The Driving Force Behind Commercial Real Estate Value - Past, Present, Future
Like any other operating business, commercial real estate value is determined by:
- Current yield
- The quality of the current yield
- The outlook for future yield
While many people believe jobs create commercial real estate value, jobs are in fact the driving force that sets the foundation for creating commercial real estate value. Many people believe that real estate’s benchmark tools such as capitalization rates, gross rent multipliers, etc., determine the values for commercial real estate. The benchmark tools of real estate are used to validate value. Validating value when buying real estate is quite different from what creates commercial real estate value.
Throughout the years, many fashions and vogues have driven the yields that affected commercial real estate value. Buyers who understand what creates commercial real estate value will have a better understanding of how to use their tools than those who don’t. They will also have a better understanding of the strengths, weaknesses, and direction of real estate prices. Since 1975, commercial real estate yields and thus property values have been driven by four different factors in four different eras.
The driving force behind commercial real estate values: 1975-1980
The 1975-1980 commercial real estate era saw a favorable economy combined with a positive supply/demand relationship for commercial real estate. Construction activity remained moderate during this period, and the supply/demand relationship maintained a reasonable balance. Because of the favorable supply/demand relationship, no rent concessions were offered and thus rental revenue was real. The environment for commercial real estate was represented by high occupancy levels and regularly increasing rents.
Sharply increasing home prices set a strong pace for further increases in apartment rents. The economy’s expansion increased the need for office space, which resulted in high occupancy levels and increasing rents. Retail space became the beneficiary of low unemployment, high consumer confidence, the introduction of credit cards, and a new concept for shopping: regional malls.
Occupancy levels for all three of the primary types of real estate were at historically high levels with strong lessees, no concessions, minimal delinquency, and increasing rents. This is a formula for strong qualitative yields. The result was higher real estate prices. Rents were the driving force behind real estate investment success for the 1975-1980 period.
The driving force behind commercial real estate values: 1981-1985
The 1981-1985 commercial real estate era saw a completely different combination of factors. The country experienced the largest amount of construction in its history. Record numbers of apartments, offices, and retail space were built. Construction activity was the result of credit, not need. Hence excess real estate was placed on the market, resulting in high levels of vacancy and the introduction of concessions, which, when factored in, meant rents were in a broad decline and were not a catalyst driving real estate prices.
