Economic fundamentals are behind the continued strong performance of commercial property.
The combination of low interest rates and economic recovery in many parts of the world is producing a robust commercial property market.
How Is This Article Useful to Practitioners?
Insignificant and even negative cash and government bond market yields create unattractive investment opportunities. In contrast, commercial property yields are attractive at 4%–5%.
Although prime property yields have been falling in the capitals of European countries to levels not seen since 2007, long-term returns from the asset class are still decent. The total annualized return of nearly 8% on US commercial properties for the 10-year period that ended September 2014 exceeds the returns on both US and UK long-term government bonds and comes close to the returns on both countries’ equities.
Such longer-term robustness in the commercial property markets may continue. Rising rates, economic downturn, and oversupply through speculative building would hasten a decline, but none of these circumstances have materialized yet. Notwithstanding various forecasts, the US and UK central banks are circumspect on rates going up given continued low inflation. The global economy, although not experiencing rapid growth, continues to grow slowly, with GDP estimates of 1% in the euro region and Japan and 3% in the United States. Finally, the overbuilding of the past has yet to occur. Indeed, development land deals declined by almost a third internationally in 2014.
Although a bubble may occur eventually—even though one seems to be developing in London’s residential property market because of an influx of foreign money and continued low rates—the current rate environment makes both second-tier and more speculative-grade commercial property attractive. It also may serve as a better hedge than government paper if inflation returns.
In down markets, reaching for yield is the ever-present goal. But doing so may bring about longer-term risks. Global commercial property markets have yet to reach that juncture. Compared with traditional asset classes, they provide stable longer-term yield and inflation protection. Cyclicality is the one constant in asset management.