Commercial sales transactions span the price spectrum, but tend to be measured and reported based on size. Commercial real estate (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: 2016.Q1 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.
U.S. macroeconomic momentum dropped during the fourth quarter of 2015, buffeted by global economic slowdown and financial volatility. Business investments took a step back, and the strong dollar impacted net exports. Payroll employment offered a bright spot, closing the year with a total of 2.7 million net new jobs, boosted by private service industries. Rising employment drove demand for commercial space across the property spectrum. Vacancies continued declining in the fourth quarter of 2015, as rising rents improved cash flows.
The pace of commercial transactions rebounded in the fourth quarter of 2015, after the third quarter slowdown. The volume of commercial sales in LCRE markets totaled $157 billion, a 20 percent year-over-year increase, according to Real Capital Analytics (RCA). The fourth quarter data saw gains in both individual and portfolio transactions, with a marked jump in entity level exchanges, which rose 224 percent.
Across the entirety of 2015, apartment transactions comprised the largest share of volume, with $150.0 billion in sales, followed by office properties, which accounted for $145.8 billion. Retail and industrial sales totaled $87.6 billion and $76.5 billion, respectively. Industrial sales posted the largest year-over-year change in transaction volume—54 percent.
In comparison, sales in SCRE markets rose 7.4 percent year-over-year during the fourth quarter, based on REALTORS® market data. The average transaction price declined from $1.9 million in the third quarter of 2015 to $1.6 million in the last quarter.
Buoyed by rising sales and investor optimism, prices in LCRE markets rose by 12.3 percent during the last quarter of 2015, based on RCA’s Commercial Property Price Index. The advance was driven by strong appreciation in prices of CBD office and hotel properties, which advanced 18.9 percent and 16.1 percent, respectively. Separately, additional price indices reflected the gains in commercial valuations. The Green Street Advisors Commercial Property Price Index rose 9.7 percent on a yearly basis during the fourth quarter, reaching a value of 122.0, the highest since the index’s inception in 1998. The National Council of Real Estate investment Fiduciaries (NCREIF) Price Index moderated from its third quarter record of 251.61, but increased 5.1 percent year-over-year in the last quarter of 2015.
Capitalization rates in LCRE markets averaged 6.7 percent in the fourth quarter, based on RCA reports, 20 basis points lower than the prior period. Cap rate compression continued, as transactions of office properties in CBD markets tied for the lowest cap rates with apartments, at 5.8 percent.
With inventory shortage continuing as a main concern, prices in SCRE markets rose a more moderate 4.1 percent year-over-year during the period. Average capitalization rates declined to an average 7.8 percent across all property types, a 13 basis point compression on a yearly basis. Apartments posted the lowest cap rate, at 7.2 percent, followed by industrial properties with average cap rates at 7.4 percent. Office and retail spaces posted cap rates of 8.2 percent and 7.8 percent, respectively. Hotel transactions reported the highest comparative cap rates—8.6 percent. It is worth noting that these cap rates are higher than those in LCRE markets, reflecting activity in markets where REALTORS® are more engaged.
Looking ahead at 2016, the GDP annual rate of growth is projected to moderate, with a 1.4 percent advance. Following what is shaping up to be a weak first quarter, economic growth is expected to pick up in the second half of 2016 to the tune of 1.6 percent in the third quarter and 2.0 percent in the fourth one. Payroll employment is projected to post 1.3 percent annual growth rate for the year. The unemployment rate is projected to fall to 4.8 percent by the end of 2016.
Commercial fundamentals are expected to improve, with vacancies continuing on a downward trend. With strong fourth quarter volume, CRE investments closed 2015 on an upbeat note, moving toward the 2007 peak. In addition, January 2016 sales maintained momentum, totaling $44.5 billion and registering the second most active January on record, according to RCA.
Given the global uncertainty and financial market gyrations, CRE is likely to remain an attractive alternative for investors this year. At the current sales pace, sales of LCRE properties are projected to total over $560 billion in 2016.
However, after a steep upward trajectory over the past few years during which they surpassed the prior 2007 records, CRE prices are expected to throttle back. With cap rates at very low levels and interest rates expected to rise, the price slowdown is projected to impact Class A assets in top-tier markets, where inventory shortages and crowding of capital have led to the recent run-up. Properties in smaller markets, where the recovery only began in 2013 are likely to see continued price appreciation.
To access the Commercial Real Estate Outlook: 2016.Q1 report visit http://www.realtor.org/reports/commercial-real-estate-outlook.