Commercial Property Price Index Declines Again

Prices of commercial property continue to decline:

MIT commercial property price index posts second straight quarterly decline, MIT News: The value of U.S. commercial real estate owned by big pension funds fell another 5 percent in the fourth quarter of 2007, according to an index produced by the MIT Center for Real Estate.

The drop in the quarterly transaction-based index (TBI), which tracks the price at which big pension funds buy and sell properties like shopping malls, apartment complexes and office towers, was the second straight quarterly decline. It was deeper than the 2.5 percent drop in the third quarter, and it means the cumulative fall since last year's midsummer peak is now more than 7 percent.

"This is evidence that the commercial property market continued to fall, and at an accelerated rate, through the last quarter of 2007, no doubt due to the effects of the credit crunch," said MIT Center for Real Estate Director David Geltner.

The TBI, based on properties sold from the National Council of Real Estate Investment Fiduciaries (NCREIF) data base, grew 64 percent from 2004 through 2006, then had another 8 percent spurt in the first half of 2007. The decline in the second half of 2007 still leaves commercial property prices at their level of a year ago, a level that was considered historically high at the time.

"If this is as far as it goes, the price decline we see so far in commercial property as reflected in the TBI may simply represent a correction of the froth that occurred in early 2007 as a result of very aggressive commercial mortgage underwriting practices," said Geltner.

The TBI measure of total returns for the year 2007 was 3.7 percent, which simply reflected operating income, with prices basically unchanged. Despite the upsurge in the first half of the year, this was the poorest calendar year annual performance for the index since 1992, when commercial property experienced its worst crash since the Great Depression. Index Co-Director Henry Pollakowski was quick to point out, however, that fundamentals in the commercial property market are much stronger now than they were in 1992.

"We don't have the kind of over-building we had then, and building occupancies and rents are much stronger. Commercial mortgage default rates are much lower than in the early 1990s," Pollakowski said. ...

While the NCREIF properties well represent institutional investments such as pension funds, a second index based on a broader population of properties was subsequently developed at the MIT Center for Real Estate. That index, now published by Moody's Investor Services as the Moody's/REAL Commercial Property Price Index, will release its 4th-quarter results later this month. While the TBI represents pension funds' sales, the Moody's/REAL Index represents the broader commercial property market and includes a monthly national commercial property index.

And, a chart from here:

Results for the 4th quarter of 2007 show a negative 5% capital return for the properties sold in the NCREIF database. This is the second consecutive negative quarterly price change in the all-property TBI, a cumulative fall of more than 7% since the peak in the 2nd quarter of 2007. The investment total return for all properties in the 4th quarter also registered a decline of 4.3 percent.

It's just froth? Maybe, but we've heard that before.

Comments

[Bruce Wilder]

Just as with residential housing, there is no national market, only local markets. CRE in New York City is different from Las Vegas is different from Michigan. Michigan CRE has been so in the toilet for so long, I doubt that it is even a blip in the index, but things are very ugly there.

The difficulty will arise, because this downturn in prices will
1.) bring an abrupt halt to the rise in non-residential construction, which has blunted the employment impact of the steep decline in residential construction.
2.) the medium-size banks, which are no longer a factor in residential mortgages, are, instead, heavily invested in commercial real estate construction. The good news about residential mortgages is that, subprime aside, foreclosures, while unpleasant, do net the bank/investor substantial amounts. (Servicing mortgages in foreclosure is actually quite a profitable business for a Countrywide, once they get past the cashflow squeeze of paying investors service on mortgages they have not yet been able to declare in default.) The bad news about commercial real estate construction is that an unfinished building is worthless, and finishing construction costly -- it is not uncommon for commercial real estate loans to be near total losses in a downturn. This could get really, really ugly for a whole new cohort of banks, not yet heard from.

[rufus]

The busting of the bubble is not a direct result of speculation in regionalized real estate markets, be they residential or commercial. The rupture and extent of the burst is a consequence of wild speculation in national, now international, markets for credit.

http://news.yahoo.com/s/ap/20080204/ap_on_go_ot/fed_bank_survey_1

[rufus]

To clarify, "markets for credit", i.e. markets for securitized lending derivatives

[Frank Howland]

This note may be of (self-)interest only to academics and school teachers. The TIAA Real Estate portfolio has done remarkably well, much better than the TBI index. The TIAA fund (an option for teachers and professors in the massive TIAA-CREF retirement fund family) is up 0.44% year to date, was up 2.15% in the 4th quarter of 2008, and is up 12.69% over the past year.

The fund buys commercial and retail properties. Should we believe their performance numbers?

[anne]

http://krugman.blogs.nytimes.com/2008/02/05/how-bad-is-that-ism-report/

February 5, 2008

How bad is that ISM report?
By Paul Krugman

The ISM non-manufacturing report came in today, and it’s bad. As I suggested in an earlier post, * we should take this seriously: the same report called the upturn in employment in summer 2003, so the fact that it has fallen off a cliff should worry us.

But how bad is it? The latest report has an employment diffusion index of 43.9 (50 means no change, anything less than 50 means job contraction). Here’s the historical relationship between the index (horizontal axis) and the actual monthly change in employment, in thousands (vertical axis), data since July 1997. If this report is at all right, we’re in serious recession territory.

[Graph]

* http://krugman.blogs.nytimes.com/2008/02/05/how-bad-is-that-ism-report/

[anne]

http://krugman.blogs.nytimes.com/2008/02/05/services-take-a-plunge/

February 5, 2008

Services Take a Plunge
By Paul Krugman

The ISM survey of services has plunged. *

A bit of history: back in 2003 a surge in this index signaled the beginning of the "Bush boom", which was never that much of a boom but at least marked the end of the alleged-recovery-that-felt-like-a-recession that had prevailed since late 2001. Now it has fallen off a cliff.

[Chart.]

* http://www.marketwatch.com/news/story/us-ism-services-sector-index-plunges/story.aspx?guid=%7B9EBD8850%2D57D9%2D45F2%2DBC02%2DE40E3E828A57%7D

[anne]

Darn; my sense is that we have begun a recession having never properly recovered from the last recession though growth was reasonable by the middle of 2003. These years were however not robust enough for middle income households let alone poorer households.

Frank Howland:

Notice that the Real Estate Investment Trust Index is down 23% these 12 months. The performance of the defensive TIAA-CREF real estate fund, which is open to all investors, is superb for 12 months but below index for 5 and 10 years.

[REIT Index]

If this keeps up, the REIT index fund may be worth buying in a few years.

[Marc]

"The performance of the defensive TIAA-CREF real estate fund, which is open to all investors, is superb for 12 months but below index for 5 and 10 years"

This is not a "defensive fund", its a conservatively managed private real estate portfolio with little leverage. Its not opened to all investors, rather they have restrictions on types of investors (403B plans and such) Its goal is to earn stable returns in the range of 7-10%. Typically this type of fund with generate 2/3 of its return via income (from revenue from the underlying properties) and 1/3 through capital appreciation. Given the run up in commercial real estate, that number has been flipped over the past few years. Going forward you should not expect the same returns of the past 3-5 years, but at the same time, this is not the type of investment that will free fall. I believe the last time I met with them, they were had an average cap rate around 5% for the properties they owned. In terms of performance relative to a benchmark, what Anne doesn't say (or probably even know) is that the NCREIF Index is an uninvestable index. This benchmark is comprised of ~5700 properties managed on behalf of an institutional investor (very frequently a plan asset). While its a good indicator for private real estate, its not something you can go out a buy. Personally, I think you are lucky to have this type of invest offered to you. There are very few private real estate options (there are tons of publically traded REIT funds) for individual investors. This product along with a product by Principal is a great way to diversify your portfolio, as its correlation to the equity and fixed income markets is extremely low over the long term. If you believe in Modern Portfolio Theory and create a diversified portfolio using Mean Variance Optimization, I would highly recommend this fund. If you are a market timer like other people on this board, and think you can predict when stocks, bonds, etc are going to go up and down (or even when value will outperform growth), this option might not be right for you.