The big money question-Commercial property as an asset: Will it win in this election?

The big money question: How do commercial properties compare to other asset classes, not only in the current turbulent environment, but in recent history? And as interest rates are the driver of real estate values, how will rates be affected by the Presidential election? The predictions may surprise you. We looked at how real estate performed compared to other institutional investments, the most popular being the S&P 500 and Nasdaq indices. In Exhibit 1: A 15-year Window of Assets (1997-2012), we see the dramatic changes that occurred over the past 15 years. The Internet boom and bust ruled in 1997-2000, spiking in March 2000 and plummeting to a low in summer of 2002. During this 60-month period when fortunes were made and lost, real estate-both housing and commercial-steadily gained in all areas, trailed by the S&P performance. However, after the stock market's nadir in the summer of 2002, real estate grew dramatically for nearly four years straight until the debt crisis hit in full force in 2008. Of the assets of choice - residential real estate, commercial real estate, S&P stocks, or Nasdaq stocks, which appears to have had the best recovery? Commercial property (+106%) and Nasdaq stocks (+99%). Unlike residential real estate, commercial properties more than doubled over the past 15 years and have nearly fully recovered from the 2008-2009 debt crisis lows. While Nasdaq and the S&P have recovered, the steady, more even growth appears to be in commercial properties. Moreover, based on the continued global urbanization trends - particularly in Asia - and the steady CPI growth, commercial real estate appears to be the long-term asset of choice. In Exhibit 2: Real Estate vs. Government Indices, commercial real estate most closely parallels the CPI in 1997-2012, according to statistics, but the growth is more than double that of the CPI. Over the 15-year period, there are several interesting occurrences: commercial properties grew 106%, outpacing commodities (+75%), residential housing (Fannie Mae at +90% and Freddie Mac at +48%), and the CPI (+43%). The conclusion from this data is that commercial properties have managed to maintain strength through one of the most dramatic upswings in commodity prices in recent history and rebounded from the severest debt crisis and credit crunch in recent history. In this asset class, the Fed policy actually proved to be effective, making this asset the growth leader in the period. Moreover, the asset is less subject to the volatility that commodities exhibit, nearly tripling from late 2001 through the end of 2010, but over the 15-year period ultimately rising only 75%. While most standard institutional investors have not invested in commodities, the asset class is popular among hedge funds. Much to the surprise of many critics of the Obama administration, the rate of debt growth appears to have slowed and stabilized post-election in 2009 through 2012, as shown in Exhibit 3: Commercial Property Tracks the CPI. Moreover, during the same period, commercial property values have almost fully recovered while the values of residential real estate have continued to decline. Over the past 15 years, the commercial property index (+106%) has outpaced the CPI (+43%), and appears to be the best investment that keeps pace with the dramatic growth of outstanding US debt, which is approaching $53 trillion (+156%). Many fear there is an inverse relationship between real estate and interest rates. In commercial investment real estate, this is particularly true as the cost of financing affects the net operating income, the basis on which many properties are valued. In Exhibit 4: Prime Rate vs. Real Estate (1997-2012), real estate continued to grow despite periods of high rates. Granted, the real estate market dramatically overheated in 2007, and the Fed increased rates to cool the heated market, but the market ultimately collapsed, the residential to a greater extent than the commercial real estate market. The post-2000 interest rate catalyzed real estate growth, the 2004-2007 rate hikes cooled the market, but the slashed interest rate environment in 2008-2009 drove the commercial property market to nearly fully recover and flourish, while the residential market rate reductions saved that market from a severe collapse in values. While one might believe that higher interest rates would blunt the real estate market growth, historically they have not. In Exhibit 5: Prime Rate 1929-2012, real estate continued to flourish despite the high interest rates of the 1970s and 1980s. Lower interest rates of course catalyzed an increased rate of growth, but it was really the credit crisis of 2008-2009 that dampened the growth in the overheated residential housing sector. As statics available for commercial properties date back only to 1997, Exhibit 5 depicts the FHFA residential housing market. We should look at the greater historic trend of prime rate when considering the relationship between prime rate and real estate. The prime rate stayed below 5% for over 35 years from the Great Depression through 1965. The oil crisis of the 1970s sent the prime rate to above 20%, and rates gradually recovered in fits and spurts into the 1990s to below 10%. Note that there were three major crises that ultimately caused lower rates: the Stock Market Crash of 1987, the Internet Collapse in 2000, and the Mortgage Crisis in 2008. Over the last 35 years we frequently have seen a severe impact on rates in the first 12 months after a change of Presidential administration (Exhibit 6). In the Carter years rates exploded, Reagan reversed them through his two terms, Bush 1 continued the Reagan trend, then under Clinton rates went up, and Bush 2 lowered and then raised them as the economy overheated. Generally, Republicans have lowered rates and Democrats have raised them; in this regard Obama is an aberration. Democratic presidents normally have administrations with a higher prime rate than the current 3.25%. If Obama remains in office, rates may remain low, as administrations tend to follow the policy they have set. If history repeats itself, then we can expect rates to remain low following the stock market collapse of 2008-2009, as they did for some 30 years after the Great Depression. We are well aware that rates inevitably will go higher, but will increases, no matter how high, halt the growth and returns of commercial properties? Based on the indices since after World War II, property values appear to outpace CPI over the long-term, and investment property survives through any interest rate environment. As an asset class, when compared to stocks and commodities, real estate appreciates with the least amount of volatility. And most recently, as an asset class separate from residential real estate, commercial investment real estate has proven the most resilient, continuing to grow even through high interest rate environments, which should be a comfort to real estate investors pondering the post-election rate prospects. Rolfe Haas is a senior associate at Besen & Associates, New York, N.Y.