Employment and Low Interest Rates Drive Commercial Real Estate Gains

Commercial sales transactions span the price spectrum, but tend to be measured and reported based on size. CRE deals at the higher end—$2.5 million and above—comprise a large share of investment sales, and generally receive most of the press coverage. Smaller commercial transactions tend to be obscured given their size. However, these smaller properties provide the types of commercial space that the average American encounters on a daily basis—e.g. strip shopping centers, warehouses, small offices, supermarkets, etc.  These are the types of buildings that are important in local communities, and REALTORS® are active in serving these markets.

The National Association of REALTORS® Commercial Real Estate Outlook: 2015.Q3 report focuses on market performance in both large (LCRE) and small commercial (SCRE) sectors.  The report provides an overview of economic indicators, investment sales and leasing fundamentals.

Gross domestic product continued on a moderate growth trend in the second quarter of this year. Higher consumer expenditures, stronger exports and an uptick in government spending provided wind in the economic sails, offsetting declines in business investments.

Payroll employment rose by 678,000 positions in the second quarter, bringing total new jobs to 1.3 million during the first half of 2015. Professional and business services accounted for the bulk of new hires, followed by education and health, as well as leisure and hospitality. The retail trade, construction and manufacturing sectors also provided solid figures over the period. The unemployment rate declined from 5.6 percent in the first quarter to 5.4 percent in the second quarter. Accompanying gains in employment, median earnings of private employees—adjusted for inflation—rose 2.1 percent in the second quarter, a noticeable improvement from the past few years.

With improving economic fundamentals, demand for commercial space continued improving across all property types. Vacancy rates in LCRE and SCRE markets converged, as the rebound has been broadening in secondary and tertiary markets.

Commercial investment sales have been riding a growing wave of capital, coupled with continuing low interest rates. The volume of commercial sales in LCRE markets during the second quarter of this year increased 23 percent on a yearly basis, according to Real Capital Analytics.  In a sign of increasing investor optimism, portfolio transactions have been on the rise, even as individual transactions comprised the largest market share. Prices increased by 3.1 percent in the second quarter, driven by strong appreciation of apartment and CBD office properties.

In comparison, sales in SCRE markets rose nine percent year-over-year during the second quarter, based on REALTORS® market data. With inventory shortage continuing as a main concern, prices accelerated during the period, with properties trading at 6.6 percent higher average prices compared with the second quarter of 2014.

Cap rates in SCRE markets were, on average, higher by 80 basis points compared with cap rates in LCRE markets. With the interest rate on 10-year Treasury Notes averaging 2.1 percent during the second quarter of 2015, the spread between cap rates and 10-year Treasury Notes ranged from 462 basis points in LCRE markets to 542 basis points in SCRE markets. The large spread indicates that CRE investors continue to enjoy healthy returns in rebounding markets.

The outlook for the second half of 2015 remains positive. With economic growth expected to remain moderately positive, demand for commercial properties will continue to provide downward pressure on vacancy rates. As funding sources increase, commercial real estate investments are projected to close over $500 billion by the end of the year.

To access the Commercial Real Estate Outlook: 2015.Q3 report visit http://www.realtor.org/reports/commercial-real-estate-outlook.