WASHINGTON, DC—The Dow Jones industrial average, as we all know, closed on Friday some 531 points lower, entering into a correction for the first time since 2011.Likewise the Nasdaq Composition, which closed on Friday 3.5% lower.
The reason, again as most people are aware, is due largely to the uncertainty about China, egged on a bit further by oil prices that dropped, albeit briefly, to below $40 a barrel.
Ironically, the US economy itself is fine although certainly not as robust as most would like to see, but then that has been its story since the beginning of the recovery.
We will know soon enough whether the stock market will continue to fall on Monday and throughout the week, or perhaps recover slightly as sometimes happens in a correction.
What will take time to unfold, however, is the depth of the impact the correction will have on the commercial real estate industry. And yes, there almost surely will bean impact.
Here’s why.
Yellen’s big decision
Right now the entire global business community would love to get inside FederalReserve Bank Chair Janet Yellen’s head for just five minutes. Will she pull the trigger onraising interest rates in September or not? The guessing game will continue up until thelast moment, but certainly last week’s events give her another reason to hold off for atleast a quarter.
For the CRE industry, whether rates are increased in September both does and doesn’t matter.
Sure, a rate increase will affect borrowers for current projects, as well as borrowers that are seeking to refinance CMBS and other loans made during the last cycle and now coming due. But there have been signs that debt is tightening and borrowing conditions have been worsening for some time now. More volatility will hasten this and cause lenders to retrench even faster – even if this volatility also forces Yellen to conclude she must hold off on a rate increase.
Assets’ true value becomes clear. Investors don’t like what they see
There is a school of thought that the Federal Reserve’s easy monetary policiesof the last ten years have caused asset price inflation, even a bubble. With Treasury yields a nonstarter for investors for much of the past decade, they have fanned out in search of other categories, placing money in alternative assets including real estate.
It has been assumed that when Treasury yields increase many will return home to these securities. This widespread assumption is why, after all, REITs have been struggling for much of this year.
But with rates at near zero for so long, the Federal Reserve has no firepower at the ready should another crisis unfold. Sure, it could keep rates at their current level, but that would have at best a muted effect, many economists have said.This is the scenario investors should fear: The Fed keeps rates at zero but it isn’t helping. All of a sudden, the perception that the Fed will keep the economy safe and sound crumbles for investors. The crisis unfolding overseas worse nsand starts to impact the US economy and guess what? There are few buyers interested in these investors’ now overpriced assets.
Yes, that scenario includes commercial real estate and it is not a new one.
There has been an uneasy sense brewing for some time that the property prices are inflated beyond their “true” value, a fear that was also voiced by Yellen recently and that Situs RERC quantified recently in its 2Q15 surveyresults of institutional commercial real estate investors.
They signaled a clear shift away from a bull market with prices aligned to an overpriced market, it said especially for core properties in the top markets.
Among its findings:
- The required goingin cap rate for office, industrial warehouse,apartment, and neighborhood/community retail sectors were the lowest ratings on record, which means valuations are soaring while yields depressing.
- Required pretax yield rate for the apartment sector was the lowest it has been since 1989.
- Respondents rating of cash holdings (vs. CRE, stocks, bonds)increased to a level that had not been reached since 2011 duringthe uncertainty related to the debt ceiling crisis.
All of this, it must be noted again, occurred prior to the past week’s events.