Three Warning Signs for Commercial Real Estate and REITs

Forecasting the direction of real estate prices requires the same disciplined approach as for other goods and services. Here are three reasons why commercial real estate supply exceeds market demands, and the implications for your clients and their REIT investments.

Commercial real estate continues to be touted by analysts and media pundits as a sound investment. Since I have been one of the few consistent dissenters from this euphoric optimism, now is a good time to briefly review what I have been saying over the past few years.

In my article on commercial office markets published here three years ago, I pointed out that the red-hot sales of 2014 were very uneven. Nearly half of all investor money had poured into just five major metros – Manhattan, Boston, San Francisco, Los Angeles and Washington DC.

It was a very different story in most of the other major markets where weaknesses left over from the crash of 2008-2010 were still evident. Real estate data firm Cassidy Turley reported that 18 of the 79 major metros which they tracked showed higher vacancy rates in late 2014 than a year earlier.

Cassidy Turley also emphasized that the absorption of office space around the country since 2010 had been very narrowly focused. All the new space absorbed by tenants were in buildings either newly-built or newly renovated. Owners of traditional, older space, which comprised 60% of all office buildings in the nation, were still struggling to find tenants.

I warned investors not to be fooled by the strength shown in the hottest half dozen markets.

My follow-up article published in the summer of 2016 reported the cooling was showing up even in the hottest markets. Although total nationwide sales volume for 2015 had nearly reached the insane levels of 2007, this was due to continued enthusiasm shown by investors for those same six major metros. Manhattan alone accounted for 20% of all office sales.

By the middle of 2016, signs were beginning to appear that all was not well in the hottest markets. A construction boom throughout Greater San Francisco was throwing nearly 10 million square feet of new space onto the leasing market while the IPO market in Silicon Valley had slowed drastically. The soaring amount of sub-lease space thrown onto the market by firms that had leased too much during the boom years was another sign that the market was deteriorating.