IRVINE, CALIF. — In the first quarter of 2015, U.S. commercial real estate deal volume reached an all-time high, pushing capitalization rates to multi-decade lows, according to online real estate marketplace Auction.com’s “Commercial Real Estate Market Monitor.”
Deal volume in the first quarter reached $124.3 billion across all sectors of commercial real estate, which is a 47.4 percent increase from a year ago and a 0.1 percent increase from the fourth quarter of 2014. Since the fourth quarter commonly has the highest deal volume of the year, this represents the first time the first quarter represented a quarter-over-quarter increase since 2007.
“Investors continue to drive up market prices and compress cap rates, which suggests that they’re probably ahead of what the underlying fundamentals would support, especially in some of the hotter markets and sectors,” says Rick Sharga, Auction.com executive vice president. “Part of this is due to the availability of capital and the low interest rate environment we’re in.”
Another reason for the high deal volume, Sharga says, is a wave of foreign investment in the U.S. market.
“The continuing infusion of foreign capital is also a big factor — China and Singapore in particular have ramped up their U.S. commercial real estate investment, and the $1.95 billion purchase of the Waldorf Astoria in Manhattan by the Chinese firm Anbang Insurance Group was the highlight of the first quarter,” says Sharga.
It is uncertain how long the foreign investment wave will continue, as a strong U.S. dollar pushes investors toward Europe and China.
Sector-by-Sector Review
All five sectors saw a year-over-year volume increase in the first quarter of 2015, though a quarterly increase was only seen in industrial and hotel. The hotel sector experienced a 68.1 percent year-over-year jump in volume due in large part to the Waldorf Astoria sale. The industrial sector’s deal volume is nearly double its year-ago level.
Transaction volume in the office and apartment sectors increased 42.5 percent and 67.8 percent, respectively, year-over-year. The retail sector, which continues to face structural headwinds like online shopping and declining space per capita, saw the smallest year-over-year volume increase at 4.8 percent.
Click to view year-over-year pricing graph
Property pricing remains on a steady upward trend, up 15.9 percent from a year ago. Office, apartment and industrial sector prices are up 15.9 percent, 16.6 percent and 17.3 percent, respectively, from a year ago. Retail and hotel pricing have also rebounded following two quarters of relative weakness, with retail increasing 13.7 percent and hotel up 10.8 percent year-over-year.
Hotel, retail and industrial sector pricing continue to work back up toward pre-recession peaks, while the office and apartment sectors have already surpassed these levels, according to the Moody’s/Real Capital Analytics Commercial Property Price Indices. Industrial prices are just 1.6 percent below the prior all-time peak and are on pace to surpass it in the second quarter of 2015.
Retail property price growth has accelerated after slowing in the second half of 2014. However, retail property prices remain 9 percent lower than the prior all-time peak, and most retail markets have struggled to make inroads in absorption and effective rent growth.
Risk Premiums Increase, Cap Rates Compress
Auction.com’s calculations of risk premiums show that they are up from a year ago across all five sectors, with the apartment sector seeing the most significant increase — a 38 basis-point jump — and office, hotel and retail risk
Click to see risk premiums graph
premiums trailing slightly with respective 37-, 32- and 31-point increases. The industrial sector saw the mildest increase at 28 basis points.
“The gradual upturn in risk premiums reflects the recent run-up in pricing and valuations across all sectors,” says Peter Muoio, Auction.com’s chief economist. “In our view, the increase in risk premium is primarily driven by the rapid drop in Treasuries in the face of global capital market shifts versus the more languid pace of recovery for real estate fundamentals.”
Due to a decline in the 10-year U.S. Treasury rate, which has dropped 70 basis points in the last year, capitalization rates saw a year-over-year decline in all five sectors. Cap rates are significantly below the 10-year average, with office, apartment and retail cap rates now at their lowest rates since 2001. The office and retail sectors each saw cap rates decline 30 basis points from the previous quarter — the most significant quarterly compression among the sectors.
Click to see capitalization rates chart
“While the Federal Reserve is expected to increase interest rates at some point in 2015, which would lead to increases in the 10-year U.S. Treasury rate and potentially put upward pressure on cap rates, the current higher risk premiums should act as a buffer to keep cap rates from rising significantly,” says Muoio.
The Auction.com Commercial Real Estate Market Monitor is a quarterly report that tracks commercial real estate performance across all five major sectors — office, industrial, apartment, retail and hotel. The report covers transaction volume, pricing trends, cap rates and risk premiums on a quarter-over-quarter and year-over-year basis.
— Jeff Shaw