The Fickle Market

As the economy recovers, investors and lenders alike have been eagerly pouring money back into real estate. The capital markets, however, remain a fickle place. Recent events prove yet again that the field is best served by those who really understand it.

In May, the 10-year Treasury began increasing amid worries about the Federal Reserve’s plan to cut back its bond investment program. Then in June, comments by Fed chairman Ben Bernanke prompted an uptick in interest rates, even though the federal funds rate remained untouched.

None of these increases have been significant in a historical context, but these days even a hint of higher rates stirs panic. Moreover, the broader investment market tends to equate real estate with bonds and higher interest rates with lower yields, as the National Association of Real Estate Investment Trusts recently reported. As a result, REIT stocks have underperformed other indices of late: the FTSE NAREIT U.S. REIT Index posted a total return of 0.83 percent in July, versus 5.09 percent for the S&P 500 and 6.56 percent for the NASDAQ Composite, NAREIT noted.

Even the most experienced real estate investors are still proceeding cautiously. Many are targeting only 24-hour gateway cities, and even the much discussed expansion into secondary markets usually means the larger “primary-secondary” markets that offer space constraints and strong job growth. Those venturing farther afield—and they do include foreign investors and pension fund advisors, as well as typically more adventurous private money—are sticking to better-quality assets or those with stable tenants.

All that said, real estate continues to attract investors in droves, though the fastest-growing categories are shifting. Multi-family property sales totaled $33.3 billion during the first half, but volume increased only 5 percent compared with the same period last year, according to Real Capital Analytics Inc. Office sales rose 22 percent, to $38.4 billion, and hotel deals jumped 69 percent to $12.8 billion. That’s quite a switch from a year ago, when first-half apartment sales grew 23 percent and office deals edged up just 7 percent. (Industrial sales rose 10 percent during the first half of this year, and retail transactions fell 11 percent.)

Does this point to a multi-family bubble in the making—or, instead, to a maturing market? Jones Lang LaSalle Inc.’s first-quarter apartment property clock, which shows the sector peaking in many cities, suggests the latter.
Some investors and financiers are also raising the bubble question about the mortgage market. While origination volume is much lower now than it was at its 2007 peak, according to the Mortgage Bankers Association, the CMBS market is growing. Since life insurance companies and banks are lending more, that bodes well—but only if lenders stay disciplined.

Where do we go from here? That depends on the decisions of both lenders and investors as we await improvement in market fundamentals. Take a closer look at debt, investment, valuation and REIT trends in this month’s special focus on investment and the capital markets.

Suzann D. Silverman, Editorial Director