John Bejjani, analyst and office sector co-head at Green Street Advisors, joined REIT.com for a video interview during REITWeek 2015: NAREIT’s Investor Forum, held in New York.
Bejjani reflected on the level of real estate valuations in the current market. He explained that valuations have to be looked at from two perspectives: operating income growth and capitalization rates.
Operating income growth is healthy across most property types, Bejjani said. Accelerating job growth, moderate gross domestic product (GDP) growth and limited new supply are benefitting real estate fundamentals in most property sectors, according to Bejjani.
Cap rates, meanwhile, are clearly tied to the direction of interest rates, Bejjani continued. Because of the difficulties in predicting interest rate movements, Bejjani said Green Street prefers to take a relative valuation approach to real estate.
In other words, Green Street looks at how investors’ return expectations on real estate compare with those of other asset classes, particularly fixed-income. “On that basis, real estate looks modestly expensive relative to investment-grade bond yields, but cheap relative to high-yield bonds. Overall, we’d argue that real estate is roughly fairly valued today,” Bejjani said.
Turning to individual property sectors, Bejjani said apartments and malls are relatively cheap in the private market, while industrial and strip centers are moderately expensive. Office properties are the most expensive. Bejjani explained that Green Street believes that office properties appear to be expensive in the private market because investors tend to underestimate the capex needs of this property type.
Public investors partially correct for this issue by pricing office REITs at discounts to their underlying private market real estate value, Bejjani said. “However, they don’t go far enough,” he said.
Bejjani noted, however, that it is still possible to uncover relative value in the office sector.