Commercial Real Estate Slows

By  USDR

Auction.com, LLC, the nation’s leading online real estate marketplace, today released its Q3 2015 Commercial Real Estate (CRE) Market Monitor™, which reveals that CRE market activity is continuing to show signs of slowing and stabilizing after several years of run-up and appreciation. Total transaction volume across the five major CRE sectors dipped 6.5 percent on a quarter-over-quarter basis, sitting just 2.6 percent higher than one year ago — down from 24 percent higher in Q2. The slowdown in deal volume occurred amid the patch of U.S. economic softness in late summer, though the overall capital markets climate remains bullish. Cap rates continued to tighten and prices across all sectors maintained their  ascent.

“A drop in sales volume back in Q2 signaled an unexpected shift in the CRE market after a very strong first quarter, and now we’re seeing actual proof of a slowdown,” said Auction.com Chief Economist Peter Muoio. “While all of the major sectors are still performing better than a year ago, CRE as a whole is feeling the pinch from recent shifts in the U.S. economy. Paced by a promising hotel sector, however, CRE pricing still remains on the uptick, even though that sector’s price growth has decelerated over the past quarter and could cool in the immediate  future.”

Office and apartment transaction volume increased in Q3 as a share of the five sector total relative to the second quarter. While apartment deal volume climbed and pushed the sector’s quarterly share 440 bps higher than its 10-year average, office volume was only slightly trailing its 10-year average. Retail and industrial shares of volume did not significantly deviate from historical trends, though the hotel sector saw a pronounced pullback in activity. That sector’s share of total five sector deal volume shrank from at least 11 percent in each of the last two quarters to just 7.1 percent in  Q3.

CRE Deal  Volume

Sources: RC Analytics, Auction.com  Research

Outside of the hotel sector, the other four major sectors continued seeing year-over-year price growth stabilization between 10 percent and 20 percent. Hotel pricing skyrocketed 30.4 percent from one year ago. Hotel sector prices contracted on a year-over-year basis in Q2 and Q3 of 2014, but bounced back moderately in Q4 that year before exploding in the first, second and third quarters of 2015. Office (18.6 percent), retail (13.7 percent), apartment (13.2 percent) and industrial (11.2 percent) all are up from one year  prior.

Hotel pricing hit an all-time peak with retail being the only remaining sector yet to make its way back to pre-recession peak pricing. Retail prices in Q3 were still 4.4 percent short of their pre-downturn peak, while apartment (33.5 percent), office (17.9 percent) and industrial (3.1 percent) pricing were higher than their prior all-time  peaks.

Year-over-year hotel price growth decelerated slightly in Q3 from Q2, but still remained strong since operating conditions, including room demand, average daily room rates, RevPAR, and occupancy rates continued to hover at or near their all-time peaks, and the supply pipeline has been ramping up  considerably.

“Both CRE transaction volume and pricing have showed signs of softening over the past few months,” said Rick Sharga, Auction.com executive vice president. “It’s likely that what we’re seeing is the result of reduced capital spending due to some weakness in the U.S. economy, coupled with a highly volatile economic climate in China and ongoing financial issues in  Europe.”

Year-Over-Year CRE Pricing  Changes

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

Risk Premiums Increased in  Q3

Auction.com’s research calculates that CRE risk premiums increased in Q3 from Q2 across every CRE sector except apartment, where the premium declined. The 10-year U.S. Treasury rate, the other component of cap rates, dropped from 2.36 percent in Q2 to 2.17 percent in Q3 — reversing much of a sudden jump seen in the second  quarter.

The apartment sector’s premium was the lowest of the five major sectors in Q3, resting at 3.6 percent. This potentially leaves apartment cap rates with the highest exposure to rising interest rates. Despite the apartment sector’s quarterly decline, the risk premia in all sectors remained higher than one year  ago.

CRE Risk  Premiums

Sources: RC Analytics, Department of the Treasury, Auction.com  Research

Due to Q3 compression in the 10-year U.S. Treasury rate — which dipped nearly 20 bps on the quarter — cap rates decreased nearly across the board from Q2. All five sectors’ cap rates remained significantly below their 10-year average, while apartment, retail and industrial cap rates dipped to their lowest marks since at least 2001 (the earliest data available per RC  Analytics).

Apartment cap rates saw the biggest quarterly decline, dropping 20 bps from the second quarter to 5.8 percent. The office, retail and industrial sectors saw cap rates decline 10 bps each, while the hotel sector was the lone holdout, where cap rates held constant at 8.3  percent.

All opinions expressed on USDR are those of the author and not necessarily those of US Daily Review.