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Investor Demand Further Compresses Capitalization Rates for U.S. Commercial Assets in 2017

Investor Demand Further Compresses Capitalization Rates for U.S. Commercial Assets in 2017


Commercial Real Estate Cap Rates Stable for Most Asset Types During H1 2017
 
According to global property advisor CBRE, increased investor demand from both international and domestic buyers contributed to further capitalization rate compression in the U.S. industrial real estate sector over the first half of 2017.
 
Industrial remains the strongest performer out of the five sectors, given the especially robust fundamentals, record low vacancy rates, tangible rental rate growth and strong tenant demand.

The CBRE North America Cap Rate Survey provides insights on movements for the major property asset classes. Cap rates for U.S. commercial real estate assets were little changed in H1 2017, with slight increases or decreases in pricing depending on asset type. Cap rates for stabilized assets generally held firm for both the industrial and multifamily sectors, further testimony to their pricing strength.

"With the exception of B and C retail in secondary markets, there was limited movement in cap rates for U.S. commercial real estate during H1 2017. At the same time, we have seen a decline in sales transaction volume during the first half of 2017. Instead, many would-be sellers are choosing to refinance rather than sell in an increasingly uncertain market, particularly in multifamily," said Spencer Levy, Senior Economic Advisor and Head of Americas Research, CBRE.

Among the major commercial real estate sectors:

* Industrial cap rates for acquisitions of stabilized assets continued to compress, down seven basis points (bps) to finish H1 2017 at an average 6.66%. Cap rates for Class A and B assets also dropped slightly, ending the first half of the year at 5.41% and 6.47%, respectively. Class C cap rates held firm at 8.15%.

* Among primary industrial assets in H1 2017, the markets with lowest cap rates were along the coasts, with Seattle, San Francisco, Orange County, Oakland, Northern New Jersey, Los Angeles and the Inland Empire leading the way.

"From a capital markets perspective, the U.S. industrial real estate sector is having another great year. The investment sales volume is on pace to make 2017 one of the best years ever. Investors are attracted to the asset class for its reliable and predictable returns, which continue to increase due to tangible rental rate growth and very strong fundamentals overall, said Jack Fraker, global head of Industrial & Logistics, CBRE Capital Markets. 

* The multifamily sector continues to show great cap rate stability, even in the face of some supply concerns. Cap rates for infill multifamily assets held firm in H1 2017. The average cap rate for stabilized infill multifamily assets fell by five bps to 5.27% in the first half of the year--a relatively insignificant change from H2 2016 and a very important indicator of market pricing stability. Cap rates for stabilized suburban multifamily properties also fell marginally (-7 bps) in H1 2017 to an average rate of 5.66%. That said, there has been a decline in multifamily transaction volume as many would-be sellers, have chosen to refinance rather than sell their assets.

* Cap rates for stabilized CBD office properties ticked up modestly for the third straight survey, rising by 3 bps to 6.66% in H1 2017. Tier I markets registered the largest increase (8 bps) to 5.51%--nearly 10 bps higher than the cyclical low of 5.41% in H2 2015. Overall suburban cap rates increased modestly by eight bps to 7.83% in H1 2017, but this was more than double the increase in overall CBD cap rates during the same period. Cap rates for stabilized suburban assets increased for all classes and all market tiers.

"We are continuing to see a divide between suburban markets that have urban characteristics and/or and those markets with transit oriented development, and those suburban markets that lack one or both of those elements," added Mr. Levy.

* Hotels showed modest cap rate expansion, primarily but not solely in the economy sector. CBRE professionals found the increases in cap rates for U.S. downtown hotels fell in line with the increases reported for the office sector. Every hotel market segment in CBDs (i.e., luxury, full-service, select-service and economy) recorded single-digit upticks in cap rates ranging from 4 to 8 bps. On the other hand, suburban hotels, on average, registered slightly less cap rate widening than their downtown counterparts. CBD and suburban hotel cap rates averaged 7.98% and 8.49%, respectively.

* The retail sector posed the most complex element of the H1 2017 cap rate analysis given the material distinctions between major market and secondary market retail, and the enormous distinction between open-air and grocery anchored retail versus other formats. Despite this, retail is the one asset class that showed material cap rate expansion in secondary and tertiary markets, particularly in Class B and Class C. Power centers bore the brunt of most, but not all, of this expansion.
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