4 Reasons Why Commercial Real Estate Values Are Dropping

Kathy Fettke

Kathy Fettke

If you plan to buy commercial property with the hopes of gaining future appreciation, perhaps you should think again. The timing may not be quite right just yet…but could be in the near future.

According to a newly released report by Pacific Investment Management Co., commercial real estate prices may decline by as much as 5% over the next 12 months. The company, also known as PIMCO, says tight regulations, maturing debt obligations, and an increase in property sales by publicly traded companies could force downward pressure on commercial property values this year.

Portfolio managers John Murray and Anthony Clarke authored the report, called “U.S. Real Estate: A Storm Is Brewing.” The report said that voracious global demand for U.S. property pushed real estate values to record highs over the past 6 years, but that may be slowing down for several reasons.

1 – China

China has hinted at increased controls on capital outflows. Will the wealthy still find a work around? Most likely, but there’s always the chance the Chinese government could crack down.

2. Lower Oil prices

Lower oil prices could result in fewer dollars coming to the U.S. from Middle Eastern and Canadian investors.

3. Maturing Debt

Commercial debt created during last decade’s real estate boom is now maturing and starts coming due this year. Not all those borrowers will be able to refinance or pay off the balloon payments. This could create an opportunity for investors to fund those borrowers who come up short because it’s getting more and more difficult to get commercial bank financing.

4. Stricter Lending Guidelines

Changes in regulations for commercial mortgage-backed securities have increased borrowing costs for landlords, which lowers cap rates, and subsequently caps future price growth. PIMCO said this is especially true for properties in secondary and tertiary markets, where landlords depend on Wall Street banks for funding.

It’s a matter of liquidity. New Dodd Frank regulations made it more expensive for Wall Street banks to hold those securities. The report says that prices for debt plummeted in February when hedge funds were forced to sell their CMBS holdings amid global uncertainty. According to Murray and Clarke, the selloff “highlighted an increasingly important headwind” to commercial real estate from the debt market and had little to do with property fundamentals.

4. The U.S. election

There are global concerns about the U.S. presidential election featuring two of the most hated candidates in history. There are questions as to how it will affect U.S. policies after November – making continued investments from other countries “far from guaranteed” according to the report.

Commercial property values in the largest U.S. metros have dropped 3% in the past 3 months, according to Moody’s Investors Service and Real Capital Analytics Inc. These are the same areas that saw the largest gains from foreign buyers over the past 6 years.

Brokerage firm Cushman & Wakefield predicted in April that real estate transactions in New York City would decline by as much as 30% over the next 12 months.

Some real estate investment trusts, also known as REITS, have been hurt by the volatile stock market. Many of these REITS, including shopping malls, office buildings and hotels, are selling shares below the value of their holdings.

Keep in mind, these are also the industries that have been hurt by new high tech companies, like Airbnb – which affects the hotel industry, and the many, many online shopping options that keep consumers out of malls. These losses are forcing some REITs to become sellers, according to the Pimco report.

This isn’t all bad news. A real estate shakeout that results in lower prices makes for a buying opportunity. It could allow some smart buyers to snap up properties at bargain prices.

This appears to be PIMCO’s plan. The Newport Beach, California-based company has traditionally focused on fixed-income securities with $1.5 trillion in assets under management. But in an effort “to serve our clients in this fast-changing asset-management industry landscape,” the company recently cut 68 workers and offered buyouts to others, according to Bloomberg News.

PIMCO currently manages about $25 billion in alternative assets, such as real estate, debt, hedge fund and private equity strategies – and may be boosting it’s holdings as prices come down.

We will be doing the same at RealWealth. Our developers and property scouts will be on the hunt for situations where commercial property owners took on too much debt and need help.

This is exactly what we did in Reno, where we bought residential land that was already entitled. The developer took on a hard money loan that came due, so they needed a quick sale. We bought the property for a huge discount. On the week of closing, we received an offer from a national builder to buy half the lots for more than we paid for the entire parcel.

Kathy Fettke