Is Commercial Real Estate in a Bubble? Here's What 13 Top Economists Think
Commercial real estate prices are through the roof, and now the Fed has voiced concerns over a potential bubble. But has it formed yet? We reached out to some of the country’s top economists to get their take. Here’s what they told us.
Ray Torto, Harvard Lecturer and Former Global Chief Economist, CBRE
"No, not yet! Nationally, earnings are growing, and will continue to do so for a few more years. There are some markets where earnings are slowing, however, and are near bubble territory. The key is to know the difference!"
Mark Vitner, Senior Economist, Wells Fargo Securities
"I would not characterize the commercial real estate market as a bubble right now but certain investment themes have become pretty frothy. The whole Millennial craze seems to have gotten ahead of itself. There is a mad rush to get apartment projects started around much of the country and there is little doubt that supply has gotten ahead of demand. But demand has also proved to be stronger than many naysayers had expected. Most other product categories have seen much less modest additions to supply. Lower interest rates have helped fuel a run-up in values, which will soon be tested by rising interest rates and the stronger dollar. From an operating standpoint, however, demand is just now showing its first real signs of improvement, and office vacancy rates have fallen enough that rents are now high enough to support new construction in many areas. We are optimistic about the economy's prospects during the second half of this year and 2016, so it is hard to get too worried about commercial real estate right now."
Robert Bach, Director of Research - Americas, Newmark Grubb Knight Frank
"Alan Greenspan said we don’t know we’re in a bubble until it pops, and Ben Bernanke proved him right by failing to recognize the subprime mortgage bubble until it was too late. Janet Yellen is covering her bases by expressing concern for rapidly rising prices in commercial real estate. Having said that, I think we’re not in a bubble now, and the reason we’re not is that inflation and interest rates are so low. Here we are entering year seven of the recovery cycle—already longer than the last recovery cycle and also the average post-World War II recovery cycle. Yet interest rates remain extraordinarily low, and inflation remains below the Fed’s target. The key is wage growth. The Fed wants wages to rise, but if wages rise quickly, it would feed into overall inflation, and the Fed would have to raise interest rates quickly—which would bleed through to cap rates and property values. The Fed and the Fed-watchers have agonized about this for years, and the Fed may raise rates by a quarter of a point in September or December. And maybe they won’t. In the meantime, fundamentals continue to tighten. It’s the golden age of real estate. Will it end? Of course it will. Real estate is cyclical. And in hindsight, we’ll say we were in a bubble. But the conditions just don’t seem ripe for it to burst anytime soon."
Victor Calanog, Chief Economist, Reis
“It seems premature to say that there is a bubble forming in commercial real estate. Largely because interest rates are still low, spreads remain high despite cap rates in gateway markets trending in the 4s and 5s. Credit conditions remain tight except perhaps for multifamily lending in the most active of markets. This doesn’t mean that mini-bubbles aren’t forming, and the prospect of foreign dollars pushing prices up even more as non-domestic investments look increasingly risky is always present. Directly investing in commercial real estate also doesn’t represent hot money that can be pulled out quickly if herd mentality shifts negatively. There are wild cards in the international scene and financial imbalances can creep up in unexpected places, so vigilance is always key. But for now, fears of commercial real estate overvaluation approaching bubble-like conditions appear overstated, except in a handful of markets and property types.”
Jamie Woodwell, VP for Commercial Real Estate Research, Mortgage Bankers Association
"Current commercial real estate pricing is a direct function of today’s low interest rate, low-yield environment. Property incomes have been increasing, which helps boost values. In addition, investors in commercial real estate properties continue to receive a strong premium over base rates like the 10-year Treasury. So even though prices are high and capitalization rates are low on an absolute basis, on a relative basis, they are right about where you’d expect given the current climate. So, no, pricing is not untethered from market fundamentals.”
Suzanne Mulvee, Director of Research, CoStar Portfolio Strategy
"Although pricing is now very near—if not above—last cycle’s peak, CRE is far from bubble territory. Instead, valuations on average are well supported by current fundamentals and in-place cash flows. With most markets in an expansionary part of the cycle, there is optimism that rent and NOI will continue to rise. This would certainly support higher valuations even if cap rates were static. However, capital flows into real estate are likely to increase this year, as both domestic and foreign investors look to increase exposure to US CRE, which could arguably put additional downward pressure on cap rates. There are specific markets and select property types that are feeling frothy—multifamily in San Francisco, for example—but on average, it should be another solid year of performance for US commercial real estate."
Mark Dotzour, Chief Economist, Real Estate Center, Texas A&M University
"It's a tale of two markets in the US commercial real estate market. Properties that are purchased by REITs, pension funds and foreign sovereign wealth funds are clearly in a bubble. But the vast majority of properties across America are highly priced, but not in a bubble."
Rajeev Dhawan, Director of Economic Forecasting Center at J. Mack Robinson College of Business, Georgia State University
"The idea that commercial real estate has a bubble is very intriguing as I am of the viewpoint (based on what I was taught in graduate school) that you can smell it, even feel it at times but you cannot prove it in a court of law using known statistical tools that a bubble exists! That said, the talk of a bubble usually surfaces when the business cycle is maturing and the Federal Reserve is then hinting about raising rates. This usually sets off soul searching among buyers of real estate that could they be the last one left standing when the music stops. For a bubble to burst you need a large supply of the product to hit the market in very short time. This is not happening collectively for the nation. But looking at the apartment building boom of high-rise apartments for rent from San Francisco to Atlanta, down the road—when investors offload these assets—the buyers may not be as willing to pay the premium. For office buildings, I have a fear that monthly job growth of a quarter million doesn’t generate as much demand for office space as the late 1990s would. That said, a rate hike by the Fed, whenever it happens, would signal that the growth pace is hot, which is always good news for valuations. So just breathe!"
Brad Case, SVP of Research & Industry Information, NAREIT
"No. Property values have already come down more than 9% from where they were six months ago. They’re currently only 1.2% above the earlier peak they reached in early 2007—nearly eight and a half years ago—even though 5.6% more people are working. Meanwhile, the real value of new construction is still one-third less than it was in 2007 levels—in fact, construction hasn’t even recovered to where it was in 1993. In short, supply continues to be constrained while demand continues to increase, so property values are actually quite well supported by macro conditions in the real estate market."
Jeffrey Havsy, Americas Chief Economist, CBRE
“No, I don’t think commercial real estate is in a bubble. There are certain markets and property types that are flashing warning signals, but the majority of markets and property types have good fundamentals. Similar to fundamentals, pricing is extremely aggressive in a few places, but most markets are within an acceptable range. Though at the high end of the range, we are seeing LTVs rise and the availability of interest only loans are being offered with greater frequency and that does bear watching. As we know from past history, real estate has the ability to go from boom to bust quickly. However, we don’t think the market is overheated at the moment.”
Andrew Nelson, US Chief Economist, Colliers International
"While transaction levels are surging across many prime locations across the US, I wouldn’t say that most markets are overheating. Based on a price per-square-foot basis, property is expensive in some top markets—but the true picture of the market comes through measurement on a cap rate basis relative to property income. Cap rates are quite low for the best properties, which typically indicates modest returns and expensive pricing. But, both inflation and interest rates are at historic lows. Taking this into account, pricing looks much more reasonable as the spread between cap rates and the 10-year US Treasury note are still above their long-term averages."
Ben Breslau, Director of Americas Research, JLL
“We’re not in a bubble yet. There are some pockets that feel frothy for sure, but we believe this economic cycle is only in about the sixth or seventh inning. Even with initial rate liftoff later this year, monetary policy will remain extraordinarily accommodative, job growth is fueling steady demand in most places, and construction overall is just getting ramped up. Capital is abundant and risks around the world mean the US markets are positioned well comparatively. The trajectory will be different across geographies and property types, but look for two to three more good years in this run.”
Christopher Thornberg, Founding Partner, Beacon Economics
"No bubble…yet. Bubbles are leverage-driven speculative financial plays that push prices far beyond their stable long-run value. The market today is driven by cash—a glut of savings trying to find a home in a low capital demand world. Valuations still look reasonable and the pace of building still muted. Will it turn into a bubble? Maybe—rallies often overshoot. But we aren’t there yet."