Yield Premium Favors REALTORS® Commercial Markets in Q2.2015

Commercial real estate transactions span the price spectrum, but tend to be measured and reported based on size. While the majority of buildings (81 percent) are relatively small (SCRE), with the bulk of commercial space (71 percent) concentrated in larger buildings (LCRE)[1], larger buildings account for the majority of sales. CRE deals at the higher end—$2.5 million and above—comprise a large share of investment sales, with transaction data readily available from several sources, including Real Capital Analytics (RCA).

Data for smaller transactions—$2.5 million and below—many of which are handled by REALTORS®, are less widely available. NAR’s Commercial Real Estate Market Trends gathers market information for SCRE properties and transactions.

Based on the latest NAR report on REALTORS® CRE markets, capitalization rates declined to an average of 7.5 percent across all property types, an 85 basis point decline on a yearly basis. Apartments posted the lowest cap rate, at 6.8 percent, followed by hotel properties with average cap rates at 7.4 percent. Office and industrial spaces posted cap rates of 7.7 percent and 7.5 percent respectively. Retail transactions reported the highest comparative cap rates—8.0 percent.

The interest rate on 10-year Treasury Notes—a standard measure of risk-free investments—averaged 2.08 percent during the second quarter of 2015, unchanged from the first quarter. Based on the prevailing rates, the spread between cap rates and 10-year Treasury Notes ranged from 462 basis points in LCRE market to 542 basis points in SCRE markets. The spread denotes that CRE investors are continue to enjoy healthy returns in the rebounding markets.As the Federal Reserve’s “forward guidance” has been hinting at a hike in the target rate in the latter half of this year, the impact on the CRE sector is likely to be minimal. On one hand, the Fed’s funds rate is essentially a short-term rate, whereas the more relevant Treasury notes carry longer-terms. On the other hand, with communications from the Federal Reserve Board being somewhat more transparent, the initial rate increase has likely been already capitalized in market prices. And on the proverbial economist’s third hand, with spreads exceeding 400 basis points, CRE investors retain a healthy cushion, as cap rates are not likely to change dramatically in the short term.

To access the latest Commercial Real Estate Market Trends report, visit: http://www.realtor.org/research-and-statistics/commercial-real-estate-market-survey.

 

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[1] Smith and Ratiu (2015), "Small Commercial Real Estate Market," National Association of REALTORS^®