No Commercial Real Estate Bubble - Business Week

A recently released Deloitte & Touche USA LLP report, “Real Estate Capital Markets: 2006 Industry Outlook & Top to Issues” predicts that commercial real estate does not have a bubble to burst.

“While most of the focus has been on the residential real estate bubble, commercial real estate sits at the other end of the spectrum,” said the report’s author, Dennis Yeskey, a principal with Deloitte Financial Advisory Services LLP and leader of the organization’s real estate capital markets practice. “We are in the twelfth year of a substantial real estate rally that, with very few exceptions, has produced an extended and record up-cycle for real estate. Commercial real estate has offered investors an attractive combination of steady returns and low volatility compared both to stocks and bonds, especially over the last five years— and this is something that should continue this year.” Do you agree?

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From Deloitte

The U.S. economy is expanding, now at a slower rate, and investments are on the increase again. The economy appears poised for continued positive growth in 2006. Interest rates remain relatively low and, contrary to conventional wisdom, are not increasing as quickly as expected, creating the famous “conundrum” in the economy. Yet a number of concerns remain on the horizon, especially with the budget and trade deficits; selected residential “bubbles;” post hurricane Katrina, Rita and Wilma impacts; along with the Iraqi war.

Given the past few decades and the cyclical nature of the real estate industry, insiders often pay attention to certain critical issues to determine whether the upward trend will continue, a downward fall is eminent, or if there may be a “soft landing” with minimal impact. Industry professionals often gain insight into where the market is headed by paying attention to these critical issues.

The first two critical issues for 2006 include the following:

1. Economy Growing Steadily, But Slowing. Although the economic outlook has slowed from its highs in 2004,the economy remains relatively healthy with consistently low interest rates and the dollar is attempting to stabilize and possibly continue to improve. Looking toward 2006 and beyond, a number of troubling trends (e.g., the expanding twin U.S. budget and trade deficits) could potentially derail the economy. That said, how will these trends affect the economy and industry, and how strong will 2006 be?

2. Fundamentals Turn the Corner. For the first time in more than three years, most commercial real estate market fundamentals are recovering, with declining vacancy rates and stabilizing rents in many property categories. No place is this more evident than the office and hospitality sectors. If economic growth continues, property fundamentals should continue to improve modestly in 2006. Even if value increases plateau, the increase in property fundamentals could mean that the real estate market has outgrown its former boom-and-bust character; however, the length of time it takes for these fundamentals to trickle down to other areas such as property rents and profitability could affect the overall outlook.