Commercial Real Estate Shows Improvement

Auction.com released its Q2 2014 Commercial Real Estate (CRE) Market Monitor Report, which shows commercial real estate transaction metrics trending in a positive direction, with deal volume and pricing shifting upward as cap rates and risk premiums decline. Here’s what the data revealed:

“The picture continues to brighten for the commercial real estate market, as more investors take advantage of the current low-interest rate environment and drive transaction volume and pricing upward across all of the major sectors,” said Auction.com Executive Vice President Rick Sharga. “Even the sectors that are beginning to level out in terms of transaction growth are performing better than they have in the past five years.”

According to the report, CRE deal volume is healthy – up from recessionary lows and led by the historically dominant office sector. The total combined commercial volume in the office, retail, apartment, industrial and hotel sectors reached $81.6 billion in the second quarter of 2014, up nearly 14 percent from one year ago. Office and apartment transactions combined to account for more than 55 percent of the five-sector total, similar to one year ago, though the apartment sector’s portion of that volume has shrunk. Meanwhile, retail transactions made up 16 percent of the total.

CRE Deal Volume

Deal Volume

Property pricing is also on a steady upward trend across all sectors, with industrial pricing leading the way in terms of gains. A 15 percent year-over-year increase in May 2014 elevated the industrial sector’s price growth to second among the sectors – right behind hotel, which has averaged between 15 and 20 percent year-over-year growth since June 2013. The retail sector saw a surge in price growth in 2013, similar to what industrial is experiencing now, but year-ago gains have begun to decelerate in recent months as the sector continues to face headwinds including the rise of online shopping and shrinking space needs per customer. Office pricing continues to make steady headway as the sector maintains the largest share of total CRE transaction volume and runs in the middle of the pack in terms of average pricing and cap rates. Meanwhile, the apartment sector’s year-over-year price growth has flattened, reflecting the more mature portion of cyclical expansion for this segment following robust gains in recent years.

Year-Over-Year CRE Pricing

Year-Over-Year CRE Pricing

Downward Trend in Risk Premiums and Cap Rates

Auction.com Research’s risk premium calculations show a slight decline from one year ago and more significantly from two years ago. “Risk premiums are still higher than they were in 2008, in the midst of the recession and its aftershocks,” noted Peter Muoio, PhD, managing director of Auction.com Research. “This signals the potential for further cap rate compression even in a presumed higher interest rate environment as the Fed ends its quantitative easing.” The apartment sector currently offers the lowest risk premium (in the mid 3 percent range), while hotel is the highest, as has been the case in recent years.

CRE Risk Premiums

Risk Premium

Cap rates have been trending down in all five major property sectors recently. Values are now below their 10-year average, and apartment cap rates are currently at a 10-year low point. Hotel is the only sector that has seen rates rise modestly in the past few years.