With eclipse-mania in full force, we note that according to market professionals, commercial real estate has gone through an eclipse of its own and is now starting to wane. A survey released last week by JP Morgan of major real estate investors to include banks, insurance companies, pension managers, hedge funds, money managers and REITs shows that most investors believe we are in the late stages of the commercial real estate market expansion and that a more defensive posture is warranted. Only about a quarter of these investors actively sought to put new capital to work in commercial real estate without about half holding neutral and maintaining their existing exposure. In this article, we explore the results of that survey and translate into a crowdsourced outlook for what it means to the debt holders of the commercial real estate capital structure.
The Commercial Real Estate Cycle
Earlier this month, we gave our forecast (HERE), based on our data set and model, of where we think we are in the current cycle. We looked at a variety of metrics to arrive at the analogous inning for every major sector for every major city. Today’s analysis now takes a different approach and instead of just looking at pure data (vacancies, rents, asset prices, etc.), we used JP Morgan’s recent survey done in August to marry both data and experience and get a crowdsourced view of the future of commercial real estate.
Survey results indicate that a majority of the investors, some 84% believe we are either at our peak or past our peak with 13% calling for the beginning of the end and that we have now entered an early correction phase.
When asked when will the CRE cycle might start to correct, most thought (47%) that next year is the likely year of when we enter the correction phase with 26% of that number going so far as calling the second half of next year of when that event will occur. 37% called 2019 as the year the CRE market was going to contact, and risk gets monetized, and 11% thought it was in 2020 or beyond.
The catalyst most often cited for this correction is a combination of higher interest rates and a change in investor behavior driven by a combination of greater political risks in the U.S. hurting the future outlook of improving returns.
With regards to sector type, we took the survey’s output and turned the data into a sentiment score for the current confidence level by property type. Core, urban market office properties, for example, are currently viewed favorably with an average of 64% of the investors still looking to put money to work in that property type. Multifamily, while overheated in some markets, is also still the most aggressively sought type of investment. Supply is projected to be short of demand in many markets helping future economics. Conversely, smaller retail centers with no major tenants, while strong last year, has taken a turn and is a sector that is actively being divested.
Putting This Into Action
Community banks often don’t distinguish when it comes to credit ratings, pricing or underwriting the difference in sectors. As you can see above and by our past analysis, the performance difference and future outlook is materially different and directly impacts a loan’s credit performance. While what the “smart money” thinks may not have a direct impact on your particular bank’s footprint, it is highly likely that it will at least have an indirect impact. Considering that these survey respondents can alone cause a correction, it is at least worth keeping tabs on how their sentiment trends.
Submitted by Chris Nichols on August 21, 2017