Has U.S. Real Estate Reached a Tipping Point?

The recent buying frenzy of U.S. commercial property has left investors increasingly concerned that the market could soon reach a tipping point as prices rise past valuations. According to Real Estate Research Corporation’s (RERC) recent report, “Precarious Balance,” based on a survey of valuation experts, several asset classes are now fully priced or overpriced—namely apartment, retail, and office. Despite the high prices, RERC’s president and chief executive, Ken Riggs, says demand for properties is set to stay strong amid a flood of foreign capital looking for a safe haven, continuing low interest rates, and a lack of investment alternatives.

Riggs says the value and price of commercial property is “precariously balanced,” with investors concerned that the sector could be heading for a tipping point. If prices are pushed up without an increase in value to match, investors might be forced to accept lower returns and added risk. Some are already moving up the risk spectrum and seeking out select assets in secondary markets, Riggs says RERC’s value-versus-price rating fell for most asset classes during the second quarter of 2014. On a scale where 5.0 means values and prices are evenly matched, the apartment sector fell from 5.0 to 4.6, signaling that prices passed values. Office and retail dropped from 5.3 to 4.9, and the industrial sector declined from 5.8 to 5.7. The hotel sector’s rating rose from 5.5 to 5.7. Riggs says that at the moment “there’s no sign of slowing whatsoever” and that the commercial real estate market is displaying similar characteristics to the pre–financial crisis days, with aggressive buying tactics such as reduced due diligence periods. Pressure is even higher than in the pre-2008 period, he says, with many other asset classes and geographies now out of favor with investors. Riggs says higher interest rates could alleviate some pressure and maintain market balance. “What’s pushing it is interest rates,” he says. “That’s what fuels the bubble—telling people to take risks. We would like to see a bit of wind taken out of the sails now.”