Andy McCulloch, managing director and head of real estate analytics at Green Street Advisors, joined REIT.com for a video interview at REITWorld 2015: NAREIT’s Annual Convention for All Things REIT at the Wynn Las Vegas.
McCulloch discussed the major findings of a recent Green Street report on the real estate cycle. The report concludes that the current commercial real estate cycle is nearing the end of its lifespan, although McCulloch conceded that the cycle could be extended. Valuations have become “fairly expensive,” according to McCulloch.
“Over the past six years or so, values for commercial property have roughly doubled and prices today sit about 20 percent above the previous peak in 2007,” McCulloch observed.
To understand where the market goes from here, Green Street looks at both the bond and REIT markets because they tend to be good predictors of trends in commercial real estate values, McCulloch said. In the bond market, Green Street looks at the spreads between corporate bond yields and unlevered returns on real estate. With REITs, Green Street considers where they are trading with respect to their underlying assets.
The two markets had been sending bullish signals for real estate for more than five years, until the first quarter of this year, when they did a “180-degree turn,” according to McCulloch. “Those are bad signals for the future value of real estate,” he said.
McCulloch stressed that Green Street is not calling for a significant correction in asset values. Rather, the firm expects asset pricing to flatten out and potentially fall 3 percent to 5 percent in the next 12 months, he said.
McCulloch acknowledged that the Green Street stance is an outlier compared to other forecasters, and he admitted that a bullish case can also be made based on healthy operating fundamentals and robust capital inflows.
“The bull case means that this cycle could go into extra innings. Values could rise slowly for the next couple of years,” he noted.
As far as operating fundamentals are concerned, Green Street believes that they have not advanced as far as asset values. “They feel more like the sixth inning,” McCulloch said.
While Green Street believes asset value appreciation is going to stop and potentially reverse, rents are likely to grow well ahead of inflation for the next several years, he added.