Solid Gains In Commercial Real Estate

Includes: VNQ
by: Calafia Beach Pundit

According to data from the CoStar Group, the commercial real estate market is enjoying very healthy conditions. Prices have been rising at a 10% annualized rate for the past five years. Sales activity was up 14.5% in the first half of this year compared to a year ago, and only 8.7% of properties were selling at distressed prices, the lowest such rate since Q4/08.

It's hard to find anything to complain about here: there's been a robust and ongoing recovery in a market that was severely punished in the Great Recession. This wouldn't be happening if the economy weren't improving. However, the strength of property prices is likely driven at least in part by easy money and low interest rates, and as such could be a "canary in the coal mine" signaling rising inflation pressures. It's certainly hard for the Fed to square this data with the need for extremely low interest rates for the foreseeable future.

Meanwhile, it's a bonanza for investors in commercial real estate: 10% annual price gains plus rental income of 4% or more. That helps explain why the Vanguard REIT ETF (NYSEARCA:VNQ) has registered a total annualized return of 23% since mid-2009: back then, investors feared that the real estate market would never recover, and consequently many real-estate-related securities were trading at seriously depressed valuations. In any event, should the Fed indeed make an inflationary mistake by keeping interest rates too low for too long, investors should remember that real estate has traditionally been a good hedge against unexpected inflation.