Are Real Estate Returns Headed for a Correction?

May 20, 2016

Core real estate investments have flourished since the financial crisis, with the NCREIF Property Index¹ (“NPI”) returning 13.3% in 2015, its sixth consecutive yearly gain after the real estate recovery began in 2010. Not surprisingly, investors are now wondering if this run can continue, or if it is time to pull back on their allocations to real estate. In this week’s chart, we look at the historical total returns of the NPI going back to 1978² broken out by appreciation and income. The NPI was first launched in 1978, and since then, real estate cycles have historically lasted more than 10 years. The first cycle featured 13 years of positive total returns followed by a negative 5.6% return in 1991 as a result of severe oversupply in the market. These negative returns only lasted two years before again turning positive from 1993 until 2008, when returns flipped negative due to the global financial crises.

Since the Global Financial Crisis, core real estate has made a robust recovery, generating double-digit returns over the past six years, but the real question is whether or not such impressive returns can continue. On one hand, supply for most commercial real estate sectors is still below their pre-recession averages, cap rates may compress further given their spread to Treasuries, income levels are favorable, leverage is manageable, and debt maturity profiles are appropriately structured. On the other hand, valuation levels are high as a result of price appreciation, and significant capital has flowed into the asset class. Ultimately, we do not believe that real estate returns are poised for a correction, but anticipate they will retreat from the double-digit territory we have seen over the past six years to a more realistic mid- to high-single-digit range.