Real Estate Challenges Stock Market for Investor Favor

By Ken Riggs, CEO, Real Estate Research Corp.

Institutional investors frustrated by and skittish about the slowing economy as well as the volatility and risk of the stock market are finding the commercial real estate increasingly attractive, despite the approximately 35 percent loss in value the asset class has endured during the past few years. This loss is even more significant for lower-quality assets and leveraged positions. In fact, for the first time in nearly two years, commercial real estate regained the lead over stocks among the various investment options rated by institutional investors responding to RERC’s investment survey. As reported in the summer 2010 RERC Real Estate Report, commercial real estate earned a rating of 5.6 on a scale of 1 to 10, with 10 being high. (Stocks earned a rating of 5.0 in the same survey and on the same scale.)

This is no surprise to those who have noted the increased investment demand in the commercial real estate asset class during the past few months, or the shockingly high prices being paid for top-tier properties, like the recent sale of a Chicago office tower for $655 million, broaching $500 per square foot, a historic record high price for an office investment for Chicago. The increasing competitiveness in the market for such properties is pushing some players out on the risk spectrum to riskier plays in the commercial real estate market. Although not all commercial real estate properties will see higher prices, expect to see investors continuing to demonstrate their willingness to pay such prices for the highest-quality properties in top-tier markets, as they look to add diversity, stability, and higher absolute returns to their investment portfolios.

In looking more closely at the specific return versus risk ratings for the various property types, RERC’s institutional investment survey respondents gave the apartment sector their highest rating, 6.2 on a scale of 1 to 10, with 10 being high, during second quarter. The industrial sector came in second, with a rating of 5.8 on the same scale.

These were the only two sectors with a return versus risk rating above 5.0, indicating that these are the only two major property types where the expected return outweighs the risk.

However, with respect to the value versus price of commercial real estate, the industrial sector was the highest-rated property sector and retained its first quarter rating of 5.7 during second quarter, while the rating for the apartment sector declined to 5.2 in second quarter from 5.5 in first quarter, indicating that the value of apartment properties is declining in relation to the prices being paid. Even so, one of our survey respondents suggested that the apartment sector would continue to hold value and investors should continue to “invest in apartments because of the reduction in construction, pent-up demand from households that have not formed in the past two years, and the reduction in easy single-family mortgage financing.”

Commercial real estate may not offer the most excitement on a daily basis, but with the tangible value of this asset class and its stability over stocks, it is no wonder that investors with the time and patience to wait on returns are rekindling and finding favor with commercial real estate.