Capital Is Rushing To U.S. CRE In Search Of Yield, Causing 'Potential For A Bubble'
The spread of negative interest rates throughout the globe is puffing up the chests of U.S. commercial real estate as a strong asset as foreign investors chase yields. But that could soon turn into the overinflation of a bubble as the rush of investors pushes up pricing.
Foreign investors have purchased more than $60B in U.S. commercial real estate from the third quarter of 2018 until the third quarter of this year, Real Capital Analytics reported, with $25.5B coming from Canada and another $17B from Europe. That inflow, along with overall demand from investors in the U.S. for commercial real estate, has been pushing up property pricing, Summit Investors CEO Greg Winchester told a Bisnow audience last week at the Atlanta 2020 Outlook event.
But there is still a lot of capital poised to pounce on deals. Institutional investors have some $200B, as of the third quarter, available to invest in U.S. commercial real estate, according to a recent Newmark Knight Frank report.
“There's also the risk of too much capital. That is one of the highest levels of concerns that I have,” Winchester said. “There may be too much money that comes into our industry and causes overbuilding or excess in terms of debt and investments.”
Winchester cited the proliferation of debt in commercial real estate as well, as banks and other investors search for better yields. Real estate debt is $1 trillion more today than commercial real estate owners took on in 2008 — the year of the credit crisis and the start of the Great Recession — Winchester said.
“Overall financing activity is poised to exceed 2018's total of $597B, as debt remains historically inexpensive and as liquidity and transaction volume is at a cycle high,” NKF officials wrote in the report.
So far that debt is being managed by historically low interest rates, especially after the Federal Reserve made another recent cut to the federal interest rate, Winchester said. U.S. commercial real estate remains an alluring alternative to other global markets or investment vehicles.
While yields on U.S. commercial real estate continue to get squeezed, even a return of 4% to 5% is more appealing than staying in some European banks where storing money in an account actually costs customers, a phenomenon known as negative interest rates, Winchester said.
Since 2014, various countries have experimented with negative interest rate policies, including Japan and Switzerland. Most recently, the European Central Bank pushed rates into negative territories even further.
“That's causing a chase for yield. And real estate is right in the bull's-eye for many money managers and pension fund managers and people with serious capital,” Winchester said. “We're the beneficiaries of that, but we need to be careful. I don't think we're in a bubble yet, but there's a potential for a bubble.”
Many investors are focused on the income already in place in a building over what potential cap rate they will achieve when they resell the asset in the future, an industry metric known as cash-on-cash yield.
“In most markets to get an 8-on-8 cash yield, you've got to go really far up the risk spectrum. In the U.S., you can do it with a pretty reasonable risk profile. So I think it remains attractive for foreign institutions,” Cortland Vice President Max Rothkopf said. “The real estate returns still look pretty attractive even without any upside of cap rates upfront.”
That chase for yield is pumping up demand for commercial properties in Atlanta, The Graham Group Managing Partner Jeffrey Graham said.
“It's interesting to now see how that dynamic has changed. Now [I've] got all of the REITs looking for office here in Atlanta again, and retail,” Graham said. "I think that Atlanta, while there [are] challenges certainly around, is certainly looking more opportunistic."
Winchester cautioned that real estate investment and development deals could be set up for failure by aggressive investors and lenders.
“Lenders and investors kind of inch out onto the risk spectrum and start taking a little more risk because they've got to do that next deal or they feel they have to do that next deal," he said. "So if you're involved in a deal and it feels like in order for it to really work everything must work … I would pause and I would think about how can I avoid having a deal where everything must work. Because anybody whose been in the business knows, there's something that's going to occur that's going to cause a change or delay."
Yet Winchester and other panelists' outlook on the Atlanta economy was bullish through 2020, despite a number of headwinds. Part of the optimism is being driven by projected spending on Metro Atlanta infrastructure in the coming years.
With a projected influx of 3 million new residents in the region, the Atlanta Regional Commission is finishing up a 20-year outlook on growth and the regional issues that come with it. That has the ARC planning to spend more than $170M on everything from roads and bridges to new parks and transit, the Atlanta Business Chronicle recently reported.
“The amount of construction, whether its rail, light rail, pedestrians trails, roads, whatever, is going to be profound,” Winchester said.