If you read a lot of sell-side research you know Street analysts aren’t particularly adept at penning executive summaries.
Generally speaking, you should be able to summarize the main points of a piece of research in series of bullet points, and if you can’t, you’re either not a very good writer or else you may not completely understand what it is you’re writing about.
Really good writers who do actual research can summarize hundred page documents in one paragraph. That’s one reason why the vast majority of peer-reviewed academic journal articles are never read – there’s usually an indented introduction that tells you everything you need to know (aside: the other reason academic journal articles are almost never read is because nobody cares and in the case of the social sciences, most of the conclusions are self-evident).
Well Goldman is bucking the trend on Thursday with a piece on commercial real estate. The full note is worth a read, but Hatzius manages to drive the point home pretty goddamn emphatically in just a few quick paragraphs.
Because it would be difficult to improve on this in terms of conciseness, we’ll present the first page of the piece below without trying to summarize further, although we would encourage you to take special note of the bit about how more than a trillion worth of CRE collateral has been packaged and sold as non-agency paper (i.e. as “you’re fucked if something goes wrong” paper).
Commercial real estate prices have increased 76% in real terms over the last seven years and are now above pre-crisis levels. At the same time, elevated supply growth, demand risks, and rapid credit growth in some subsectors suggest additional focus on the asset class is warranted.
Updating our equilibrium valuation models, we believe commercial real estate valuations are becoming increasingly stretched and are now moderately overvalued – between 0.5 and 0.9 standard deviations rich – even after taking into account the lofty levels of other assets classes.
Additionally, the combination of higher interest rates and potentially unfavorable supply & demand dynamics suggest heightened risk that the misvaluation could worsen. Indeed, these developments could ultimately become the catalysts that produce such a repricing.
Elevated prices and volumes in commercial real estate (CRE) have garnered increased attention among Fed officials recently. Commercial real estate loans in the banking system now total $2.0 trillion, and have risen considerably as a share of GDP over the last five years (see Exhibit 1).
In addition, over $1.1tn of CRE loans have been securitized and sold in commercial mortgage backed securities (CMBS) products, over half of which are held in non-agency securitizations that are not insured against credit losses.
Prices of commercial real estate appear elevated as well, as the Federal Reserve Commercial Real Estate Price Index has increased 76% in real terms from its post-recession trough and is now 2% above its peak in late 2007. The pace of price appreciation has started to slow recently – a likely welcome development in the eyes of policymakers – with the Federal Reserve measure slowing to +5.9% year-on-year in 4Q16 (vs. +6.6% in Q3 and +11.4% in 2015) and the more timely Green Street Advisors price index up 0.8% year-on-year in May (vs. +3.2% in December).
Because of the importance of this asset class as a source of collateral and its prominent position on bank balance sheets, any dislocations or misvaluations in this market could pose significant risks to financial stability.