Commercial real estate bubble?
John Vanhara Roger Thompson comments on the commercial real estate industry in the article “Rebuilidign Commercial Real Estate“. “Students of recent United States real estate history can’t help but notice unsettling parallels between the red-hot commercial market of the late 1980s and today. Then, as now, money gushed into the market, driving office and retail property values to unprecedented heights while creating fortunes for savvy dealmakers.”
“That question is at the heart of a long-running debate within the profession. As property prices have risen, returns on investments have fallen. Today, returns, expressed in real estate parlance as cap rates, have declined to levels last seen just before the 1989 crash. (A property’s cap rate is calculated by dividing cash flow from operations by the purchasing price, yielding a percentage annual return. Thus, a $1 million property that generates $100,000 in cash flow would have a cap rate of 10 percent.) Historically, the cap rate for commercial real estate has averaged 9 percent. As property prices soared in the 1980s, cap rates sank to between 5 percent and 6 percent. After the crash, they rose back to the norm until recently. “Over the past 24 months, cap rates have dropped probably 200 to 300 basis points,” says Furber. “That’s a monster change and somewhat unprecedented.”