Cap Rates in Decline for Class-A Properties in All Sectors

Cap Rates in Decline for Class-A Properties in All Sectors
Mar 9, 2010 - CRE News

The days of rising capitalization rates are coming to a halt for class-A properties in all commercial sectors, says CB Richard Ellis.

Cap rates for those assets with stabilized incomes in the office, multifamily, retail and industrial sectors last year declined or held flat in more markets than the number of markets in which they rose, according to the brokerage's analysis of sales data from Real Capital Analytics.

Going forward, CB expects the number of markets with flat or falling cap rates will even more significantly outnumber those in which they increase.

Cap-rate declines last year were slightly less prominent for class-A office, multifamily and industrial properties that are considered value-add in nature. Those are properties whose incomes could be significantly increased through renovations, re-tenanting and other strategies.

In several regions, the number of local market cap-rate increases for value-add properties within specific sectors exceeded the number of cap-rate declines. But in 2010, the number of markets in which cap rates for those value-add properties in office, industrial and multifamily sectors decline will exceed the number in which they rise, CB predicted.

For the retail sector, CB said that "rates appeared to have peaked." It expects rates for both class-A and -B assets to decrease in 2010, particularly on the East Coast, while rates should rise for lower-quality, class-C retail assets.

It noted that cap rates for power and grocery store-anchored centers have recently declined in markets that include Boston, Tampa, and Dallas. CB also said investor interest last year increased from the year before in virtually every retail market that it covers and is expected to spike further this year.

Its retail-sector coverage did not differentiate between stabilized and value-add properties.

Across all sectors, the brokerage expects buyers' growing sense that pricing has hit bottom will rev up their already-strong interest in class-A assets. That would also prompt them to make higher bids, which translate into lower cap rates.

It further noted investors have been building their acquisition war chests, led by REITs, which last year raised $28.3 billion of capital, including $17.2 billion of equity from 59 stock offerings.

It also expects sales activity to increase as a result of more properties being offered by sellers, particularly lenders with assets that back loans that are in default. Cap rates for class-A properties have been kept down by a combination of owners' general unwillingness to sell over the past year and strong investor demand for higher-quality properties, as compared to the weak demand for class-B and -C assets. Investor demand pushes up offering prices, which pushes down cap rates.

When you combine all quality properties, and even after accounting for the dull investor appetite and low bids for B- and C-quality properties, CB noted that cap rates are increasing "at a moderate level."

Cap-rate compression for class-A properties has varied somewhat by property type and geographic markets. For example, in the office sector, it's been most evident on the East Coast, where the rate for stabilized properties last year dropped in eight of the 14 central business districts tracked by CB, compared to drops in seven of the 23 CBDs in the Central and Western regions combined.

Pricing reflects property performance, and CB noted that office-vacancy increases in major markets in the East were less steep than those in its Central and West regions.

In the Central's 11 CBDs, cap rates for stabilized class-A office properties declined in four, rose in four, and held flat in the remainder. For 2010, CB sees cap rates holding flat in eight Central markets and falling in Chicago, Cincinnati and Detroit.

In the West, rates rose in seven of the 12 CBDs tracked, dropped in three and held flat in the other two. Rates there are seen rising this year in Denver, which recorded a range of 8.5 to 9.0% last year, and Sacramento, CA, whose rate last year ranged from 8.0 to 8.5%.

The West, however, slightly led the East in cap-rate compression for class-A multifamily properties that are stabilized. In 11 of the 12 Western markets covered, cap rates declined last year and are expected to fall again this year. The sole exception was Portland, Ore., where cap rates held flat at a range of 6.5 to 6.75% and are expected to increase by less than 50 basis points this year.

Cap rates for stabilized multifamily properties declined in eight of the 14 Eastern markets, held flat in two and increased in four: Miami, Philadelphia, Jacksonville, Fla., and Raleigh, N.C.

For 2010, CB expects cap rates for stabilized multifamily to decline or hold flat in every market in the East except Memphis, TN, where it foresees a 50-plus bp gain from the 2010 range of 6.75 to 7.25%.

In the Central region, cap rates for stabilized, class-A multifamily dropped in five markets and increased in the other six. Rates are expected to hold flat in all of the Central region's 11 multifamily markets this year.

The Central region had the highest proportion of industrial markets cap-rate declines last year, dropping in five of the region's nine markets and increasing only in Detroit and Cincinnati.

Rates declined in six of the East's 14 industrial markets, rose in another six and were flat in the other two. In the West, the rate declined in eight of 12 markets, rose in three, and was flat in Phoenix.

As an example of how cap-rate suppression has been slightly less evident for value-add properties, eight East Coast markets last year recorded cap-rate increases in class-A industrial transactions that were considered value-add, versus four with declines and two with no change in rates.

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