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BlackRock: Not all CRE is risky

Investment firm points to industrial commercial real estate as a lower-risk opportunity for investors.

The discouraging news surrounding the commercial real estate industry as of late might make some hesitant to invest, but there are some less risky corners in the market, according to asset management firm BlackRock. The firm noted in its weekly commentary that industrial CRE remains an attractive investment opportunity, Market Insider reports.

“Financial cracks have fed concerns over commercial real estate’s outlook,” the BlackRock team, led by Wei Li, the company’s global chief investment strategist, said. “We’re cautious on the sector. Yet we go granular in our portfolio views. We see better value in real estate sectors that may see long-term demand, like industrial.”

High interest rates, more stringent loan terms and remote work trends have all hurt the CRE industry in recent years. Additionally, large impending rollover of debt that was first financed when interest rates were lower still looms.

Together, these issues have increased investors’ concerns about CRE loan defaults and property prices dropping, eventually leading to a recession.

CRE investors are not the only ones concerned about the industry’s status, however. The Federal Reserve’s experts have warned about the CRE sector in its Financial Stability Report, according to Market Insider. The Fed said the central bank is watching CRE loans’ performances more closely. It also expanded its examination protocols for financial institutions with high risks connected to CRE.

“Banks’ exposure to real estate added to market jitters,” the BlackRock team said. “Banks held 40 percent of outstanding real estate debt as of 2022’s third quarter. That has raised fears high-vacancy or highly levered U.S. properties will struggle to refinance debt, causing some to hit the market at cheaper valuations or default. That dynamic may create a funding gap but also chances to scoop up discounted assets – with risks. We see the gap as a bigger concern for U.S. assets: Private European valuations are cheaper than U.S. peers, MSCI and NCREIF indexes show.”

BlackRock believes that “commercial real estate is not a monolith,” however and there are still valuable areas of the industry that are lower risk and have potential for gains, including industrial CRE.

The team pointed to capitalization rates’ divergence as a signal that CRE sectors aren’t all one in the same. BlackRock projects that retail cap rates will continue to increase because of pressure from e-commerce growth. Additionally, office CRE rates are expected to go up as well, as they have since 2022.

“Investors are requiring higher cap rates for offices, given rising interest rates and higher vacancies and remote work,” the team said.

Meanwhile, BlackRock said it expects industrial CRE cap rates to stay low relative to its peers because it sees higher earnings growth for the sector.

“We favor selected sectors such as industrial real estate as we see long-term forces like e-commerce and geopolitical fragmentation fueling demand,” the team said.  “Industrial assets – referring to warehouses used for distribution, manufacturing and research and development – have fared better than office. Industrial assets have a vacancy rate around 2% as of March and their share of the commercial real estate market has doubled since 2016 to take up roughly a third of the market now, according to NCREIF data. This differentiation is why we get granular.”

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