Strong Commercial Real Estate Capital Inflows Limiting Cap Rate Growth in U.S.

Strong Commercial Real Estate Capital Inflows Limiting Cap Rate Growth in U.S.

Commercial News » New York City Edition | By Michael Gerrity | February 22, 2017 9:03 AM ET

U.S. Industrial Properties Most Stable Asset Class in 2017

According to the latest research from CBRE Group, Inc., capitalization rates on U.S. commercial real estate remained largely stable in the second half of 2016, as prices softened slightly. Ongoing investment demand, especially from foreign buyers, counteracted the rise in interest rates and cyclical factors.

The CBRE North America Cap Rate Survey provides insights on movements for the major property asset classes. Cap rates in the second half of 2016 either largely stayed the same or increased slightly compared to the first half of the year. The industrial sector remained the most stable sector, benefiting from market expectations that it will have stronger rent growth than other asset classes in 2017.

"The second half of 2016 was noteworthy for the election of President Donald Trump and a Republican-controlled Congress, as well as a rising interest rate environment. Late cycle factors combined with rising interest rates put pressure on pricing towards the end of the year; however, strong capital flows, especially from foreign investors, meant that cap rate expansion was only modest," said Spencer Levy, Americas Head of Research, CBRE.

"Despite concerns about capital flow controls in China, inbound real estate investment from that country in the last two months of the year was very strong. For the first time since 2007, China was the largest foreign investor in U.S. real estate, accounting for approximately one-quarter of total cross-border investment," Mr. Levy added.

Among the major U.S. commercial real estate sectors:

Robust fundamentals, along with record-setting metrics for net absorption and rental rate growth contributed to the industrial sector remaining as the most stable asset class. Tenant demand exceeded new supply last year and that trend is expected to continue in the coming years. A large majority of markets expect industrial cap rates to remain unchanged in H1 2017 for both stabilized and value-add properties.

"The U.S. logistics sector has emerged as a preferred asset class for institutional investors both domestic and foreign. Global investors have targeted the sector for both acquisitions and development, especially opportunities with scale. New economic drivers such as e-commerce and the entire supply chain model, including the "Last Mile", are creating further growth in the sector," said Jack Fraker, Vice Chairman & Managing Director, Industrial Properties, Capital Markets, CBRE.

"Industrial assets provide institutional investors with reliable and predictable returns with very manageable operating expenses. Investors and their asset managers like the fact that tenants have very high renewal probabilities that significantly mitigates leasing costs such as new tenant improvements and leasing commissions," added Mr. Fraker.

Cap rates for stabilized and value-add CBD properties exhibited little movement in H2 2016, particularly for properties in Tier I and Tier III markets. Suburban office cap rates, on average, increased by 10 basis points (bps) despite the fact that fundamentals (rent growth expectations) are similar or exceed CBD overall at this stage of the cycle.

The multifamily sector continued to reflect the lowest cap rates among the major property sectors. Cap rates widened marginally in H2 2016 and generally maintained historically low levels. Nearly all of these increases were by less than 10 bps. Slightly larger increases were seen in the Class A and the Tier I groups, partly due to the impact of new supply. The multifamily outlook for H1 2017 is for stable cap rates for about half the markets and small increases (mostly less than 25 bps) for the remainder.

Despite increasing negative "chatter" about the retail asset class as a whole, the softness was concentrated in Class B & C retail power centers, with cap rates in Class A retail stable. The retail sector had a fundamentally good year in 2016 with rising rents and occupancy and this is expected to continue in 2017.  

Increases in hotel cap rates slowed in H2 2016. All segments and geographic regions recorded modest single-digit upticks in cap rates, with the exception of suburban-economy, which fell by 1 bp. These movements were less pronounced than in H1 2016 and slight compared with other property types.

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