Commercial Real Estate Market Recovery Continues To Strengthen According To Auction.com Research Report

Apartment Sector Shines as Valuations Reach All-Time Peak While Retail Sector Shows Weakness in Volume and Pricing

IRVINE, CALIF. – November 12, 2014 – Auction.com, LLC, the nation’s leading online real estate marketplace, today released its Q3 2014 Commercial Real Estate (CRE) Market Monitor™, which shows healthy increases in deal volume and pricing as cap rates and risk premiums decline. One of the main drivers of the CRE market recovery is the apartment sector, which accounts for the second-largest share of CRE transaction volume behind the office sector and has the lowest cap rate and risk premium among the five major sectors.

The US apartment market’s recovery has advanced far ahead of the other real estate sectors. Valuations are at all-time peaks and apartment cap rates just dipped below the 6 percent mark for the first time in more than 15 years, reflecting the perceived strength of multifamily properties as investments. Vacancies are very low across a majority of major US metros – between three and four percent in most markets – and rent growth is proceeding at a healthy clip, which has prompted a surge of new construction.

“The continued strength of the apartment sector is directly related to the trends we’ve been seeing in residential real estate – namely the rise in household formations and the ongoing decrease in home ownership rates,” said Auction.com Executive Vice President Rick Sharga. “In many markets demand is likely to continue to outpace supply, even with new inventory coming online, as young adults decide to delay home purchases for a variety of reasons. Whether this is a cyclical or structural change in home buying patterns, it suggests that the apartment sector is going to continue to be strong for the foreseeable future.”

CRE Market Activity Overview
The total combined volume in the office, retail, apartment, industrial and hotel sectors reached $97.5 billion in the third quarter of 2014, an 11.6 percent increase from one year ago, indicating confidence in US real estate amid global geopolitical risks and the tenuous economic situation in Europe. Office and apartment transactions combined for nearly 60 percent of the five-sector total in the third quarter, higher than their 53.2 percent proportion of transactions one year ago. Conversely, the retail sector saw deal volume drop to 12.8 percent in the third quarter from 16.5 percent in the second quarter – down significantly from 26 percent in the first quarter, though Auction.com’s research suggests that the increase in retail deal volume early in the year may have been an anomaly considering the headwinds this sector has faced, including the rise in online shopping, shrinking space needs per customer and a less supportive housing market. Industrial volume also accounted for 12.8 percent of the five-sector total, dropping from 16.5 percent one year ago. Hotel volume, which made up 7.5 percent of the total one year ago, increased slightly to 8.7 percent.

CRE Deal Volume


Sources: RC Analytics, Auction.com Research

Property pricing is on a steady upward trend. Prices are up 14.8 percent from a year ago. Office, apartment and industrial sector prices are up 15.5 percent, 17.4 percent and 18.7 percent, respectively, from one year ago. Meanwhile, the retail and hotel sectors have shown some weakness. 
Retail prices grew just 5 percent on a year-over-year basis. Auction.com believes this trend reflects a recalibration of retail values following the unexpected jump in investor interest seen earlier this year and the fall-off since. One of the biggest surprises of the quarter is the sharp drop in the hotel sector’s price per key. Though hotel sector data lags slightly behind the other four CRE sectors and is only currently available through June, pricing dropped sharply for the period measured. The hotel price index hit a new cyclical peak in March before suffering the decline, which could indicate an inflection point in the market. Hotel market vacancies appear to be leveling off as new supply starts hitting the market, slowing down room rate growth. This smoothing of supply-demand dynamics is likely to result in more modest hotel price growth going forward.

Year-Over-Year CRE Pricing


Sources: Moody’s, RC Analytics, Auction.com Research

Downward Trend in Risk Premiums and Cap Rates
Auction.com’s calculation of risk premium takes cap rates and factors out the 10-year US Treasury component, focusing on the expected yield corresponding to the risk of investment in each CRE sector. This means that a higher risk premium signifies a riskier investment, with a higher yield needed to justify that additional risk. CRE risk premiums are largely flat from one year ago, with the exception of the apartment sector. The apartment risk premium – still the lowest of all five CRE sectors – is down 12 bps from one year ago and 30 bps from the prior quarter, reflecting the perceived security of multifamily properties for investment.

“This improvement in CRE risk premiums has enabled overall cap rates to continue to decline despite higher interest rates,” noted Peter Muoio, PhD, executive vice president of Auction.com Research. “Now that the Federal Reserve has officially ended quantitative easing, we could see a jump in interest rates, though other factors could keep interest rates low even as the Fed shifts gears. The potential for CRE risk premiums to edge lower and interest rates to resist the long-awaited increase may point to lower cap rates.”

CRE Deal Volume

Property pricing is on a steady upward trend. Prices are up 14.8 percent from a year ago. Office, apartment and industrial sector prices are up 15.5 percent, 17.4 percent and 18.7 percent, respectively, from one year ago. Meanwhile, the retail and hotel sectors have shown some weakness. 

Retail prices grew just 5 percent on a year-over-year basis. Auction.com believes this trend reflects a recalibration of retail values following the unexpected jump in investor interest seen earlier this year and the fall-off since. One of the biggest surprises of the quarter is the sharp drop in the hotel sector’s price per key. Though hotel sector data lags slightly behind the other four CRE sectors and is only currently available through June, pricing dropped sharply for the period measured. The hotel price index hit a new cyclical peak in March before suffering the decline, which could indicate an inflection point in the market. Hotel market vacancies appear to be leveling off as new supply starts hitting the market, slowing down room rate growth. This smoothing of supply-demand dynamics is likely to result in more modest hotel price growth going forward.

Downward Trend in Risk Premiums and Cap Rates

Auction.com’s calculation of risk premium takes cap rates and factors out the 10-year US Treasury component, focusing on the expected yield corresponding to the risk of investment in each CRE sector. This means that a higher risk premium signifies a riskier investment, with a higher yield needed to justify that additional risk. CRE risk premiums are largely flat from one year ago, with the exception of the apartment sector. The apartment risk premium – still the lowest of all five CRE sectors – is down 12 bps from one year ago and 30 bps from the prior quarter, reflecting the perceived security of multifamily properties for investment.

“This improvement in CRE risk premiums has enabled overall cap rates to continue to decline despite higher interest rates,” noted Peter Muoio, PhD, executive vice president of Auction.com Research. “Now that the Federal Reserve has officially ended quantitative easing, we could see a jump in interest rates, though other factors could keep interest rates low even as the Fed shifts gears. The potential for CRE risk premiums to edge lower and interest rates to resist the long-awaited increase may point to lower cap rates.”

Cap rates have been trending down in all five major property sectors recently and are now below their 10-year average. Apartment cap rates are currently at a new 10-year low, under 6 percent. In fact, apartment sector cap rates are at their lowest point since at least the beginning of 2001. Office cap rates declined a substantial 24 bps from the prior quarter, while hotel sector cap rates dipped just below 8%, to 7.99%, for the first time since the end of 2011.

CRE Cap Rates


Sector

Current Cap Rate

10-Year Average

High

Low

Office

6.7%

7.2%

8.6%

6.5%

Apartment

5.9%

6.4%

7.1%

5.9%

Retail

6.8%

7.1%

8.1%

6.5%

Industrial

7.2%

7.6%

8.6%

6.8%

Hotel

8.0%

8.6%

9.9%

7.8%