NEWPORT BEACH, CA—Green Street Advisors is calling for a modest decline in asset values over the next year due to a variety of indicators, managing director Andy McCulloch said in a webinar Tuesday that spoke to what's in store for the commercial real estate industry in 2016. While the fundamentals are strong and the industry is healthy, several reliable indicators are causing the firm to be bearish on asset values, he said.

McCulloch pointed out that the firm's Commercial Property Price Index, which is higher-weighted toward institutional-quality assets and major MSAs, shows that asset values for institutional-quality real estate have been strong, and the recovery has been robust. At the sector level, asset values have been up across the board, but asset-value growth has been slowing. "Some fairly large deals have been falling apart recently, and healthcare REITs have been pulling back from acquisitions," he said, which is a precursor for value decline.

Cap rates are at or near all-time lows and haven't risen in any sector except for senior housing nor in any market except for Texas and Denver due to oil-price declines, said McCulloch. Houston cap rates have risen between 40 bps and 70 bps in the office sector.

As far as the fundamentals go, "Real estate is in the 9^th inning with regard to asset values, but not operating fundamentals, which are healthy and which we expect to continue rising. Some sectors may be later in the cycle and some earlier, but we expect that the industry will be relatively healthy over the next several years," said McCulloch. He expects rents to grow in excess of inflation in all property sectors except for low-quality malls, in which he is forecasting a rent decline over the next five years.

Another indicator for bearish valuations is the NOI forecast, which is down for the first time in years. "One of the worst individual sector readings was in lodging, which could indicate a weakening economy," said McCulloch. "We're watching this closely."

There have also been signals from the bond and REIT markets that valuations are dropping, said McCulloch. While the high-yield market is currently sending a negative signal, it is less bearish than in comparison to investment-grade bonds, which could be overly influenced by energy companies. "The bond market is sending some bear signals," he said.

Green Street also looks at the public REIT market, which is showing discounts in the double digits. "The REIT market is right more often than wrong in calling change in the direction of asset values," said McCulloch. "The REIT market is a pretty good predictor of private-market values recently, which also happened during the early '90s and during the Great Recession. This is a warning signal. It's not a correction like what we saw in those two periods, but it's calling for a modest decline in asset values over the next year or so."

In addition, McCulloch said all property sectors are currently trading at discounts, although the firm is bullish on self-storage and expects private-market values to continue to rise and cap rates in this category to continue to fall. "Self-storage has been an outlier for some time. Everything is pointing down in all property sectors to 0% to 5% modest [pricing] declines, except in self-storage."

McCulloch pointed out that REIT managers are financial professionals now, and if a big buyer group pulls back, cap rates can flatten. "All real estate investors, REITs or not, have to pay attention to what the REIT market is telling you."

Also, the world has been ripe for M&A activity and this activity should remain elevated over the next 12 months, McCulloch added.

Ultimately, "The signals are scary," said McCulloch, "but the operating fundamentals are very healthy, and there's still lots of capital chasing commercial real estate; oil could be skewing bond-market signals, but it would lessen them, not change them; and cycles usually shoot well beyond fair. We don't think we're in a bubble environment—cycles can run long before they correct; the debt markets are not yet in crazy town—meaning there's a lot more equity in the capital stack than there was in 2007; and while we have seen a pullback from sovereign wealth funds into commercial real estate, the correction won't be nearly as severe" as it was during the Great Recession.

McCulloch said the firm expects slow growth going forward, job growth of 150,000 jobs per month and long-term expectations of inflation of just below 2%. "We don't have any recession built into any of our forecasts."