate was selling for top prices then too (remember Blackstone’s purchase of Equity Office Properties Trust for $39 billion in the world’s biggest leveraged buyout in late 2007?).
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Today, the abundance of capital in the U.S. and from abroad continues to pressure commercial real estate prices to increase, especially for top assets, despite the risk involved. Although at some point prices will outstrip values and a price correction will occur, that is not the case now.
In fact, according to RERC’s third quarter 2014 return vs. risk ratings as reported in the RERC Real Estate Report, “Prices Pressure Values,” commercial real estate returns are expected to increase for all property types (except for the hotel sector) compared to the amount of risk involved. The return vs. risk rating for the apartment sector increased the most, from a rating of 4.8 on a scale of 1 to 10, with 10 being high, in second quarter 2014, to a rating of 5.8 in third quarter, indicating the increased return potential of this sector during risky times. (A rating below 5 indicates that returns are less than the amount of risk, a rating of 5 is neutral, and a rating above 5 indicates that returns are greater than the amount of risk.) The industrial sector earned a return vs. risk rating of 6.6, indicating that returns are expected to be strong compared to the amount of risk involved.
RERC’s third quarter 2014 value vs. price ratings reflect the same trend and have increased over second quarter ratings (except for commercial real estate overall and the hotel sector), despite the continued increase in property prices. With value vs. price ratings all higher than 5.0 in third quarter, RERC’s investment survey respondents believe that value still outweighs the price for commercial real estate. (A rating below 5 indicates that the value is less than the price, a rating of 5 is neutral, and a rating above 5 indicates that the value is greater than the price.) As shown below, the industrial sector earned the highest value vs. price rating.
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