Part 2: Interview with Dr. David Geltner
In part 1, Dr. David Geltner (writer of commercial real estate investing) described the look of the next recession.
Part 2 of his discussion on CRE includes insightful information which helps expand your portfolio.
TRCR: Why hasn’t academic research into U.S. commercial real estate mirrored that of stocks, bonds, or the housing market?
Geltner: For several reasons.
First, the CRE data is fast and significantly enhancing, and so is securities market data. Real estate catching up is a moving target.
Second, property investment markets in the United States and other countries are more diverse than securities markets. They are making it more difficult to analyze them from a theoretical standpoint and to attract widely general results.
It can be challenging to assess the significance of empirical research on auditable asset transaction prices because of commercial property asset markets. Some locations may function very differently from securities markets.
Third, I believe there is a cultural issue, particularly in the investment industry and academia in the United States. In this country, real estate has traditionally lacked the recognition of securities investments.
The United States never had an aristocratic class revered as the national “upper class.” The land was frequently almost free to be had; what isn’t scarce isn’t highly valued by markets or cultures.
The value of real estate is more remarkable than other investable assets. A business school’s typical finance department will have many faculty members researching various aspects of corporate finance and securities investments.
TRCR: Purchasing housing or commercial property as an inflation hedge over the long term? Do we know why?
Geltner: In the grand scheme, there are two distinct issues concerning real estate investment and inflation.
One is the question of inflation “hedging,” or real estate safeguards against UNPREDICTABLE increases in inflation. Inflation risk is the topic at hand. Regardless of whether the apartment buildings or non-residential commercial properties, real estate ought to be effective at preventing that.
Apartments have advantages over houses because they don’t have long-term leases. They allow unexpected inflationary increases to be reflected in the property’s actual income more quickly.
The second issue concerns the long-term trend rate of asset value growth specifically. Real estate values tend to keep pace with purchasing power. The vital thing to the investor is individual property value with actual buildings. The structure value component is always a “wasting asset.” It loses value net of inflation, even on a “net” basis (despite landlords’ expenses on regular capital improvements and upkeep).
However, the land value does not usually devalue; instead, it tends to rise and fall in real terms over time (secular trend). Owner-occupied housing is trending higher than income-property trends. Primarily due to the different relative secular trend rates in land values between many central locations.
Income properties tend to locate in more peripheral areas (especially when built first).
Transportation costs per mile traveled and per week/year of living have been falling for decades. Beyond the traditional metropolitan, cities have new satellite “centers” or “edge cities”.
These are places where people have work and recreation outside the standard urban core.
In the outskirts, you will find a single-family home. Income-generating properties were in more central areas. It tends to reduce land values in central locations while increasing land values in peripheral locations. Central land values are higher (per acre) than peripheral land values. The greater building structure density or intensity on main sites makes economic sense. The difference in relative trend rates over time in land values underlies the deviation in the two asset price index lines. Below is the chart:
The land values beneath houses may have increased/decreased more than those commercial structures on average throughout the United States history, as was shown in the chart.
It does not necessarily mean that houses depreciate less than commercial structures. (Manhattan can be an exception!)
TRCR: Because of the recent rise in demand, institutional investment properties have become very expensive. Janet Yellen publicly stated that it might be in an asset bubble because things have gotten so bad.
However, many investors overlook the non-institutional option (properties with low-quality structures or not in prime location). How has it competed in comparison to other institutions?
Geltner: I concur that prices for institutional real estate are now at worryingly high levels, like during 2007 when prices reached their previous peak.
According to the evidence, more minor, pricey “non-institutional” properties are significantly lower and with higher yields, typically 200 basis points (bps).
However, I believe that long-term history indicates that pricey non-institutional property at a higher yield. Even so, it does not generally offer a lower long-term growth trend nor show higher volatility or cycle amplitude.
It would imply an arbitrage, i.e., that institutional property is more expensive than non-institutional property (provides a return for the same threat).
It could be because of many factors. One possibility is the quality of available information. Investors despise uncertainty (the inability to know what they don’t know).
Another might be the cost management burden of managing a sizable number of modest, regional players and assets. Institutions with regulatory requirements to be conservative may put off investing in non-institutional property.
The psychological factors can be perfectly rational until developed investment vehicles make this possible.
And we must accept that institutions are likely not immune to “herd behavior.”
Additionally, the “herd” is not rushing to private property (not the institutional herd). But there is a reasonably broad “borderland” that attracts more institutional capital.
Such as prime properties in non-prime locations or the opposite (like a new Class-A office tower in downtown Pittsburgh or a 50-year-old Class-B office building in downtown Boston).
TRCR: Thank you for the insightful interview.
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