The data is clear – commercial real estate (CRE) property prices are undergoing an adjustment. With that in mind, many industry professionals and investors are asking the next logical questions – how far will prices fall and when will prices bottom out and recover. Examining historical CRE data offers some clues, but, as the old adage goes, history doesn’t repeat, but it often rhymes.
“What we do know is that CRE property prices have declined for two quarters and in the two historical examples we examined it took two years for prices to begin to recover.”
CRE Prices in Two Prior Downturns
In the Great Financial Crisis, CRE property price declines were deep. Prices fell for nine consecutive quarters, topping out at a 30 percent annual decline in the fourth quarter of 2009. During the Great Financial Crisis, the Federal Reserve brought the federal funds rate to near zero, where it stayed for much of the next decade. Today, the federal funds rate target range is between 5 percent and 5.25 percent, and the Fed is widely expected to increase it further before the end of the year. So, at least as it applies to the interest rate environment, today’s CRE price adjustment is clearly different.
Some believe the Savings and Loan Crisis of the late 1980s and early 1990s offers a better historical comparison to today. The Savings and Loan crisis was triggered, in part, by competition for deposits which drove a cycle of increasing savings rates paid to depositors, increasing costs to the lenders. At the same time, Savings and Loans were overweight on fixed-rate residential mortgages, which limited their income growth. Higher savings rates led to higher expenses for Savings and Loans, and with limited income growth, this squeezed profits. What’s more, deposit savings rates for Savings and Loans were capped by the federal government, so they faced the dual challenge of compressed profit margins and were limited in their ability to compete for new deposits. During the Savings and Loan crisis, CRE property prices declined for 16 consecutive quarters, exceeding the duration of price declines during the Great Financial Crisis, but prices did not decline as steeply, peaking at 11 percent in the second quarter of 1992.
Public REIT Share Prices May Offer Some Clues About Severity of Private Price Declines
Some research suggests that public equity REIT prices are a leading indicator of private CRE property prices. Since REIT shares are publicly traded, the argument goes, they more quickly incorporate new information into their prices. Private CRE markets, by contrast, are much less liquid and properties need to be bought and sold for price data to reflect new market dynamics.
Over the long term, REIT share prices are roughly predictive of private property prices. However, there are two notable divergences. First, in second half of the Savings and Loan crisis in the early 1990s, when REIT share prices increased from 1991 to 1994 while private property prices declined. Second, in the first half of the 1970s, an inflationary period that some have compared with today, REIT share prices fell while private prices appreciated. Today, both REIT and private prices are falling.
Historically, REIT prices are more volatile than private prices, so it’s reasonable to think that private prices are unlikely to decline as far as REIT prices. But we don’t know yet whether REIT share prices will fall further. What we do know is that CRE property prices have declined for two quarters and in the two historical examples we examined it took two years for prices to begin to recover. However, neither of the two prior examples were preceded by a global pandemic that radically changed the way we use space, so perhaps history will not repeat in this case, just rhyme.
