CRE Message: Are we at the peak of the cycle? - by Donald Bouchard

Donald Bouchard, CRE

Ask any assortment of commercial real estate professionals, fund managers, and investors a key question and you will get a sense of their confidence in core real estate as an asset class: “How do you plan to exit this investment?”

Every elementary text on real estate investing advises the reader to identify how they intend to exit the investment when their expected holding period comes to an end.

With record low going-in returns and yield rates used to underwrite good quality assets, how will investors sell out at a profit? How will they refinance their debt should rates spike in the next few years? Is there, with apologies to Jean Paul Sarte, “No exit?”

There is no clearly defined consensus with an abundant field of optimists and pessimists each touting their own personal views of future performance. The hope, indicated one investment fund manager with whom I lunch with a few weeks ago, is that rental rates and net incomes will rise at a pace that will still allow for asset appreciation, even if interest rates and the cost of debt rises. He did admit, however, that “We aren’t buying lots of product at this point. It’s tough to compete and make the numbers work and we lose out on lots of deals because we just aren’t willing to be aggressive enough.” Have we reached a point where increases in NOI will slow substantially in some sectors? Does the Simon Property Group postponement of their huge Copley Place residential project signal the initial signs of a market slowdown?

One friend from an investment management firm complained recently that they continue to find it difficult to make the numbers work. He noted that “people are trying to sell us value-add deals at 4.5% caps! How do I make that work?” Another individual I ran into in the lobby just this morning lamented the state of the market and how hard it was to support the logic for many potential acquisitions. “It’s hard but at some point you just have to put the money to work – you can’t leave it in a drawer, the capital sources want to see some action. You can make any investment work if you tweak the Argus runs accordingly…but are we fooling ourselves in the rush to put capital to work?”

“It all comes down to risk,” noted one pension fund manager, “our advisors provide us with an annual report across fifteen asset classes and they model recommended allocations. They still think core real estate is an area where we have to be, given the returns. What we continue to hear is that core commercial real estate is still seen as one of the more attractive areas in which to invest despite the identified risks and we continue to allocate a substantial portion of our funds in that area.”

While it is important to identify that investments do not always work out for a host of reasons, the actions of buyer and sellers are what really express the sentiments of the investment community as a whole. What the market has been telling us is that the pricing of high quality core assets in good markets was supported by a broader economic outlook and the relative attractiveness of commercial real estate as a stable asset class. I am beginning to see a bit of nervousness in people. Perhaps is the length of the current cycle. Perhaps it’s the chaos and uncertainty of the election season. Regardless, that is of course always a way out of any investment…one way or another of course.

Donald Bouchard, CRE is a senior vice president at Lincoln Property Company, Boston and is the 2016 chair of the New England Chapter of the Counselors of Real Estate.