Market Insight: What Inning Are We In?

The fact that economies and real estate markets go through cycles is nothing new. The frequency and severity of any given cycle depends on the power exerted by specific economic events over time. The last four downturns were precipitated by completely different events, but the most severe of them came in 2007 with the near systemic failure of our banking system. The so-called Great Recession was the result of an ill-conceived and unsustainable funding source for residential and commercial properties that caused a buying frenzy and rapid rise in prices. The precarious nature of these Residential and Commercial Mortgage-backed securities was discovered the hard way and the whole world suffered.

Since then the real estate market has bounced back stronger than ever. Anyone who has acquired commercial property since 2009 has seen their assets appreciate handsomely. Pricing continues to increase for a variety of reasons, but largely due to low borrowing costs that have resulted from the Fed’s aggressive monetary policy.  User and investor demand continues to exceed supply, causing an acute supply shortage, especially in the industrial sector. The same is true for multi-family properties, as investors are attracted by strong rent growth and low vacancy. The lack of construction activity, particularly in the smaller size ranges, is compounding the supply shortage, as soaring land prices make ground-up development projects difficult to pencil, even at today’s price point. 

As mentioned in my last post about the Federal Reserve cutting rates, mortgage rates fell to a new low in the past month and many experts believe they will go even lower.  What is interesting is that capitalization rates have not continued to compress on investment properties as a result of the rate drop, as has been the case throughout this economic recovery cycle.  This suggests that the market is beginning to flatten out as buyers become more cautious in the underwriting of potential acquisitions.

When buyers no longer believe in the long term strength of the market, buildings will take longer to sell even if available inventory remains low.  If prices drop in response to waning demand, they tend to fall fastest at the front end of the correction period. So, if you have a short or mid-term hold strategy, it may be best to leave some potential appreciation on the table and exit your investment while demand is still strong.

It is important to note that unemployment is historically low and consumer confidence remains high, but that is offset by a falloff in performance of several closely followed economic metrics.  Expressed in baseball terms, it seems to me like we are deadlocked in the ninth, each team still has fresh arms in the bullpen and extra innings are on the way.