Bubble Talk Neglects Small-Cap CRE

Tucker, Michael mtucker@mba.org

November 30, 2015


The growing debate regarding whether commercial real estate prices approach bubble territory needs to include smaller-market and small-cap assets to be accurate, said Randy Fuchs, principal with Boxwood Means, Stamford, Conn. 

"Construction cranes, trophy deals and soaring asset values in some big cities can hoodwink us about the overall circumstances of CRE prices," Fuchs said. "However, we also tend to reflexively conflate the price performance of assets in high-profile or gateway cities with what's happening in other places like Dallas or even Dubuque."

Fuchs noted that Federal Reserve Bank of Boston President Eric Rosengren recently observed that that CRE prices warrant scrutiny going forward. "This parochial view is reminiscent of the famous New Yorker magazine cover depicting Manhattan's 9th and 10th avenues and the Hudson River in the foreground and foreshortened images of the rest of the country--and beyond--as if an afterthought," he said.

CRE prices in New York and in Rosengren's Boston have jumped dramatically, Fuchs agreed. "But like the New Yorker cover, there's more than meets the eye. "Asset prices in top-tier cities are through the roof. These magnets for global investment capital have pulled out all stops on price appreciation." He noted that the Moody's/RCA Major Markets Index for New York, Los Angeles, San Francisco, Chicago, Boston and Washington, D.C. floated 32.5 percent above the December 2007 pre-crisis peak level.

But more balanced price growth reigns elsewhere, Fuchs noted. "The Non-Major Markets Index from Moody's/RCA suggests that asset prices in secondary and tertiary cities are recovering at a more reasonable rate," he said. The Non-Major Markets Index increased a solid 12.9 percent year-over-year during August to reach near parity with its pre-crisis peak. "This equivalence says a lot about prices for the majority of the country when compared with the lofty peak-to-current status of the Major Market Index."

Moreover, Fuchs said the price spread between major and non-major markets has expanded. "By our reckoning asset prices in the former exceed the latter by 56.7 percent--the biggest gap on record and far more than double the spread between the two indices at the market's previous 2007 peak," he said. "Clearly, this collection of cities has lacked the luster and capital inflow relative to the gateway cities and, as Moody's recently reported, trails the major market recovery by about two years."

Fuchs said price recovery remains a longer-term proposition for smaller commercial real estate assets. "We've always maintained that small-cap CRE prices have more in common with residential housing prices than they do with institutionally oriented or large-cap CRE trends," he said, noting that Boxwood's index of 117 markets advanced by only 4.4 percent year-over-year and has recovered 55 percent of its losses since hitting bottom in January 2012--a full two years after the trough for the equivalent Moody's/RCA's Core Commercial Index involving larger-sized assets.

"This type of discussion is a recurring theme through real estate cycles and a prudent one at that," Fuchs said. "But the tendency among some observers to conclude that the major-market phenomena of construction cranes, trophy deals and soaring prices are ubiquitous is to grossly distort the national picture--just like that New Yorker cover."

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