Commercial Real Estate: Too Much Buying?

 | Feb 08, 2016 | 2:30 PM EST
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While the rest of the world was apparently watching 17 hours of Super Bowl coverage yesterday, I spent a little time catching up on some overdue reading. I did watch the actual game as I really wanted to see Peyton Manning win one for us old guys and got out on top, but I simply cannot fathom watching the eternal pregame antics.  

After spending part of last week traveling, I had a stack on the desk and needed to wade through the pile; 13F filings are already starting to come in and I need to clear the current mess in order to build a new one over the next week.

One report I had skimmed earlier this year was the Colliers International Global Real Estate Outlook. I own lots of real estate-related securities, and of course real estate valuation and performance have a huge impact on banks. Community banks have really focused on commercial real estate (CRE) the past few years, so what's happening in these markets can affect my portfolio on several different level. Colliers has 502 offices in 67 countries and is involved in brokerage, property management and just about every other aspect of the commercial real estate business.

The report found that investors still have an appetite for real estate. It surveyed more than 600 investors around the world and found that more than half intend to increase their allocation to real estate in 2016. There is a bit of a cautious attitude and most prefer the major urban markets around the world, such as New York, London, San Francisco and Tokyo. Most also express a desire to take less risk and so are drawn to what they perceive as stable long-term markets with above-average liquidity. I have to say my contrarian nature thinks that looking for lower risk in markets that have cap rates near record lows is a bit silly, but it would seem that institutional real estate investors are as subject to the herding instinct as stock investors.

Central business district offices remain the preferred investment around the world; 61% of CRE investors, up for 46% last year, had downtown offices as their favorite asset for new money in 2016. In Europe, that number leaps to 71% as years of falling property values have made investors perhaps even more risk-averse than their global peers. Industrial and logistics properties are the second choice, with high demand from North American investors pushing that asset class up the list this year. Globally, multifamily real estate appears to be losing its luster as it dropped from second to sixth in popularity as a target for new money.

Here at home, foreign investment could be a huge driver for U.S. commercial real estate. The Colliers survey found that 31% of Middle Eastern investors will be investing in the Americas, as will 27% of investors from continental Europe and 24% of those investing from Asia. Boston; Chicago; Washington, D.C.; San Francisco; Los Angeles and New York are the most favored markets, with Manhattan still being the belle of the ball when it comes to attracting investment capital. Thanks to e-commerce and high first- and last-mile demand for space, industrial properties are the most desired sector in the United States, while central business district office space overtook shopping centers to move into second place on the most attractive asset class for new investment. American investors have seen strong CRE markets the past few years, and I think that is the reason why 21% of investors expect to be net sellers of commercial real estate in 2016.

My real takeaway here is that most of the investors in the survey seem to think we are in the late stages of the commercial real estate recovery. Their reaction to that is puzzling; I fail to see how sound a practice it is to engage in bidding wars for the best properties in the best markets after a seven-year bull market in CRE. Prices in some markets are looking a bit frothy, and I find myself nodding in agreement with Sam Zell's statement in December that, "With pricing currently available in the commercial real estate market, it is very hard not to be a seller."

The report suggests to me there are some very attractive investment opportunities in the REIT market for long-term investors. Brian Kingston, CEO of Brookfield Properties (BPY), recently noted, "2015 featured a significant divergence between the prices of publicly traded real estate companies and private real estate valuations."

While institutional investors are making direct property investments, REITs that are not widely represented in ETFs and indexes are trading at valuations well below the current level of transaction prices in the marketplace. Tomorrow, we will take a look at some REITs that take advantage of the trends noted in the Colliers report that can make us money as long-term investors.

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