Public vs. Private CRE: The Price vs. Value Debate
The intrinsic value of real estate may be stronger than the public markets currently indicate.
The public REIT market had an amazing 2019 with a total return of about 25 percent. Contrast that with private CRE total returns, as measured by NCREIF, which ranged from 4.4 percent to 6.4 percent for 2019.
As we entered 2020, CRE prices and their underlying asset values in both the private and public markets were climbing to new high- water marks. With CRE being a strong, real asset investment alternative in a very low interest rate environment and with the economy on seemingly solid ground, many investors thought prices and values would plateau and hold up relatively well throughout 2020.
But the global pandemic brought the U.S. economy to a standstill.
Recent CRE pricing behavior in the public REIT market has caused a divergence in perspective between public and private markets on the underlying value of CRE assets. The market impact of COVID led to large negative returns of 23 percent for the public REIT market in the first quarter 2020. However, the private CRE market, as measured by NCREIF, eked out a slightly positive return in the first quarter 2020. Over the past 15 months, the public REIT market is about neutral, with losses offsetting the gains, and the private market is in positive territory generally by 5 percent. One argument, though, for the difference in total return for the private vs. public markets over the past 15 months could be in part explained by the quality and type of properties captured in the respective indexes.
Proponents of the public REIT market have criticized private market participants for not writing down values enough considering the massive uncertainty that COVID-19 has caused. But times of grave uncertainty is when relying on fundamental valuation methods vs. technical analysis matters the most. Technical analysis differs from fundamental analysis in that the price and sales volume are the only inputs. Technical analysts do not attempt to measure a security’s intrinsic value. Instead, they use stock charts to identify patterns and trends that suggest what a stock will do in the future.
Looks Can Be Deceiving
It is obvious by examining the markets’ performance for 2019 plus the first quarter 2020 that public markets are trading on technical analysis and the private CRE market is examining the fundamental values. While the country grapples with the economic fallout of COVID-19, which could get worse before it gets better, a new reality for CRE is that the market fundamentals for CRE might be healthier than we think. Rent collections in April and May were strong—except for those in retail, which were admittedly abysmal. For now, the private market must wade through mixed signals. Supply and demand dynamics are the cornerstone of private market valuations.
The economic crisis caused by the coronavirus is unprecedented, but the U.S. economy has shown its resilience in the past. Eventually, we will learn what the “new normal” is, but that might not be until a vaccine is widely available—and that probably won’t be until sometime next year. In the meantime, we are faced with a new reality.
While it’s not pretty, it could be much worse for the broad CRE markets (excluding hotel and retail mall devastation). In a post COVID-19 world, the annual yield and value provided by CRE in an extremely low interest rate environment will most likely be better on a risk-adjusted basis than the post-COVID-19 investment alternatives—and CRE may be the darling of the investment world in the future.
Ken Riggs, CFA, CRE, MAI, FRICS, CCIM, is president of RERC, a SitusAMC company.