Commercial Real Estate Didn't Boom and Bust. Is This Why?By
When the U.S. housing market boomed and busted in the past decade, commercial real estate was comparatively placid. Prices were more stable, there was little overbuilding, and bankruptcies never soared. The question is why. A research paper attributes the stability of commercial real estate at least in part to the “civilizing influence” of real estate investment trusts, which are a bigger presence in the market than they are in housing.
“REITs played a central role” in discouraging speculation in commercial real estate of the kind that led to doom in housing, write the authors. “Commercial markets stayed in balance throughout the biggest real estate bubble in the United States since the 1920s.”
The study, which appeared in the Journal of Portfolio Management, is by Frank Packer, head of economics and financial markets for the Bank for International Settlements in Hong Kong; Timothy Riddiough, a real estate professor at the University of Wisconsin Business School; and Jimmy Shek, a BIS statistical analyst. The article appeared in the journal last year but hasn’t received much attention outside REIT circles.
The authors’ hypothesis is that REITs increase the transparency of the real estate market, allowing investors to spot overvaluation or undervaluation quickly. If a big construction project is announced in, say, Los Angeles, and REIT prices fall, that’s a signal to other builders and lenders that L.A. could be getting overbuilt. It helps that REITs are ongoing concerns that have a strong incentive to be perceived as reliable because “management reputation and consistency over time are critical to continued affordable access to capital markets.”
The proof of the hypothesis, the researchers say, is that overshoots and undershoots of construction in the U.S. office building market were more moderate at times when REITs had a bigger market share. They presume that the rest of the market pays more attention to the REITs at times when their market share is bigger. To zero in on the impact of REITs’ market share, they held constant two other factors that might affect office building construction, namely the prices of buildings and the cost of construction. Similar effects were found in other commercial real estate sectors in the U.S., as well as with office buildings in Japan.
That’s not a perfect demonstration because other, unseen factors could have affected the construction of office buildings over time that the researchers didn’t measure. The authors acknowledge that markets have also moderated in European and Asian countries that don’t have well-developed REIT markets. The case would have been stronger if the researchers had shown big differences in metro areas, based on their relative REIT penetration, but Riddiough tells me that “getting that level of detail was problematic for us.” Says Riddiough: “We’re the first ones who have done something like this. That said, there’s better ways to do it.”
The chart at the top of this article shows prices, not construction volumes, for single-family homes and office properties. The scale is set so that each index has a value of 100 at its lowest point after the financial crisis.
Riddiough is a member of the investment advisory council of the National Association of Real Estate Investment Trusts, but he says that his research was conducted independently and none of the researchers received support from the REIT industry. “They knew nothing about this research until I finished the paper.”
No surprise, though, that NAREIT likes the results. “The Riddiough, Packer, Shek study makes it clear that REITs provide real benefits for the broader commercial real estate industry, for investors and for our nation’s economy,” NAREIT Chair Ronald Havner Jr., who is chairman, president and chief executive officer of Public Storage, wrote in REIT Magazine earlier this year.
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