Trends in Commercial Real Estate
Speaking in New York on Tuesday, Boston Fed President Eric Rosengren discussed commercial real estate valuations. While a variety of favorable conditions account for some of the elevated valuations, he noted that at such times it is worth asking what could go wrong and cause a reversal.
"While I do not expect that a downturn in commercial real estate prices would by itself cause a significant problem for the economy, in some past recessions such an occurrence has propagated an initial adverse shock – and by constraining financial intermediaries, made the extent of the subsequent economic downturn more severe for a wide range of households and businesses that depend on intermediaries for credit," Rosengren said, echoing themes he has stressed in prior analysis.
Rosengren said the regulatory community must also remain attuned to developments, understand how a reversal may propagate through the financial system, and consider whether the system is resilient enough to withstand such shocks, should they occur.
He acknowledged a number of favorable "tailwinds" accompanying rising commercial real estate valuations, including low and stable inflation, accommodative monetary policy, and the relative economic strength in the U.S. compared with the rest of the world. Rosengren also said that greater urbanization, later marriage age, and preferences among the large cohort of millennials are additional favorable trends for multifamily commercial real estate.
However, Rosengren cautioned that it is harder to know if these conditions warrant the extent of price increase we have seen to date.
"For almost any asset category, positive trends can sometimes evolve into prices that increase more than fundamentals justify," Rosengren said. "It is very hard to distinguish how much of the price gain is the result of the favorable fundamentals, and how much reflects an abundance of optimism by investors."
Rosengren noted that government‐sponsored enterprises (or "GSEs") have significant holdings or guarantees of multifamily loans outstanding. If future reform proposals required the GSEs to reduce their holdings of multifamily loans "a potential and significant shock to this sector of the commercial real estate market could occur."
Rosengren concluded by noting that leveraged institutions and GSEs have significant exposures to commercial real estate. In the event of an adverse scenario such as a recession, these exposures could pose significant risks to these institutions.
"While I am certainly not expecting such a scenario to occur, central bankers are charged with thinking about adverse risks to the economy. So current valuations in real estate are one such risk that I will continue to watch carefully," Rosengren said.
Rosengren was speaking at the Risk Management for Commercial Real Estate Financial Markets Conference at New York University's Stern School of Business.