Time For CRE Prices To Fall? Yes, No, Maybe So.

Roughly three months into a global economic crisis spurred by the coronavirus pandemic, the direction of commercial real estate valuation is still uncertain.

Bargain-hunting buyers want to buy, but apparently not at the prices sellers want to sell or have to sell, yet.

Pricing remains problematic because deal volume has collapsed, with U.S. CRE investment down about 71% year-over-year in April.

"Buyers and owners are becoming more cautious," Real Capital Analytics Senior Vice President Jim Costello writes. "That caution will lead potential buyers to reduce what they are willing to pay and will leave owners hesitant to sell at any price.

"Measuring the disconnect between buyer and seller expectations is tricky, but possible ...," Costello writes, citing calculations by the MIT Center for Real Estate Price Dynamics Platform. "The gap in expectations between buyers and sellers is such that if we wanted to see a more normal level of deal volume, owners would need to cut office prices by 12% for the market to clear." 

The apartment sector would need to see an 8% correction in prices to put deal volume at normal levels, while industrial only needs a 6% adjustment, according to Costello.

"The key issue, though, is that this decline has not happened yet," he writes. "As long as the lending market does not seize up like in the global financial crisis, where credit was unavailable at any price, owners can delay potential losses."

There are some indications that prices are beginning to slip. In June, Green Street Advisors reported that its Commercial Property Price Index dropped by 0.7% in May, but almost all of the decline was down to hospitality property prices, which fell 10% that month.

Other property types didn't move much compared with April. So far this year, the index is down 11%.

“It’s too early to be definitive, but at this point, 10%, plus or minus feels like a good betting line for COVID’s impact on pricing,” Green Street Managing Director Peter Rothemund said in a statement.

“Of course, there are relative winners and losers," Rothemund said. "Property types such as industrial, manufactured home parks, and self-storage are experiencing only modest slippages in pricing, while the most impacted sectors, lodging and malls, may see declines at least twice as large as the average by the time the dust settles.” 

How much will prices slip this year? The Urban Land Institute's latest Real Estate Economic Forecast, which is based on a May survey of 39 economists and analysts at 35 real estate organizations, predicts that commercial real estate prices will fall by only 7% in 2020, which compares favorably to price drops in 2008 (13.6%) and 2009 (20.8%), as measured by RCA.

In predicting a relatively mild drop, survey respondents noted that debt financing is expected to be more available this year than it was during the global financial crisis of the 2000s. For example, issuance of CMBS is expected to total $45B in 2020, dwarfing the 2009 total of $3B.