One of the most striking outcomes of the Great Recession in the U.S. is the contrasting experience of the “haves” and “have-nots.” This is true for individuals: those who kept (good, full-time) jobs are, in many cases, better off than they were in 2007/08, whereas those who lost jobs are in dire straits. This is also true for corporations: the largest companies (especially big banks) are now raking in record-setting profits, while smaller businesses continue to be squeezed. For that matter, this is even true for fully discretionary expenditures: in the midst of 10% unemployment and a seemingly endless foreclosure epidemic, there are plenty of ultra-high-end restaurants in every major city that still need to be booked months in advance.
And this is definitely true for commercial real estate markets. Transaction indices suggest, and anecdotal observations confirm, that U.S. commercial real estate (CRE) prices have risen substantially over the past year in a few high profile markets, notably New York and Washington, DC, due to intense investor interest. Yet values in most other U.S. cities, if they have moved up at all, have not benefited nearly as much as those in top-tier markets. Conventional wisdom suggests that over the near term there will be a pricing convergence between these “international gateway” cities and the rest of the U.S., either via falling prices in the former or substantial price increases in the latter.
This paper argues against this conventional wisdom. Pricing divergence between the have and the have-nots will remain, and in fact widen, for the next two to three years due to a combination of persistently low risk-free rates, hungry global capital, earlier recoveries in international gateway cities and, most importantly, a scarcity of willing lenders for non-stabilized assets. Specifically, this paper will look at the three drivers of property pricing: 1) tenant demand; 2) investor demand for CRE; and 3) debt availability. Although the first two drivers will be net positives, the scarcity of debt will more than offset them in most markets, delaying a price recovery in the have-nots until the deleveraging cycle has run further.
For near-term investments, the key question is which have-not markets will move into the ranks of the haves, and which will remain have-nots. These “next-tier” markets are likely to attract a lot of capital, with cap rate compression similar to what occurred in the international gateway markets in 2010.
Source : CBRE Global Investors