CRE is in a mini-bubble, but not nearly the bubble that residential real estate, and more specifically single-family residences, is in. Recall that when appraisers appraise a SFR they basically just use comparable sales to value the property – this is a recipe for bubblicious behavior as there’s no mooring to value based on cashflows. Where most CRE is concerned there is an interest coverage ratio – typically 1.10x to 1.20x – that the lender generally requires that puts a ceiling on the valuation (and, conversely, puts a floor under the cap rate) assigned to the property. REITs are currently assiging cap rates of about 5%-5.5% on big class A properties here in SoCal (too low by about 1.5% in my opinion) and smaller properties that are being funded by banks are being assigned cap rates of about 6%-7% these days (again, probably too low by about 100 – 150 bps). But, despite the fact that these cap rates are probably lower than they should be, they’re cashflowing well and vacancies are very low (here in SoCal that is), so while there’s reason for caution, CRE isn’t in nearly as bad a shape as SFRs.
