Based on Jones Lang LaSalle recently issued 2011 U.S. Mid-Year Capital Markets Outlook, there is a significant increase in commercial transaction volumes for the office, hotel, industrial and retail sectors in the second quarter of 2011, up 157 percent compared with second quarter 2010 and 82 percent compared with first quarter 2011.
This marks the highest level of activity since the end of the boom. Separately, multifamily transaction volume also posted a sharp increase during the quarter, with $12.8 billion in activity, up 63 percent on Q1 2011 and 141 percent on Q2 2010.
"On balance, investment demand continues exceed supply in the United States, pushing average yields down sharply in Q2 as solid demand for core properties in primary markets sparked increasingly competitive bidding," said Jay Koster, President, Capital Markets Americas of Jones Lang LaSalle. "In this competitive environment, that pursuit of higher yields will push investors outside of the global gateway markets and into cities such as Chicago, Dallas, Houston and Atlanta."
The U.S. economy as a whole grew at a significantly slower pace during the first quarter, expanding at just 1.9 percent annualized following much healthier growth of 3.1 percent at the end of 2010. Slower government and consumer spending, along with disappointing employment numbers and a very much still struggling housing market have all taken their toll. On the positive side, anticipated higher industrial production over the summer and autumn months, as well as continued towering strength exhibited in corporate profits should help to partially offset weakness elsewhere in the economy and lead to greater investment levels.
U.S. Office Cap Rates
The average cap rate nationally for office investments, weighted by dollar-volume, plunged during the second quarter to the high five percent range. Among major product types, only multifamily offered lower initial yields, and the gap with multifamily declined to less than 50 basis points. This outsized yield compression is very unlikely to be repeated in coming quarters, and in fact, the decline may be partly revised away or temporarily reversed later in 2011. Still, it is clear that the market returned to an underlying trend of yield compression in the second quarter.
Real Estate Capital Environment
Increased market liquidity, through the continued reemergence of CMBS lenders, has strengthened the ability to finance assets that need additional structure. In light of recent CMBS pullbacks due to the perceived instability in European sovereign debt markets and slower-than-anticipated U.S. economic growth outlooks, CMBS lenders remain generally comfortable with all major asset types as well as some specialty products given the right fundamentals. This remains true for lenders of all types, except for land and construction loans, which remain difficult to finance at any level, outside of the multifamily sector.
"In the past 90 days, while we've seen spreads widen slightly, overall CMBS pricing to borrowers has only slightly increased--providing continued attractive rates and structure," said Tom Melody, Executive Managing Director. "Life company lenders remain focused on the strength of the sponsor, tenancy, length of lease terms and location, however, CMBS and other lenders have become increasingly comfortable lending in secondary and tertiary markets and on product that is less than investment grade. We are also seeing an increased appetite for un-stabilized product and product with short lease terms. Capital is abundant--you just need to know where to look."
New issuance of securitized loans surged to slightly more than US$17 billion during the first half of 2011 from just US$2.4 billion during the comparable period in 2010. Issuance in Q2 was roughly even with the pace established in the first three months of the year, as US$8.4 billion in bonds were priced during Q2. Looking ahead to prospective third quarter activity, it does appear that full-year CMBS issuance is well on track to easily triple-to-quadruple the total of US$11.6 billion recorded in 2010. Such a pace would return the market to average 1995-2000 era levels, as 2011 will likely mark the year when CMBS issuance started its return to more normalized levels and participation rate in the overall commercial property lending universe.
More than $900 billion in commercial mortgages and construction and development loans held by U.S. banks is scheduled to mature through 2013, with banks accounting for the lion's share of maturities.
In addition, more than $12 billion in distressed note sales have traded so far this year, and that number could rise to as much as $25-30 billion by the end of the year. In the last 12 months, banks and special servicers are turning to liquidations more frequently than modifications. For special servicers, the ratio of liquidations to modifications is currently 3:1.
"The average distressed note sale has doubled from $10 million to $20 million this year and the predominant sellers are now banks, rather than the special servicers who dominated the market in 2010," said Peter Nicoletti, Managing Director and leader of the firm's Special Asset Services. "We will also see several billion-dollar portfolios come to market this year, with pricing expected at just a 5-10 percent discount."
Outlook: investment horizon
As the second half of 2011 unfolds, it is probable that the rapid recovery in the capital markets for institutional-quality office properties ($13.8 billion in total office volume for Q2 2011) will continue to incrementally expand the appetite for additional markets and product sub-types, as the US remains on schedule for an increase in investment sales volume of 70 percent for the full-year.
The office and multifamily sectors continue to show the most momentum, with retail and industrial also showing increasing activity levels, but trailing somewhat in the pace of acceleration.
Multifamily, in particular, has shown increasingly solid growth, with sales of an estimated $20.7 billion during the first half of 2011 more than double that during the same period in 2010,. Investors have been eager to participate in this drastic shift of capital and the sector continues to have one of the strongest performances on record.
"We've seen a massive uptick in purchases from REITs and other institutional investors in the multifamily sector," said Jubeen Vaghefi, Managing Director and leader of the firm's Multifamily Investment Sales practice. "Much of this stems from the fact that financing for apartments is available through not only traditional portfolio and CMBS lenders, but also through Fannie Mae and Freddie Mac."
Deliveries of new multifamily product remain very low historically and this will remain the case through the first half of 2012. This will begin to change, however, in the latter half of 2012 into early 2013, as multifamily construction starts have been trending up since early in 2011. In the meantime, the demand picture remains bright, as positive demographic trends for the sector, including a national homeownership rate that has declined by more than 250 basis points over the past 5 years and is still falling, combined with the still weak for-sale housing market present a compelling case for the population of renters in the U.S. to experience strong growth over the coming several quarters at least. Longer term, the Millennial Generation has entered its prime rental years, so broad demographic trends are also supportive of strong rental unit demand continuing over the medium-term.
While the industrial sector lags slightly behind, overall vacancy rates continue to decline. Speculative development is beginning to appear in the major distribution markets such as the Inland Empire and Central Pennsylvania--mostly in what's known as the "Industrial Smile", however, new construction in general will not develop into a major significant national factor in the immediate term.
Preliminary estimates for transaction volume in the industrial sector during Q2 2011 rose to just $4.6 billion but portfolio sales such as the sale of 19 industrial properties for Pinchal & Company, which Jones Lang LaSalle completed in June, are increasing in velocity. The team has closed the sale of more than 9.2 million square feet of industrial properties, valued at more than $414 million so far in 2011.
"We secured a great deal of interest from life insurance companies and pension funds--entities that have been searching for quality, large, portfolios in which to place a great deal of capital," said John Huguenard, head of the firm's Industrial Capital Markets. "We're also seeing a desire for properties with shorter lease terms--the sweet spot seems to be three to five years--allowing investors to capitalize on rising rents."
Low consumer confidence levels and a related high unemployment rate are prolonging the bottoming-out of the retail sector to a greater extent than the other major property types, yet preliminary estimates for U.S. transaction volumes in the second quarter of 2011 rose to $17 billion due in large part to the $9 billion sale of the Centro Portfolio. Currently, investors are targeting grocery-anchored supermarkets and trophy malls on the one hand, and distressed assets on the other--with little interest in the product in between.
"Overall, the recovery in the U.S. has proven exceptionally strong and momentum is still building across all sectors, while investment activity is broadening both geographically and (albeit slowly) in terms of asset quality," concluded Koster. "Add to this an improvement in debt market liquidity and still attractive spreads and the second half will be even stronger than the first six months of this year."