Commercial Real Estate: Bubbles, Bursts, Recovery, When?
Of course I don’t have the answer to this question. But maybe through looking back a little at how we got here, we can gain a little foresight as to what the future will bring. We know now that the Real Estate Bubble — that started in 2004 and ended in 2007 — took prices and volume to unsustainable levels, and resulted in the burst and the doldrums that we are currently facing. Prices for commercial real estate in that period nearly doubled and volume soared. The fuel that created this bubble was the unprecedented way banks were lending , and the over-speculative mindset of buyers during that period. Many observers and investors during that period knew that many of Headline deals at that time just didn’t make any sense, but that didn’t slow things down. Every office building sales offering included the terms like “Plenty of Upside” and “Below market rents”. Weekly news of RE Investors making huge profits on buildings they had only held a year or two blinded banks and investors from foreseeing the inevitable burst.
Commercial Real Estate: Low Prices and Low Demand.
You will hear many times, that now is a good time to buy, that pricing is at 2004 or 2005 levels, and that the excess pricing of the bubble years has been wiped away. By the same token, though, volume is nowhere close to 2004 levels. Ask anyone in the RE industry… they’d be more than happy to see sales volumes at 2004 levels. Based on basic supply and demand principles, price and volume have everything to do with each other.
Today, most people in the real estate industry blame banks for being too tight on credit and on sellers for unrealistic pricing. It’s true that banks have tightened lending in response to their near collapse, and sellers are holding on to inflated prices because lowering prices will wipe out their equity. More than ever, banks are modifying loans rather than forcing properties into foreclosure, lessening the amount of properties on the market.
Commercial Real Estate: Price Properties Based on Income.
In a common sense approach, pricing should have everything to do with net income, and almost nothing to do with projected upside in rents and future pricing. Rents are based on what a particular market will pay. Businesses that pay rent look at rent like any other expense, and will only pay what they project will keep their company profitable. Like any other expense, rents do to tend to rise, just like labor, supplies and services. However, they only tend to rise at small yearly increments, tied into inflation. This is the basis of a stable economy and a stable industry, Tying in RE prices to rents and net income would produce a very stable RE market.
So back to the question “Recovery: when?”, the answer is still the same. Maybe prices are where they should be. Most buyers right now are only looking at income as a way to set prices. Or perhaps, based on the current volume, prices still have further down to go. Who knows? What I do know is that we are still in the recovery stage. Banks and investors still need more time to repair themselves.
If nothing else, I hope we’ve learned from this period and won’t make the same mistakes that affected businesses and economies. After all, economies should affect commercial real estate, but real estate should never affect economies.
