Part 1: Dr. David Geltner’s interview
The author of the world’s most cited real estate textbook looks into the future.
Not “if,” but “when” will there be another recession. It is critical to safeguard your portfolio to maintain your net worth.
What will the next recession bring?
Speaking with you is an honor for me, Professor David Geltner, the world’s leading expert on research in commercial real estate.
Two of his excellent papers on commercial real estate recessions are “Commercial Real Estate as well as the 1990-91 Recession in the United States” and “Real Estate Price Indices and Price Dynamics: An Overview from an Investments Perspective.”
Dr. David Geltner is the principal author of the world’s most widely read real estate investment textbook, “Commercial Real Estate Analysis & Investments.” Faculty Chair of MIT’s Center for Real Estate (CRE) Master of Science in Real Estate Development (MSRED) program. Associate Director of Research at the CRE Research Associate Director.
Associate Director of Research at MIT’s Center for Real Estate (CRE), Professor of Real Estate Finance (Department of Urban Studies and Planning), also Director of Rea.
In 2011, he received the Graaskamp Award from U. S. Pension Real Estate Association for outstanding performance in real estate research.
Geltner has held positions as Academic Advisor to the National Council of Real Estate Investment Fiduciaries (NCREIF) and Director of MIT’s Commercial Real Estate Data Laboratory.
These positions have allowed him to play a vital role in developing ground-breaking commercial property price and investment performance indices, such as the Moody’s/RCA CPPI, the NCREIF-based TBI, and the FTSE-NAREIT Pure Property® Indices.
Geltner was an External Academic Member of the State Teachers Retirement System of Ohio’s Real Estate Investment Committee from 1999 to 2012 (a pension plan sponsor with over $5 billion in directly managed real estate holdings). Since 1989, he has been teaching graduate-level property investments and finance.
TRCR: Discussing recession and your study on commercial property cycles and downturns is fascinating.
In one of your papers, you noted the CRE (commercial real estate) pricing cycle does not generally correlate to the economic process (three instances since 1969 versus five).
What about commercial real estate that allows prices to remain stable or rise during an economic recession (when recruitment and GDP are falling)?
Geltner: Commercial real estate, which is real estate that generates income and uses as an asset class for investments, is priced according to two markets:
1. The market for occupied and utilized built space (also known as the “rental market” or “leasing market”);
2. The market for real estate assets, where ownership can be transferred (the investment market).
During a macroeconomic downturn, the commercial space market typically suffers due to falling rents, resulting in declining net income (sometimes lagging behind the downturn and recovery).
However, depending on the recession’s nature, extent, and duration, particular space market types and discount outlet centers, maybe revenue.
More importantly, the real estate asset market may respond independently from U.S. macroeconomic fundamentals. In other words, the fundamentals for renting properties have changed. Money may still flow to real estate investments.
It can be true for “first-tier” assets (well-leased primary properties in prime markets, currently the “gateway six” being Bos, NYC, DC, Chi, SF, and L.A.), regarded as a form of “safe harbor” investment.
As in the case of long-term bonds in 1981 and tech stocks in 2001, reallocation of capital is relatively possible from controversial asset classes to real estate. It can stop the price of real estate assets from falling.
However, the nature of the economic downturn and the real estate market are factors. Even a mild economic decline could be disastrous for commercial real estate if the space market had many supplies during the late 1980s. It may scare away investors. It frequently depends on how equity capital responds.
The conservative debt sources shy away from commercial property in an economic decline. But suppose there is sufficient equity capital to temporarily take the place of the debt. In that case, the overall property asset market can ride out the storm relatively well.
TRCR: According to your research, the cost process has been surprisingly consistent, enduring 16 to 18 years. It is incredible, even with random events (similar to CRE, different from other interest rates, assets, and liquidity).
Do we currently understand why it has remained so consistent?
Geltner: I don’t, in all honesty. And I don’t believe that it will always be that predictable. A large sample does not consist of just three observations! However, it appears to the availability of debt. The way commercial real estate debt lending has grown even with three cycles says it is a coincidence.
Unaware of the downturn and recovery of the 1970s. I believe that a budding lending REIT industry contributed. Of course, that particular form and lending supply did not recur significantly.
After that downturn, the commercial mortgage lending sector (based mainly on life insurance) adopted some “reforms” like balloon loans with 10-year maximum maturities.
During the 1980s lending boom, the “bad guys” included the actual life insurance companies. The severe offenders were the regulated thrifts and financial institutions focused on raising capital (that is why there is an overflow of space markets).
In the 1990s, CMBS (commercial mortgage-backed securities) and REITs—especially the latter on the debit side—came to the rescue. After CRE withstood the 1998 financial crisis, the real estate sector believed that actual “discipline” had been brought to real estate and development by public markets.
Of course, the “bad guys” mainly in the 2000s bubble were CMBS. But that one had more to do with the asset market’s pricing bubble and trim with the space market’s overbuilding (maybe because CMBS was not lending construction).
My argument is that the precise origin, character, and essence of the “debt culprit” have not persisted; they have changed with each cycle. It does appear to be related to institutional memory from one crash to the next (A famous person once said, “History rhymes, but it does not repeat.”)
For instance, during the Great Recession’s recovery, banking institutions and special servicers showed restraint and “pretended & extended” instead of holding fire sales and depressed the economy in the early 1990s.
However, real estate prices have been absurdly high for the past 15 years.
The general pattern and the memory of the previous have faded enough for a different source of debt capital to go over the top. It was reassuring itself that whatever is considered a conservative investment.
But it’s all just storytelling. It isn’t a solid piece of academic theory. Furthermore, it does not specify the timing of the upcoming downturn.
(I have publicly stated that I believe the next U.S. recession may be for the Chinese is the first recession, but what do I know? I am not a macroeconomist.)
TRCR: It is a matter of when, not if, there will be another recession. Numerous economists believe the current economic cycle is “long in the tooth” and foresee a downturn within the next two to four years.
Do you think we would also experience a decline in CRE asset prices if that were to occur? Or do you believe a recession with rising prices is more likely?
Geltner: Really, I have no idea. And a lot could depend on what occurs in the interim.
Particularly in premium markets like Manhattan, CRE pricing is already very high. Therefore, if prices keep rising at their current rate and the recession doesn’t start for three or four years. Prices may have reached high levels that a recession strikes the space markets would then puncture an asset market bubble.
Additionally, if the building picks up, we might experience some overcrowded space markets, worsening the situation. Because rates (yields) are already so low, the asset market does not have room to cushion itself against a significant decline in the space market.
On the other hand, it may have taken three or four years to enable particularly long interest rates to increase. Like the rentals, there is protection against such a significant accident in CRE asset prices. Rent prices can help fund rising asset values, and the Central Bank may have the flexibility to keep interest rates low.
It is challenging to predict. However, I have a hunch that the next recession will see at least a slight decline in CRE prices overall. If not a massive crash like in the previous three cycles, maybe a significant “correction.”
The value of the land and the building’s structure make up the two components that make up the CRE asset value. The supply of the former is moderately elastic. In contrast, either supply is very inelastic, making the land aspect of worth particularly susceptible to changes in the market. And I think that since the previous cycle’s low point in the 1990s, the value of land component has grown as a percentage of property value.
Since 2000, land values—rather than structure values—have been the primary beneficiaries of the yield compression. It can be more challenging for CRE value of assets to avoid suffering collateral damage. (However, it is also the reason there is less of a tendency to overbuild today because high land costs deter development.)
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