CRE Values to Outpace Stocks, Bonds

Commercial real estate value is holding its own and expected to increase over the next year, according to the new “Valuation: Now and Then,” a quarterly report from Real Estate Research Corporation (RERC).

“Commercial real estate values have recovered about 25 percent from the bottom of the crash several years ago, according to our research,” explains Ken Riggs, president and CEO of RERC. “According to our analysis, we expect that within another year, commercial real estate values will have recovered just above 30 percent from the bottom, although it will still be below the high-water mark.”

Founded in 1931, RERC is one of the most respected firms dedicated to valuation management and fiduciary services, appraisal and litigation services, and research, risk analysis, and publications.

RERC’s first quarter value versus price rating for commercial real estate overall was 5.5 on a scale of 1 to 10, with 10 being high, indicating that the value of commercial real estate is slightly higher than its price. Stocks scored 5.3, while bonds were rated at 3.4 and cash registered 3.7.

Regarding the individual property sectors, the value versus price ratings increased for the office, industrial, and hotel sectors in first quarter, while the rating for the retail sector declined slightly and the rating for the apartment sector remained at 5.0. The highest value versus price rating was 5.8, and was earned by the industrial sector.

Historically, about 75 percent of commercial real estate returns have come from the income component and the rest from appreciation. According to the report, RERC’s outlook for total unleveraged returns is estimated at 6 percent income, plus 2.5 percent capital appreciation, for a total unleveraged return of 8.5 percent per year for average core properties in 2014. For a broader range of properties, RERC anticipates total unleveraged returns ranging from 8.5 percent to 10 percent.

“Add some positive leverage, and returns get into the low teens for core properties,” notes Riggs. “Riskier properties would be expected to have an even higher rate of return.”

Some investors have noted that capitalization rates and discount rates are nearing pre-credit crisis levels. In fact, as stated in the report, several of RERC’s required going-in cap rates reached new lows in first quarter 2014, including the central business district (CBD) office sector at 5.7 percent and the apartment sector at 5.1 percent.

However, according to Riggs, although cap and yield rates are at levels similar to where they were pre-2008, 10-year Treasury yield rates are lower than they were in 2008, and serve as a cushion for falling cap and discount rates. “These low Treasury rates are already built into values, so returns should remain positive. That is why our value versus price ratings are mostly stable and will likely remain so for the near term,” he says.

The new report is available for purchase by single issue or by annual subscription in the RERC store.