Why the CRE Cycle Still Has Room to Run

Six years into the U.S. commercial real estate cycle, MetLife Investment Management’s head of real estate and ag research doesn’t anticipate a downturn any time soon

The commercial real estate cycle in the U.S. could have another two years of runway, says Melissa Reagen, head of real estate and ag research at MetLife Investment Management.

Despite the current cycle already entering its sixth year—with some industry economists and experts predicting a downturn by mid-2017—Reagen argues there are reasons to remain bullish.

“Some people are saying six years, that’s long enough,” she says. “To us, that’s not a good enough reason to expect the cycle could be turning. We’re a bit more in the bullish camp.”

While volatility and investment risk appear to be rising globally, much of it is focused outside of the U.S., Reagen says. In turn, that is making the U.S. more attractive to institutional investors, not to mention the favorable fundamentals in commercial real estate and the disciplined financing in the asset class.

“Right now we really like the fundamentals,” she says. Key property sectors are not facing oversupply, with new inventory as a percentage of existing stock at a 30-year low for the office and industrial markets.

The lack of new supply is primarily due to the need for banks to hold more capital against loans. “That cut off a lot of construction financing,” she says. “The financing of real estate is much more disciplined this time around compared to the last cycle.” She adds that most transactions now require more equity and fewer slices of riskier mezzanine debt.

Reagen says that, of the seven cyclical risk warning signs she and her research team are looking for, only one is flashing.

Contracted rent—the difference between asking rent for a space and the rent agreed to in a signed contract—has been rising slightly. “When that spread becomes larger, it reflects overoptimism on the part of landlords,” she says.

But with supply and demand in balance, and construction financing scarce, most risks to real estate are exogenous factors that affect all asset class.

“Our perception is that in this market there are some black swan [events],” Reagen says, citing the fallout of negative interest rates, the failure of Abenomics in Japan, and a possible Trump presidency among them. “[But] in our view, these [black swan events will] likely mean more capital will flow into U.S. real estate.”

Reagen is more cautious when it comes to hospitality and hotel investing in markets such as New York, Miami, and Houston, where significant capital flows have driven up prices and led to greater supply. Apartments in Miami also warrant caution, she says, adding: “There’s so much supply. How can all of that be absorbed?”

Bright spots in the U.S. real estate market, though, are retail and warehouse property, Reagen says.

While weak results at traditional department stores have dominated the headlines, the opportunity in retail is in high-quality, experience-oriented malls that can deliver a lifestyle proposition encompassing entertainment and dining, rather than just shopping.

Retailers are also driving a new wave of demand for large suburban logistics centers as well as smaller urban delivery-fulfillment centers, Reagen says, as they respond to the need for overnight or same-day delivery from online retailers. “It’s a more recent strategy in the last 12 to 18 months because Amazon [and other online retailers have] been so aggressive,” she says. Rising warehouse demand is “really a long-term structural shift resulting from e-commerce,” Reagen says.