Downunder Daily CREeping Back

Downunder Daily
CREeping Back

The rising tide of moderate economic recovery will, it seems, lift even leaky boats – such as commercial real estate (CRE). A combined report from our US REIT, economic, banks, insurance and securitized product teams argues that the worst is almost over for US commercial property. Moreover, in line with the 2010 investment theme of discrimination and finesse, there are selective opportunities in a range of CRE-related assets. What follows is taken from that report,Commercial Real Estate 2010: Investment Cross-Currents in a Multi-Staged Recovery, 7 January.

Residential real estate took the lead in the financial crisis, but commercial property played an important supporting role. Price indexes vary, but the boom, then bust, in CRE values was on a par with that seen in residential. However, there is now a hint of stabilization in some of those CRE price measures. There are three drivers of the outlook: 1) trajectory of rates and credit spreads; 2) the pace of distressed asset liquidation, and 3) the strength and timing of the employment recovery. Our forecasts – which include a moderate but sustained economic recovery – suggest that CRE prices will flat-line through next year. Exhibit 1 shows property value forecasts under three scenarios.

The flat base-case outlook reflects the divergence between healthy and distressed assets. This divergence has been apparent through the downturn (Exhibit 2). Our team thinks that the valuation trough of healthy CRE assets was in mid-2009 as economic and credit conditions turned. Looking ahead, distressed asset values may have farther to fall if the pace of distressed sales accelerates. The price of healthy assets should stabilize, as the positive effect of tighter credit spreads on cap rates balances the adverse effect of rising interest rates and declining cash flows. Cap rate spreads to Treasuries are now above average (Exhibit3).

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