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Fed Woes About CRE Pricing May Be Overblown

The Federal Reserve is keeping a close eye on the expansion of gross domestic product, rising inflation and fiscal stimulus to determine when the next rate increase should take place, but commercial real estate is causing central bankers particular concern.  

In its semi-annual Monetary Policy Report to Congress, the Fed said rising commercial real estate valuations have been a concern for the past year, “with property prices continuing to climb and capitalization rates decreasing to historically low levels.”

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But economists at the National Association of REITs don’t share the Fed’s concern. In a recent market outlook report, NAREIT said commercial real estate should remain strong this year, benefiting from sustained economic momentum and rising leasing demand. “Indeed, we expect this real estate cycle may last much longer than the average cycle in the past,” said Calvin Schnure, NAREIT senior vice president of research and economic analysis.

Commercial property prices have more than doubled from pre-crisis levels, according to Green Street Advisors, Reuters reports. Last month Fed Chair Janet Yellen commented on inflated real estate prices during a speech at Stanford University, and other officials, including Boston Fed president Eric Rosengren, are eyeing the growth of luxury housing with trepidation. Most Fed officials have said they prefer to address any price bubbles through financial supervision rather than raising rates quickly.

Schnure said though the cycle is maturing the association expects fundamental sources of demand to remain strong. Construction remains below past peak levels, NAREIT reports, and that is taking into account construction of commercial properties adjusted for inflation and that the economy has expanded by more than 60%. In addition, the labor market has shown signs of room for growth, with unemployment rising to 4.8% in January as more Americans jumped back into the workforce.

“New supply remains in check. While construction has ramped up, it remains well below levels reached in past cycles, and there are few signs of overbuilding. Vacancy rates in most sectors are still moving down, supporting rent growth,” Schnure said. “REITs are likely to continue to benefit from solid growth of demand for leased space in this economic environment.”