Us commercial property update: a tale of two markets

With property values rebounding, greater availability of debt financing and a slew of significant recently completed merger-and-acquisition and individual property transactions, commercial real estate investors might be tempted to believe that a robust market recovery is underway. However, a closer look reveals a highly bifurcated market with enough potential future roadblocks to cause investors concern. Much like the broader economy, the ongoing recovery of the commercial real estate market is expected by many to be uneven, inconsistent across asset types and geographies, and occur at a halting rather than a steady pace through the remainder of 2011.

The biggest question mark looming over commercial real estate is the expected performance of the U.S. economy. While quarterly GDP growth has been positive since the second quarter of 2009, the increases have been volatile and consensus growth forecasts for the next 12 months vary widely. At the same time, post-recession employment growth has been weaker than historical trends. While the Bureau of Labor Statistics reported that 1.2 million jobs were added to the U.S. economy during 2010, this total represents just 13.6 percent of the 8.5 million jobs lost since the recession began in 2007. Jobs are a critical indicator for commercial real estate demand, as evidenced by a commonly held rule of thumb that four jobs equal 1,000 square feet of commercial real estate activity.

Notwithstanding the weak employment data, commercial real estate has recently exhibited a number of positive trends, starting with an upward movement in property values. The Moody’s/REAL Commercial Property Price Index has risen more than 5 percent since dropping 42.1 percent from peak pricing levels in October 2007. (The Moody’s valuation index includes all transactions greater than $2.5 million, including those involving distressed properties and those that are repeat sales.) This recent valuation increase can be attributed both to improving property fundamentals within certain asset classes (particularly with respect to multi-family and hotels) as well as to increased overall investor demand for commercial real estate.

Real Capital Analytics Inc. reported that the volume of commercial real estate transactions totaled $120 billion in 2010, a nearly 120 percent increase over the prior year. Private investors accounted for the largest share of completed transactions, followed by REITs and foreign investors. Demand was greatest for high-quality, core assets in Gateway cities, including office buildings and hotels. As a result of the increased transaction activity, capitalization rates across all asset classes have now declined from their peak 2009 levels. However, weak demand continues to persist for smaller, non-core assets in secondary and tertiary markets.

Source: Commercial Property Executive