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What Bubble?

The lofty sums of money investors are shelling out for commercial real estate assets are at an all-time high, but a recent study conducted by Global Real Analytics (GRA) found that real prices adjusted for inflation are actually lower now than they were in 1985. In the report, “Bubble, Bubble…Maybe No Trouble,” analysts with San Francisco-based GRA note that in the 61 cities tracked, office prices are 10.8% below where they were in 1985. Warehouses are 3.5% lower, and retail prices are down 5.1%.

In fact, the only place a Rip Van Winkle investor might have made money holding property for those two decades was in apartments, which are now 43.6% above their 1985 level — though some might say a real annual return of 1.85% isn't really worth waking up for.

While it's not good news for Rip, GRA analysts believe the comparison is good news for investors nervous about an '80s-style bubble. “We don't believe we're at the point yet where we have to be greatly concerned,” says Paul Wildes, director of marketing for GRA. Part of the price rise has to do with the fact that over the past 20 years, institutional investors' perceptions of apartments as an investment class have gradually improved.

Cap rates haven't gone very far either in those 20 years. Though the GRA study did not track cap rates, Daniel O'Connor, managing director of global research and forecasting for GRA, says he believes they are only slightly lower now than they were in 1985, and that given the amount of capital in markets now they're unlikely to rise anytime soon.

But at least one broker is skeptical of GRA's take on the bubble question, and foresees just such a major change in the investment climate. “I've been doing this since 1975, and in every cycle since that time when you get to the crescendo of the bubble, you've got people saying there's no bubble,” says R. Lee Harris, president of NAI Cohen-Esrey Real Estate Services in Kansas City.

The numbers Harris points to in support of the bubble hypothesis are the risk premium investors demand for owning real estate. Historically, he says, there is a risk premium of about 200 to 500 basis points above the 10-year Treasury yield, depending on the property type. Today, however, it's just a few basis points.

“Without a risk premium in place, I don't see how anybody can make the case that there's not a bubble. If you've got stocks, if you've got bonds, if you've got commodities — whatever the case might be, if there's no risk premium, I think, just simplistically, it has to reflect a bubble.”

William Wheaton, an MIT economist and founder of Torto Wheaton Research, agrees with GRA that there is no bubble, but says that the test he prefers to use is the replacement cost of assets. By that measure, the retail and industrial sectors are a little overvalued, apartments are right around replacement cost, and condos are above replacement value, he says.

The GRA study also raises an issue about long-term capital appreciation in real estate touched on earlier this year by Wheaton. In the MIT study, co-authored by Wheaton and titled “100 Years of Commercial Real Estate Prices in Manhattan,” researchers found that after discounting for inflation, office building prices in 1999 were actually 30% lower than in 1899. Wheaton's conclusion: “Owning commercial real estate historically has yielded little appreciation beyond inflation, although [it has] considerable appreciation risk.”


While many commercial real estate investors believe sale prices are at unprecedented levels, a new report concludes otherwise. When adjusted for inflation, real prices per sq. ft. are lower than in 1985.

Office Industrial Retail Apartments
1985 $163.33/sf $31.78/sf $97.50/sf $52.81/sf
2006 $145.62/sf $30.65/sf $92.49/sf $75.82/sf
%change -14.1% -7.0% -8.8% 43.6%
Source: Global Real Analytics
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