Talking Real Estate Fundamentals And Faith In The Future

Long before the mortgage mess and the credit crunch that led us to where we are today, a broker was telling me that office rents didn’t come close to justifying the prices being paid for some buildings in Los Angeles. Either the buyers were counting on rents to rise significantly, which he didn’t expect to happen, or the buyers were counting on the greater-fool theory of investing. Either way, he had been working the market for 20 years or more and didn’t expect rents to zoom to the levels required to support the high prices—and they didn’t.

This conversation comes to mind because of something that was said in an Allen Matkins/UCLA Anderson Survey that was reported on recently on GlobeSt.com. As the report said, people working in the capital markets and other commercial real estate professionals are optimistic that fundamentals will catch up with fast-rising prices. What caught my eye even more than the optimism discovered in the survey, however, was some of the wording in the introduction. Regarding the rise in CRE prices, it said: “The increase is not supported by the current rental and occupancy rates. This rise in asset prices is either an indicator of investor expectations of improving fundamentals over the next three to four years or the beginning of a new asset bubble.”

What? Another bubble so soon?

Apparently not, according to the consensus among commercial real estate professionals, who believe that pricing is simply ahead of the curve. This is a common theme in the CRE world these days. Discussions of pricing and cap rates often revolve around the idea that real estate investors are willing to accept lower returns right now because they believe those returns will rise as fundamentals improve. So the high prices and low caps show some faith in the future.

For a while there, right after the commercial real estate market stopped dead in its tracks, everybody was saying “Now, it’s back to fundamentals.” This implies that something other than fundamentals was driving the market before the crash, though I’ve never been sure what that something was.

So far, it looks like investors are still keeping their eyes on fundamentals, even if they have to look down the road a distance to see the kinds of fundamentals they like. I hope that faith is justified. (credit, howard, globe st)

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