As Investors Move Beyond Multifamily and Core Markets, Retail Leads Price Gains Among Major Property Types; West Region Sees Strongest Quarterly Gain
After posting modest gains through the first two months of the third quarter of 2013, price growth for commercial property was mixed in September, reflecting the uncertainty that existed over economic policy and an uptick in interest rates.
The two broadest measures of aggregate pricing for commercial properties within the CoStar Commercial Repeat Sale Index (CCRSI) -- the value-weighted U.S. Composite Index and the equal-weighted U.S. Composite Index -- saw little movement for the month.
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The value-weighted index, which is influenced by larger transactions, expanded by 0.3% in September; while the equal-weighted index, which reflects more numerous smaller transactions, dipped by 0.6% in September. However, both indices posted modest gains in the third quarter of 2013, and advanced 8.4% on an annual basis.
Based on 1,187 repeat sales in September 2013 and more than 125,000 repeat sales since 1996, the CCRSI offers the broadest measure of commercial real estate
repeat sales activity.
September 2013 CCRSI National Results Highlights
With pricing for multifamily assets in the Northeast and West regions approaching peak or near-peak levels, investors have continued to expand their search for yield beyond core gateway markets, leading to stronger price gains in the office, retail and industrial sectors in other regions, including the Midwest region.
After bottoming more than a year later than in the other regions, the Midwest Composite Index has advanced by 15.7% from its trough in mid-2012, buoyed by pricing growth in the multifamily and retail sectors.
CAPITAL FLOWS REMAIN STRONG
The recovery in market fundamentals and firming of property values has fueled transaction activity by giving lenders more confidence to make deals. This in turn has boosted U.S. composite pair volume, which tallied nearly $60 billion year-to-date as of the third quarter of 2013, an increase of 20% from the same period last year.
Other capital sources, including a restored CMBS market, banks and life insurers, are increasing their CRE lending volumes, joining the government-sponsored enterprises (GSEs) that have provided the primary financing support to date.
DISTRESS SALES CONTINUE TO WANE
The percentage of commercial property selling at distressed prices dropped to 11.6% in September 2013 from more than 24% one year earlier, enabling banks and other lenders to focus on growth opportunities.
The multifamily sector recorded the lowest level of distress in the third quarter of 2013 at 9.5%, which is a cumulative 77% decline from peak levels reached in 2010. The share of distress deals in the other property types ranges from 12.1% in the industrial sector to 15.8% in the office sector.
On a regional basis, distress levels have largely worked through the system in the Northeast, with just 7.1% of deals selling at distressed prices, while the Midwest has the furthest to recover with over 23% of property still selling at distressed levels.
RETAIL POST STRONG GAINS
While pricing advanced moderately across all four major property types in the third quarter of 2013, the strongest gains took place in the Retail Index, which posted the strongest pricing gains from both quarter- and year-ago levels. A broad improvement in market fundamentals has translated into pricing gains of 1.8% in the third quarter of 2013 and 12.6% over the last year.
Core markets remain attractive for investors, as indicated by the 23.7% rise in the prime retail index over the last year. However, price increases for commercial property are spreading across the wider market. All retail subtypes have benefited from vacancy compression over the last several quarters, including previously struggling neighborhood and strip centers.
Pricing in the multifamily sector is approaching previous peak levels as investors continue to allocate large amounts of capital to apartment investments. The Multifamily Index rose by 7.5% over the last year and is now just 12.6% below the previous peak for this property type reached in 2007.
Core markets remain the most competitive as indicated by the rapid growth in the Multifamily Prime Metros Index, which has already surpassed the pre-recession high water mark by 5.6%. While market fundamentals in this sector have made a full recovery, with new supply flowing quickly in many markets, vacancies are not expected to get much tighter. With pricing at or above peak levels, there are signs of a deceleration in pricing in recent quarters. Average quarterly growth of 1.8% in 2013 is nearly half the rate in the previous two years.
Steady demand for office space
, coupled with historically low levels of new construction, is driving pricing gains of 8.7% in the Office Index for the year ending in the third quarter of 2013. Pricing has already surpassed or is near the prior peak in prime office markets such as San Francisco and Boston.
Meanwhile, investor interest in non-primary markets has increased. Office transaction volume has doubled in such markets as Philadelphia, Las Vegas and Indianapolis over the last year.
An exceptionally wide gap in pricing between secondary and top tier markets (almost double its magnitude in 2005) would seem to indicate that secondary markets will likely continue to see a rise in pricing for office property in the near term.
The Industrial Index advanced by a solid 5.1% for the year ending in the third quarter of 2013. Construction of large, modern logistics buildings in primary markets such as Dallas and Houston remain in favor, which is reflected in the stronger 9.1% gain in the Prime Industrial Metros Index over the last year.
However, the recovery is broadening to smaller industrial buildings in secondary markets as well. Local economies benefiting from the ongoing housing recovery, including Charlotte, Nashville, and Phoenix, have posted solid price gains for industrial properties.
The Hospitality Index continues to make steady gains, increasing by 4.3% from year-ago levels as slow but steady economic growth boosts average room rates and RevPAR (revenue per available room.) Investor preference for high-quality hotel properties in core markets has led to stronger pricing gains in the primary metros.
QUARTERLY CCRSI REGIONAL RESULTS
West Region: Of the four CCRSI regional indices, the West Composite Index turned in the strongest performance in the third quarter of 2013 advancing by 3.2%.The West Office, Industrial, and Retail Indices each posted double-digit pricing gains over the last year, while the West Multifamily Index lost some momentum during that time. A strong and early recovery of multifamily assets and soaring pricing in core markets including Los Angeles and San Francisco have limited recent gains in the West Multifamily Index to 0.6% for the year ending in the third quarter of 2013.
Northeast Region: Pricing in the Northeast Composite Index has recovered to within 10% of its prior peak level reached in 2007, thanks in large part to impressive price growth in the region’s multifamily properties. By contrast, pricing in the other three property type indices remains nearly a third below their previous peaks. The Northeast Multifamily Index has already surpassed its prior peak pricing reached in 2007 by 11%. However, as previously mentioned, supply levels have begun to mount in many Northeast markets and yields continue to compress, causing the region’s pace of price improvement to slow as well. Since the beginning of 2013, the Northeast Composite Index has remained flat, and posted a slim 0.4% gain in the third quarter of 2013.
South Region: Overall price growth in the South region was flat in the third quarter of 2013, but strong demographics and robust population have shored up performance in the retail and multifamily sectors over the last few quarters. The movement of capital to secondary markets such as Tampa, Orlando, and South Florida, has supported gains of 9.5% in the South Retail Index and 4.9% in the South Multifamily Index for the year ending in the third quarter of 2013.
Midwest Region: Pricing in the Midwest region has begun to stabilize after bottoming out in 2012, more than a year later than in the other regions. The Midwest Composite Index was the second-best performing region in the third quarter of 2013, improving by 1.7%, contributing to a 15.7% gain from the most recent trough in the second quarter of 2012. While pricing in the Midwest’s industrial sector continued to erode over the last several quarters, the region was lifted by a solid recovery in the multifamily and retail segments. Thanks to higher yields and continued investor preference for multifamily assets, the Midwest Multifamily Index advanced by 1.8% in the third quarter of this year and 23.5% over the last year.
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