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Research Video
November 17, 2021
Is a Bubble Forming
In Commercial Real Estate?
- Do property fundamentals support current pricing levels?
- How are values and revenues across various asset classes?
- Is there a risk of a major price correction?
At a conference last week, an investor asked a great question. Is a bubble forming in commercial real estate? Now to start, there are a few property types that are definitely not in a bubble. Retail real estate price prices are up 1.9% from pre pandemic levels at the end of 2019, while revenues based on the change in occupancy and rent are up by 2.2%. Retail actually looks like a bit of a bargain right now, especially with retail centers making a recovery from the pandemic shutdown.
Urban Office is another property type that isn't showing any bubble characteristics. Prices for these assets are down by about two and a half percent from pre pandemic levels, and revenues are down by 9.6%. But the wild card on this property type is what a return to the office will look like in 2022. So I'm going to give Urban office a pass. Suburban office looks a little more aggressive.
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Prices are up by about eleven and a half percent, and revenues are down by just over 1%. But again, there's the wildcard of what the return to the office will look like. In addition, there's been significant migration to the suburbs as millennials have aged into family formation years that could drive future space demand for suburban office. So suburban office pricing doesn't look like a bubble either. It looks like a reasonable bet on future demand growth.
Now, for the big three, the property types with the greatest pricing pressure and investor enthusiasm. First, apartments, there's a lot of speculation that apartment pricing is overheated. We're seeing cap rates hit record lows and record high prices in many markets, mostly high population growth areas on a national basis. The average price per unit of apartments are up by 11.9% from where they were at the end of 2019, but revenues are up by 12.6%, and vacancies are at a record low. 2.8%.
No bubble here. The current pricing is substantiated by revenue growth, at least on a national level. In addition, there are numerous signs that we are in a severe housing shortage that will continue to fuel demand for apartments, while housing construction is not keeping up with the household formation drivers. Now, the story for self storage is comparable. Prices are up by about 15 and a half percent, but revenues are up by 17.2%, and vacancy rates are also at a record low.
5.5%. The pace of self storage construction has abated from peak levels, so supply side risk is limited for the next year or two. The big question is whether the pandemic driven demand surge will hold. That's a bit of an open debate, but millennials are driving about 39% of the self storage demand. And based on the housing crunch, I suspect their storage needs are sustainable at least over the next couple of years.
I have bigger questions about the supply and demand outlook in three to five years because it looks like the pace of self storage construction will reignite. But for now the pricing is validated by the operating income for these assets. The last property type is the one with the most exuberance. Industrial prices are up 22.3% from pre pandemic levels, and while revenues are up by 11% and vacancies are at a record low 4.4%, there's a bit of a gap there that said, investors are purchasing these properties based on rising demand.
This is driven by ecommerce and the disrupted supply chains that have forced retailers to bulk up inventories.
But even though industrial absorption is at a record level, so is construction, and new development could ultimately bypass demand. So I don't see any real bubbles forming in commercial real estate, at least not on a macro level. But investors should closely consider the three to five year supply and demand outlook when making their decisions. Commercial real estate is a long term investment and that's, as always, investors need to keep their eyes on the horizon.
Now, for the big three, the property types with the greatest pricing pressure and investor enthusiasm. First, apartments, there's a lot of speculation that apartment pricing is overheated. We're seeing cap rates hit record lows and record high prices in many markets, mostly high population growth areas on a national basis. The average price per unit of apartments are up by 11.9% from where they were at the end of 2019, but revenues are up by 12.6%, and vacancies are at a record low. 2.8%.
No bubble here. The current pricing is substantiated by revenue growth, at least on a national level. In addition, there are numerous signs that we are in a severe housing shortage that will continue to fuel demand for apartments, while housing construction is not keeping up with the household formation drivers. Now, the story for self storage is comparable. Prices are up by about 15 and a half percent, but revenues are up by 17.2%, and vacancy rates are also at a record low.
5.5%. The pace of self storage construction has abated from peak levels, so supply side risk is limited for the next year or two. The big question is whether the pandemic driven demand surge will hold. That's a bit of an open debate, but millennials are driving about 39% of the self storage demand. And based on the housing crunch, I suspect their storage needs are sustainable at least over the next couple of years.
I have bigger questions about the supply and demand outlook in three to five years because it looks like the pace of self storage construction will reignite. But for now the pricing is validated by the operating income for these assets. The last property type is the one with the most exuberance. Industrial prices are up 22.3% from pre pandemic levels, and while revenues are up by 11% and vacancies are at a record low 4.4%, there's a bit of a gap there that said, investors are purchasing these properties based on rising demand.
This is driven by ecommerce and the disrupted supply chains that have forced retailers to bulk up inventories.
But even though industrial absorption is at a record level, so is construction, and new development could ultimately bypass demand. So I don't see any real bubbles forming in commercial real estate, at least not on a macro level. But investors should closely consider the three to five year supply and demand outlook when making their decisions. Commercial real estate is a long term investment and that's, as always, investors need to keep their eyes on the horizon.
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