The rout the January stock market experienced was the worst start for the market in history! What does that mean for commercial real estate? Is that the next asset class to tumble?
The stock market absolutely impacts commercial real estate, sometimes negatively and sometimes positively, depending on several factors. Unlike the lightning reaction time of the stock and bond markets, real estate is a fairly slow moving beast. It can often take many months for a noticeable trend to develop. The stock market’s impact on commercial real estate (CRE) is determined by 3 main factors:
- The level of volatility of the stock market
- The length of time of stock market trend (direction)
- The reasons for stock market trend and volatility
Let’s examine each factor singularly and in combination. Extreme volatility with a significant downward bias, as we are currently witnessing, is certainly unnerving and can significantly impact consumer confidence and can also be a function of deteriorating consumer confidence. When this happens there can often be a rush to other asset classes (gold or real estate, for instance) for perceived safety and capital preservation. This is can often be the short term reaction, but as we all know it takes some time to make the shift to CRE as buying CRE takes time and study. When volatility is coupled a long-term downward trend in the market (factor #2), then buyers of CRE really make a more concerted effort to make a redevelopment of assets from the stock market to CRE.
Where this can all get real tricky is factor #3, the reasons for the stock market trend and volatility. Stock markets aren’t like they were twenty years ago and have morphed into sometimes an irrational and incomprehensible set of influences. They have become so globalized that every isolated conflict and financial misstep abroad can have rippling affects through every stock market in the world. The market movement for your shares of your favorite stock is no longer just limited to the financial performance of that company and the domestic economy, now you’ve got to be concerned about a debt crisis in some far off third tier country. The game has changed and investors are finally catching on that the stock market is no longer “efficient” but has become “hyper sensitive efficient.” As such the investor has to try to sift through the banter of the CNBC talking heads and self serving stock analysts to figure out if the stock market trend and volatility is just noise or if there is an underlying negative set of conditions that will likewise impact CRE. Those conditions can be long term interest rate rises and recession. When those conditions happen and are severe, the impact to CRE is abusive: consumer confidence and buying power shrink, unemployment rises and companies contract their number of stores and offices, people don’t travel as much, etc.
So where the investor thinks we are in the economic cycle and what camp he/she is in (unwelcome temporary ‘noise’ or structural problems in the economy) is going to determine if he’s/she’s a buyer or seller of CRE.
Short term high fluctuations in stock market will shift investor sentiments towards CRE. Long downtrends in the stock market will likewise result in investors to ‘throw in the towel’ with the stock market and shift to CRE. Long term structural defects in economy will make all asset classes, including CRE, face difficult times.
Of course everyone already knows the inverse relationship of CRE valuations (cap rates) and long term interest rates.
Accordingly what to do is a function of how you view the trend of the economy and what camp you are in. The one truism about CRE is that it is the epitome of the hard asset classes and not an intangible share in some stock that is subject to the whims of global markets. CRE is the long term.
