Commercial Real Estate Transaction Activity Rebounds In Q2 Following Q1 Plunge, Ten-X Research Reveals

Commercial real estate has benefited from a trifecta of factors: the abatement of policy uncertainty, the stabilization of interest rates and the resilience of the labor market. However, policy risk has not disappeared completely, given that a single political party controls both the legislative and executive branches of government.

"After hitting a post-election pause button, the industry seems to have digested and even shrugged off a flurry of policy announcements, concluding that many of the previously touted reforms will not be implemented," said Ten-X Chief Economist Peter Muoio. "Instead, commercial real estate investors are assuming the U.S. economy will continue to slowly and steadily expand in coming quarters. Even the expectation that the Fed will continue to raise interest rates has been accepted without significant upsetting of the apple cart."

CRE Transaction Volume Recovers Somewhat in Q2

The increase in total deal volume during Q2 has brought a welcome rebound after a precipitous drop in Q1. In fact, investor confidence has returned to a level that nudged transaction volume above the $100 billion threshold. However, this quarter's total was still 4.5 percent below its total in Q2 2016, when turbulence abroad attracted foreign capital in search of safe haven investments.

Of the five market sectors, all except retail showed improvement in deal volume from the previous quarter. Three of them - apartment, office, and industrial - outperformed their 10-year total dollar volume averages during the quarter. Retail accounted for just 13 percent of total deal volume and experienced its third consecutive quarter of contraction.

The apartment and office sectors continued to account for an outsized share of total deal volume, more than one-third. Hotel deal volume increased, but its share remains the smallest of the five sectors. Finally, the industrial sector enjoyed a small gain, but saw its share of volume shrink because growth of the five-sector total outpaced this individual sector's growth.

Property Pricing

Property valuations are now up 8 percent year-over-year as of June, per the Moody's/RCA Commercial Property Price Index (CPPI). After a slowdown in price growth during early 2017, the Ten-X All Property Nowcast, which gauges national pricing through a combination of proprietary and third-party data, reveals pricing has now declined for four consecutive months. Despite the recent drop, year-over-year pricing is now up 5.8 percent. The All-Property Nowcast continued to give back some of its prior-month gains, dropping 0.1 percent in August.

The Ten-X CRE Apartment Nowcast shows the long-surging sector has finally begun to slow, recording an increase of 9.6 percent over the past year – the first time it has dropped into single digits since August 2016. While month-to-month apartment pricing fell 0.6 percent in August –its second consecutive month of decline - sector fundamentals continue to be underpinned by an increased preference for renting over buying and an enduring preference for city or city-like living.

Apartment's strength and stability have helped it consistently generate the lowest cap rates and risk premiums of any sector, though Ten-X Research shows that the current trajectory is likely unsustainable. At particular risk are several large cities, such as New York City, San Francisco and Miami, where the threat of oversupply has begun to lift vacancies and cool rents. While other markets maintain a stronger outlook, shifting fundamentals and rising interest rates suggest property pricing may downshift after a record run of expansion.

Office and industrial are once again at peak price index levels after a brief slowdown, with CPPI reporting pricing in these sectors is 20.9 percent and 13.8 percent higher than their prior cyclical peaks. The Nowcast measures office pricing at just below its all-time peak, and has now increased 9.4 percent over the last year, the strongest growth of any sector save apartment. Conversely, industrial price growth slowed dramatically throughout 2016, according to the Nowcast, including a 0.4 percent drop in August. It has increased a modest 4.8 percent over the last year.

Retail pricing grew a modest 0.2 percent from the prior month. The sector is facing significant headwinds as shoppers increasingly turn to e-commerce and posted a year-over-year gain of 6.1 percent as of August, per the Nowcast. CPPI shows that the sector's prices have declined in three of the past five months, and they now stand a full 1.7 percent off their recent cyclical peak.

The hotel sector's challenges have not changed, leading to a pricing decline of 0.8 percent compared to a year ago. Those challenges include the surge of competition from online-based rivals such as Airbnb, an abundant supply pipeline, and minimal growth in per-room revenues. Hotel pricing has now declined in 12 of the last 16 months.

Ten-X Nowcast CRE Pricing Trends

Risk Premiums Rise Across All Sectors Except Industrial

Risk premiums rose across four out of five CRE sectors during the second quarter, with industrial posting the lone decline. Per REIS, vacancies in the industrial sector are now below pre-recession levels. Following a swift rise in late 2016, 10-year Treasury rates edged down to 2.19 percent despite the Fed's decision to raise rates during its July meeting. With interest rates in the U.S. looking favorably high compared with those abroad and a Fed that has signaled an intention to raise rates at least twice more in 2017, the outlook for foreign capital inflows looks promising.

The industrial sector saw the only decline in risk premiums during the second quarter, down 20 bps from the first quarter and 65 bps over the last year. Hotel saw the sharpest spike in risk premiums of any sector, gaining 50 bps from the previous quarter to reach an all-time peak of 6.8 percent. That elevated level reflects the hotel sector's current secular and cyclical challenges. Office and apartment risk premiums, which are down from a year ago, both edged up 20 bps from the first quarter. Retail, faced with the dual threat of e-commerce and a cyclical downturn, saw its risk premiums shoot past their 10-year average, jumping 40 bps from the previous quarter.

Cap Rates Decline in Three Sectors

Weighed down by a drop in treasury yields, cap rates fell in three of the five sectors – office, industrial and apartment - during the second quarter. The industrial sector's cap rates fell most sharply, down 50 bps to 6.7 percent, and now trails its historical average by the widest gap of all the sectors. Declines in office and apartment cap rates were negligible, bringing them to 6.7 percent and 6 percent, respectively. Only the hotel and retail sectors saw increases, to 9 percent and 6.6 percent, respectively. The former stands at their highest level in over a year.

About Ten-X

Ten-X is the nation's leading online real estate transaction marketplace and the parent to Ten-X Homes, Ten-X Commercial and Auction.com. To date, the company has sold 300,000+ residential and commercial properties totaling over $50 billion. Leveraging desktop and mobile technology, Ten-X allows people to safely and easily complete real estate transactions online. Ten-X is headquartered in Irvine and Silicon Valley, Calif., and has offices in key markets nationwide. Investors in the company include CapitalG (formerly Google Capital) and Stone Point Capital. For more information, visit Ten-X.com.

SOURCE Ten-X

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