Commercial real estate showing signs of life?

Non-distressed properties may have found a bottom in 3Q 2009

For the past months, everyone has been warning about the impending implosion of commercial real estate — the next un-natural disaster waiting to wreak mayhem on the banking system. So it was quite a surprise when M.I.T. released a commercial real estate index showing a 4.4% rise in prices in the third quarter, the first uptick in more than a year. Further, transactions surged 12%, a first in two years. (Click on chart, above, for a closer look at the numbers.)

Naturally, inquiring minds went: Huh?

Professor David Geltner, director of research at MIT/CRE, explains that the transaction-based index may well be signalling a bottom in prices for properties that were never truly distressed in the first place. Distressed properties, alas, remain distressed:

“Our latest results relate interestingly to recent results posted by another commercial property price index whose methodology was developed at the MIT/CRE: the Moody’s/REAL Commercial Property Price Index – or CPPI – produced by Moody’s Investors Service,” Geltner noted. “Analysis of that index shows that healthy properties, those that are not in distress, have only dropped in price about 33 percent from the mid-2007 peak, a similar drop to the supply-side index we’ve recorded here representing property owners’ willingness to trade, while distressed properties in the CPPI have fallen 56 percent. The types of properties and owners tracked by the TBI would generally be less subject to distress than those tracked by the CPPI,” Geltner noted.

In any event, for disaster lovers, the non-distressed picture isn’t lovely to behold. Prices are now down a mere 36.5% from their 2007 peak versus 39% in the second quarter. Institutional investors aren’t exactly engaging in bidding wars.

And what does this mean for the residential as well as commercial outlook? Calculated Risk explains:

Typically prices fall much faster for commercial real estate than for residential real estate (prices for residential RE tend to be sticky and decline for several years, however CRE owners have far less emotional attachment to their properties).

It is very possible that CRE prices are near the bottom for non-distressed properties. It depends on if buyers are adequately discounting future increases in the vacancy rate and lower rents. It is a different story for distressed properties.