More on the 'Trifurcated' Commercial Real Estate Market

Includes: IYR, VNQ
by: Brad Case

I commented on a post last week about commercial property values that Moody’s had reported a “trifurcated” market in which the values of “trophy” properties are already going up while the values of properties from distressed sellers are continuing to sink. David Geltner, a professor at MIT’s Center for Real Estate, fleshed out this interesting market situation in a separate commentary published on the Moody’s web site.

First, the “trophy” segment of the market “rose a strong 5% in August, its seventh consecutive positive month, bringing it now 37% above its low point last January, and taking it to only 17% below its October 2007 (peak) level.”

In contrast, “The Distressed Index fell a jaw-dropping 10% in August, its third negative month in a row, with five out of its last six months being negative. This plunges the Distressed Property Index to a new all-time low, (and) it has now fallen 62% as a fraction of the peak pricing levels of 2007. The happy headlines from the trophy market segment mask some very real and substantial pain in the distressed market segment, a pain that is getting worse in terms of the prices that distressed properties are fetching.”

The rest of the market—“the bulk of the U.S. institutional commercial property market that doesn’t get the headlines but makes up 54% by value”—declined by 2.4% in August, but is still almost 8% above its low.

According to Professor Geltner, “trading in the middle segment is very light. It is the anemic trading volume in this vast middle market segment that is holding back a broad and deep recovery in the U.S. commercial property market and preventing the integration across the segments that would normally eliminate this historically unusual trifurcation phenomenon.” In short, he says, “this ‘soft middle’ is not healthy.”

The reason trading volume is so light in that “vast middle” segment, in my opinion, is that many of them are owned by real estate investment funds whose managers have blown their clients’ entire investment, but don’t want to admit it.

Disclosure: Author is long ING Real Estate Fund and Vanguard REIT Index Fund.

Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.