Commercial real estate is showing signs of a market bottom, says Mike Kirby, chairman of Green Street Advisors, a Real Estate Investment Trust (REIT) research firm. Kirby tells TIME which parts of the market are turning up and who's doing the buying.
You've said commercial property values are up 20% from the lows. Other reports say we're still down 40%. So where are we, really?
Our view on property pricing differs from conventional wisdom. Some other indexes, published by Moody's and MIT, show that property prices went down 40% and that they've generally stayed there. But we show they're now down 25% from their peak. The reason for the difference is that their indices track transactions ours tracks deals that haven't yet closed. It takes an awful long time for their index to capture the essence of the news going on in the market right now. Buyers and sellers of commercial property are striking handshakes at prices that are substantially above where deals are closing, and that's part of what's missing from other indices.
Are all regions bouncing back?
Manhattan and Washington, D.C., in particular, have had very robust increases in value. Everyplace else, it's been weaker. And that's probably the defining differential. Manhattan took a bigger hit, so it had further to bounce back. Some of the buying activity has been foreign, and they typically flock to those two markets first. We're also seeing some activity in San Francisco and Boston, but not to the extent we've seen in the other two.
Where's the foreign money coming from?
It's mainly Arab money. They've been the main source so far. The German syndicators [i.e., investment pools] are back in business. They've been toeing around the market. There's also been interest from sovereign wealth funds of all stripes. But particularly it's Middle Eastern money.
What about the nagging worry that commercial real estate is the next crisis?
This whole premise that commercial real estate is "the next shoe to drop" is overstated. Clearly, we have problems, since there are many mortgages out there that were underwritten using very aggressive assumptions, and those will be difficult to refinance. But the good news is, if you look at our property index, we're back to 2005 pricing. So that means that most properties that were financed in '04 and '05 are not going to be much of a challenge to get refinanced. And, yes, the '06 and '07 deals, which some indices say are still underwater, will also need to be recapitalized. The good news is, there's a very long line of capital sources that have shown up in the last nine months that are ready, willing and able to play that role.
But weren't there some really bad deals?
Pretty much anything Blackstone sold at the peak out of its equity-office portfolio. Then there was the Archstone deal the privatization of a blue-chip REIT at a very rich price that did a huge amount of damage to Lehman Brothers and Tishman Speyer. There's no shortage of headlines saying, "Boy, can you believe how stupid that deal was?" but I think in general everybody's taken a small hit but nobody's bleeding too badly.
What types of properties are rebounding?
The biggest increases in value are the same sectors that had the biggest decreases in value. Hotels went down the most, offices went down the second most, and those rebounded the most. Apartments got hit the least, and malls didn't get hit too terribly hard, and their rebounds have been smaller. Even with the rebound, hotel and office land investors will continue to feel the pain over the next three to four years, more than apartment land investors.
How is the rental market?
You're still seeing problems in terms of vacancy rates and stagnant rental rates. But the important thing is that a recovery is visible. It may take a while to play out real estate does tend to lag the economy, but there are positive developments. The primary driver for real estate value is the low return requirements everywhere else. So a year ago, corporate-bond yields dropped from 9% to 6%. Real estate returns are now in their mid-sevens. It's the drop in bond-market returns that makes real estate look pretty darn good right now.
So it's a good time to invest now?
You get a decent return, and you're buying at the bottom of the cycle. Real estate being a historically cyclical animal, you know, it's not going to be a good year next year, or even the year after the cash flows are going to stink but eventually, what has gone down comes back up. So we're sitting at a historically low occupancy and rental rates, but barring a double dip, there's only one way to go.