Real Estate

Commercial real estate prices hit historical peak

Regulators concerned about imbalances

Whereas the residential real estate market continues to recover gradually, the same cannot be said for the commercial real estate market, where prices rose much quicker, according to a study by Goldman Sachs.

Recently, regulators expressed concern for the potential imbalances in the CRE market.

Keeping rates too low for too long might encourage excessive risk-taking and unsustainable gains in commercial real estate, said Eric Rosengren, Federal Reserve Bank of Boston president.

CRE generally refers to retail, office, industrial, lodging and multi-family properties.

This chart shows the difference between commercial and residential prices:

Click to Enlarge


(Source: Federal Reserve Board, Standard & Poor’s)

So what’s the difference between the two markets? According to Goldman Sachs’ study there are several factors. To begin with, the fall in construction was not as hard in the CRE market as it was in residential. Whereas it dropped by 2.8% for residential, it only dropped 1.6% in the commercial market.

Here is a chart that shows the smaller boom but smaller fall in the CRE market:

Click to Enlarge


(Source: Department of Commerce)

That being said, whereas CRE prices look expensive relative to rents, according to CoStar data, commercial rent caps, the ratio of net operating income and prices, dropped to historic lows. Earnings yields on other assets such as equity and bonds declined significantly, therefore from an asset pricing perspective, CRE prices don’t look as rich.

This chart shows the CRE versus residential markets compared to bond rates, the cap rate and earnings-price ratio:

Click to Enlarge


(Source: CoStar)

“The upshot of our analysis is that the housing recovery has been characterized by a substantial divergence between the slowly recovering residential market and the swifter recovery in commercial real estate, where prices have picked up more substantially,” Goldman Sachs Economist Daan Struyven and Vice President Marty Young wrote. “Our models point to deceleration of price gains going forward, particularly in the CRE sector.”

That being said, the company said it does not see the market declining in prices nationally any time soon.

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