Annual Physical Results for Commercial Real Estate — The Patient is Doing Extremely Well
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After getting the results of commercial real estate’s annual physical, we can see how truly healthy that market is tracking.
Fortunately for data purposes, The National Council of Real Estate Investment Fiduciaries (NCREIF), a non-profit trade association for tax-exempt investors (such as pension funds) in real estate managed by fiduciaries, makes several real estate performance series available. They report accurate, unbiased real estate return data. NCREIF employs a framework of reporting requirements assuring consistency in return analyses. NCREIF specifically breaks out return series for apartments, retail, hotels, offices and industrial properties. Their total returns index series includes more than $319 billion of institutional-grade real estate made up of 7,270 individual properties.
The many data series NCREIF tracks remain a premier source for U.S. commercial real estate performance.
These series includes both cash flow and property value change for the quarter. Assumptions include (and for more details click here):
- Each quarterly return assumes the property was purchased at the beginning of the quarter and sold at the end of the quarter with all cash flow going to the investor (Net Operating Income – Capital Expenditures)
- Properties are purchased with cash—no loans
- There are no depreciation schedules for tax purposes (tax-exempt investments), nor any capital gains tax implications, nor any gains payable or losses carried forward on the sale of property
Since 2000, the average trailing twelve months (TTM) return on each of the property types is shown. This includes both the net operating income after deducting property management fees plus value change.
Retail real estate fared the best of all property types since 2000, generating an average annual return of 9.95 percent. A muted retreat from buying by consumers coupled with almost no new construction since 2006 has seen impressive performance.
The combined effects of 20 percent down payments and increased mortgage qualifying requirements (and throw in burgeoning student loan debt) has produced the mega-trend that those graduating from trade school or college the past five years and likely the coming four to five years will be renters for at least a decade. That in turn has bolstered recent performance for apartments. Apartments have averaged 8.66 percent per year total value change and cash flow since 2000.
Industrial Real Estate
Industrial real estate, which ranges from small Mom and Pop office warehouses to massive manufacturing plants, is one of the best overall measures of where the economy is heading. Since 2000, industrial property in the NCREIF portfolios has averaged 8.26 percent annual return.
Office properties, while averaging 7.82 percent annual return since 2000, lags all other property types except hotels. I believe the causality is two-fold. First, we have not created jobs that require office space. Jobs are everything, and the U.S. job gains in the past five years can be described as abysmal at best. And perhaps as important, changing technology has muted the need for office space. Today, connectivity often trumps physical location.
Hotel properties had the least-impressive performance of the five property types. Since travel can be so discretionary, this segment typically is hit harder in times of recession. And unlike the other property types, hotels have endured two painful recessions since 2000. Following the tragedy of September 11th, business and consumer America simply stayed at home leaving increased vacancy rates and reduced revenues. Hotel performance is improving, however, with the latest 12-month performance totaling an 8.01 percent return compared to 6.36 percent since 2000.
The bottom line is that commercial properties have recovered from the plunge in values in 2009.
In this same time period, the S&P 500 Stock Index return was just 2.73 percent per year on average. It still remains time to overweight in real estate.
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