Stewart Hsu

As an investor, you need to be able to see the “forest for the trees” and you need to be aware what’s going on at a macro-level. Following are some interesting data points to help put into perspective where we are in the U.S. economic and apartment market cycles.

Larry Souza, a Managing Director with Charles Schwab Investment Management, published a report 7/29/08 titled “Commercial Real Estate: Economic Cycle Analysis.” Heavy in the economic-speak, I had to read it a few times to pull out these take aways for you. Following below are what I believe are the salient points of that analysis, slanted towards your writer’s choice of real estate, i.e. apartments.

First, as background, it’s important to know the report is based on data from Standard & Poor’s/GRA Commercial Real Estate Indices (SPCREX). The SPCREX is composed of 10 indices, namely 5 geographic regions, 1 national composite and 4 property sectors. These indicies measure the change in prices. Unfortunately, they do not cover Texas as a region (perhaps it’s because TX a non-disclosure state?), but they do track “Apartments” as one of the sectors. Per the S&P factsheet, the SPCREX is “designed to be a reliable and consistent benchmark for commercial real estate prices in the United States.”

For context (and as trivia for you to impress your real estate associates), the estimated value of all direct commercial real estate in the U.S. is $5.3 trillion, of which apartments make up $1.3 trillion of 24% of the total.

Larry Souza’s Findings

1. Since 1993, commercial real estate has gone through 2 full cycles.
2. Most of these indicies in the prior commercial real estate cycle peaked around May-Jun 1999 (avg +14.5%), and troughed around May-Jun 2001 (avg -1.2%). Apartments peaked Jun 1999 (avg +14.6%) and troughed in Apr 2001 (avg -2.0%).
3. Compared to the recent cycle, most indicies peaked around May-Aug 2006 (avg +16.3%) and troughed between Oct 2007 - Apr 2008 (avg +1.7%). Apartments peaked Aug 2006 (avg +16.6%) and troughed in Jun 2007 (avg -3.5%). Note: it has yet to be determined if the current cycle has hit bottom.
4. For the prior apartment cycle, it took 22 months to decline from peak to trough.
5. For the current apartment cycle, it took 11 months to decline from peak to trough.
6. Growth rates for national commercial real estate prices are moderately correlated (but statistically significant) with total non-farm employment growth rates. For those statistics-savvy, the Multiple R value was 0.27 for the apartment index to total non-farm employment.
7. Overall, the SPCREX indices appear to lead the troughs and lag the peaks of the overall business cycle. So, in plain English, I understood this to mean the indicies will indicate the bottom of the business cycle in advance of it actually happening… which is potentially very useful! This one idea, is the gem in the whole report, as it would provide some data that the economy has stopped declining and is back on the rebound. Also, the indices would not indicate a peak has been reached until after that has happened (don’t see as much value here, other than to be very cautious if you continue seeing it rise for extended periods of time).

Apartment Cycle Charts

A picture’s worth a thousand words, so I took the data available on the S&P website, and threw it into a chart. Here’s the “2 Cycle Apartment” chart which covers the Apartment Sector index from Oct 1993 thru Apr 2008.:

Given this prior chart covers 2 cycles and 15 years, I wanted to see what it would look like if we just went for 1 cycle over 7 years. I inserted a trendline to get a sense of where we currently stand. Here is the “1 Cycle Apartment” Chart, i.e. the apartment Sector index from Apr 2001 thru Apr 2008. Similarly, I inserted a trendline.

So, is it time to buy or sell? Only time will tell.

For all you data die-hards out there, here’s are a couple links, one to Larry’s report, and the other to S&P’s SPCREX website.