Is Commercial Real Estate a Good Investment Today?
Commercial real estate used to be a great investment. You didn’t hit any home runs, but you got a dependable income stream and fair price appreciation that almost never lost money. Real estate and REITs didn’t correlate with stocks or bonds, so you also got a good diversification.
“Buy land, they’re not making it anymore,” Mark Twain once said. That investment advice doesn’t look too smart lately, but then again, Twain wasn’t known for his financial acumen.
How does that look today?
Last week the Federal Reserve warned in its May 2020 Financial Stability Report that “asset prices remain vulnerable to significant price declines should the pandemic take an unexpected course, the economic fallout prove more adverse, or financial system strains reemerge.” It highlighted commercial real estate (NYSEARCA:IYR) as one asset that was particularly vulnerable.
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“Prices of commercial properties and farmland were highly elevated relative to their income streams on the eve of the pandemic, suggesting that their prices could fall notably,” the Fed said.
That warning shouldn’t come as a major surprise for those who have been paying attention for the past three months. Most shopping malls are closed. Other than supermarkets, Walmart, Target, and dollar stores, most retailers(NYSEARCA:XLY) are closed. JC Penney, Neiman Marcus, and J Crew have already filed for bankruptcy, and likely more will follow them. Restaurants are closed except for takeout. Many of these establishments may never reopen. Millions of people are working from home, but likely a high percentage of them will never go back to the office.
“The old idea of the commuter going into New York City five days a week may be an idea that’s behind us,” Connecticut Governor Ned Lamont told Bloomberg Television last week. “Maybe you have a great job that seems to be geographically located in New York City, you can do it two-thirds of the time from your home in Stamford.”
He’s exactly right, although he sounds a little too smug. He left out the fact that there are many huge office buildings right there in Stamford that are an even worse commute for those who live in southeastern Fairfield County and points beyond. Those buildings are in deep doo-doo, too.
Once the pandemic eases, how many of those former office workers will want to leave the comfort of their homes and get back in the car or the bus or the train and start commuting again? Not too many, I would guess.
So where does that leave commercial real estate landlords, and those of us who invest in their properties? How will they fill all that now or soon to be empty space? They were already trying to figure out how to fill shopping malls as tenants have closed up shop, never to return. Many of them have gotten creative, but those attempts don’t look like they’ll survive either.
One of the malls near me, for example, recently put in a walk-through aquarium, but with crowd sizes likely to be restricted, that idea is no panacea. It also put in a huge fitness center, complete with a lap pool, but who knows when gyms will be allowed to reopen, and how many of their customers will return when they do?
In California, Google and other large employers recently leased enormous amounts of mall space to convert into offices that they may not need anymore.
Actually, there is one huge potential building-filler that currently is under severe upward price pressure because there are not enough properties to meet demand. And that demand will likely never go away, unlike retail and office space.
The obvious answer to the coming commercial real estate bust is residential housing.
Last week the National Association of Realtors said the median price for an existing single-family home jumped 7.7% in the first quarter compared to a year earlier to $274,600, with nearly 96% of U.S. metro areas showing a year-over-year increase.
“The first quarter price jumps mostly reflect conditions prior to the coronavirus outbreak and show the strength of the housing demand prior to the pandemic,” said Lawrence Yun, the NAR’s chief economist. “Even now, due to very limited listings, home prices are showing no signs of buckling. Supply is extremely limited, and there are simply not as many homes for sale to meet the demand among potential buyers. More supply and more listings are needed to provide a faster recovery for the economy.”
With enough creativity, commercial real estate owners might be able to come up with a solution to ease their own supply problems while alleviating demand in the residential sector. It sounds like a better idea than installing a gym and a giant fish tank in a shopping mall.
We might then take the advice of another great American known for his witty sayings. “Don’t wait to buy real estate,” Will Rogers said. “Buy real estate and wait.”