Excerpt from our One Page Annotated Wall Street Journal Summary (which you can get emailed to you every morning by signing up here):
THE OUTLOOK: Commercial Real Estate Maintains Its Strength Despite a Cooling Housing Market
Summary: Commercial real estate has is performing well despite a slowing housing market because it is driven by different factors. The residential market is driven primarily by interest rates, due to individuals' dependence on mortgages. In contrast, while cheap debt increased the number of bidders on commercial buildings and therefore pushed down rental yeilds, commercial real estate buyers are more diverse and often less dependent on loans. Furthermore, other factors contribute to commercial real estate pricing. The office market, which cratered after the tech bust in 2000, is benefiting from a strong economy and restricted supply, as many offices were converted for residential use. The residential property boom raised the cost of building and thus the value of completed buildings. Vacancy rates in the top metro office markets have fallen from 17% in 2004 to under 14% now. As long as jobs growth doesn't falter, the office market should hold up. Similarly, the shopping-mall market has benefited from strong consumer spending, and hotels have benefited from strong business travel.
Comment on related stocks/ETFs: The divergence of the commercial and residential real estate markets can be seen from the chart below comparing the Homebuilders ETF (NYSEARCA:XHB) to the streetTRACKS REIT Index Fund ETF (NYSEARCA:RWR) over the last six months. However, it's unlikely that commercial real estate and housing are uncorrelated in the long run. First, a key attraction of commercial real estate such as a REIT index fund is its yeild, which makes it comparable to a bond. Rising interest rates reduce bond prices and should therefore do the same to REIT stocks. Second, housing affordability is impacted by job and salary growth as well as interest rates, and the jobs market also impacts the office real estate market. If jobs growth stalls, both the housing and office markets would be impacted. Third, the conversion of office buildings to condos over the last five years shows that in many cases real estate is real estate, with no difference what it's used for. As such, it will be interesting to see whether the decoupling of the commercial real estate market from the housing market continues.