Despite the intense economic challenges of COVID-19, certain commercial real estate (CRE) properties remain very attractive on a risk-adjusted basis, according to Ken Riggs, Vice Chair of RERC, a SitusAMC Company. Riggs hosted the “RERC Quarterly Valuation Trends” webinar on September 15, looking at the current investment environment and winners and losers among CRE asset classes. The webinar offered highlights from the latest RERC ValTrends Report, “Winners and Losers.”
Historically low interest rates underlie CRE’s allure for investors, Riggs explained. “The 10-year Treasury is down 150 basis points from one year ago, when expectations were that rates could not possibly go lower,” he noted. The decline in rates has been more structural vs. cyclical over the last four decades, from 8 percent in the 1980s, to 6 percent in the 1990s to 4 percent in the 2000s, to around 2 percent prior to the pandemic, he added.
Meanwhile, Federal Reserve Chairman Jerome Powell has suggested the economy needs low interest rates for an extended period to recover from the pandemic. “You couldn’t have a stronger voice or message from any other place that sends the market green-light signals that rates are going to stay lower much longer than we had ever expected, and that’s going to be a strong tailwind for commercial real estate in the future, especially when we get to the other side of COVID-19,” Riggs said.
Among the other highlights of the webinar:
- The bifurcation in values between public and private markets will eventually converge. The NCREIF NFI-ODCE private market has returned 1.01 percent year to date, compared to negative 13.30 percent for the NAREIT Index. “The NAREIT price you are seeing is a price for a stock, and that’s not necessarily reflective of underlying asset values of that respective public REIT,” Riggs said. “Over the longer term, there will be a convergence as the assets line up with the price of the stock with the underlying asset values and the private market goes through its value marking process.”
- Industrial is a clear winner. “It’s an Amazon world,” Riggs said. “This industrial market caught many investors by surprise, because it wasn’t a main food group back in the 1990s.”
- The apartment sector is facing growing challenges. About half of 18- to 29-year-olds are living with their parents, the highest level since the Great Depression, reducing new household formation. Meanwhile, the completion versus absorption dynamic is changing, especially in urban markets where residents are fleeing from areas that are costly and dependent on mass transit.
- Office remains a tale of two cities. The amount of sublease space is rising in major metros such as New York and San Francisco, but tech giants such as Amazon and Facebook continue to announce office expansions in urban centers. “I don’t see COVID-19 permanently or structurally changing demand for urban areas,” Riggs said. “But it could make a dent in these markets over the near term, and we will have to reprice and readjust in those markets.”
- While the media depict retail as a clear loser, sub-sector performance varies widely. Some power centers and neighborhood centers are flourishing, while some malls languish. “Malls have many challenges, but that isn’t new,” Riggs said. One trend to watch is the convergence of retail real estate risk with retail merchandising risk as some of the larger mall owners buy bankrupt retail chains.