June Swoon: #CRE Pricing Recovery Hits Soft Patch

Source: CoStar.com

While high-end properties continued to shine, the first half of 2012 ended on something of a flat note overall for commercial real estate, with uncertainty over the direction of the economy exacting a toll on property pricing gains and weakening fundamentals.

The most recent CoStar Commercial Repeat Sale Indices (CCRSI) report shows weaker investor demand across most property types in June, with pricing for higher-quality investment-grade property holding its ground but eroding for less-expensive holdings as investors returned their focus to the relative safety of the best assets in core markets.

In the second quarter as a whole, demand for space also weakened across most property types, in line with slowing global economic growth. Even so, the U.S. Value-Weighted Composite Index held its ground for the month of June despite lower leasing levels, while the U.S. Equal-Weighted Composite Index edged downward slightly. For the whole quarter, both indices rose by 2% and remained within 150 basis points of their cyclical peaks.

The investment-grade market segment reversed the price loss seen in May 2012 and advanced by 1.5%. The Investment Grade Index posted the highest quarterly growth among the four major CCRSI segments in the second quarter and remained 4.8% above year-ago levels, despite a 2.5% cumulative loss since the beginning of the year.

The Equal-Weighted General Commercial Composite Index fell by 2% in June due to the effect of the softer economy on pricing. The index had steadily recovered since the beginning of 2012 but demand weakened during the second quarter and began to erode pricing — an indication that investors appear to be pivoting from lower-priced property, which entails higher risk, to higher-quality property or other investment options. The index nevertheless closed the first half year of 2012 a full 2% above January levels.

CoStar Group this month released a new metric in this month’s CCRSI report called the CCRSI Prime Market Index, which includes analysis of pricing in certain prime U.S. markets by property type for the first time. In further evidence of the investor flight to safety, all prime market indices showed value gains, with prime retail markets posting the largest increase among all property types, according to the Prime Market Index, which replaces CoStar’s Top 10 Markets Index.

In some good news, distress continued to abate. Only 18.6% of trades recorded by CoStar in June were distressed, notably lower than the 28.8% observed over the past three years.

Apartment: Still Leading the Pack

The run-up in multifamily pricing continued in the second quarter. Apartments have led the recovery among all major property types in timing and magnitude, and the Multifamily Index has grown a cumulative 24.33% from the trough through the first half of 2012, putting the sector closest to its 2007 peak.

The retail sector had suffered steep price losses since 2007 due to curtailed consumer spending. After four years, however, retail property is finally seeing the glimmer of recovery.

Pricing for the sector, despite continued investor caution, posted 3.7% average quarterly growth over the first six months of 2012. After bottoming in June 2011, the retail property sector has since advanced by 10.1%.

The pace of U.S. office recovery has moderated, with unemployment ticking up during the second quarter and the European debt crises creating more uncertainty. The Office Index for June reflected those fears, with only modest pricing growth of 1.7% over year-ago levels.

The Industrial Index, alone among the major property sectors, recorded a pricing loss in the second quarter. To date, the recovery among industrial market fundamentals has centered on big-box distribution facilities in primary logistics hubs.

But that investment activity has not translated into enough value growth to lift the overall Industrial Index, which declined by 1.7% in the second quarter, reaching its lowest level since 2003.

However, the Hospitality Index saw a promising bump in pricing in the second quarter. Hospitality has been slow to recover since suffering the steepest overall price losses among the primary sectors.

With average room rates rising in most markets, hotel properties are becoming a much more desirable asset class among investors, however. The index has recovered by a cumulative 13.2% since the beginning of 2012.

Land prices continued to erode, reflecting the general aversion to development at this time.

By Region, West Is Best

Among the CCRSI’s four major U.S. regions, the West Composite Index turned in the strongest quarterly increase with a 5.5% pricing gain in second-quarter 2012, based mostly on very strong increases in the multifamily and retail property sectors. Through the first half of 2012, the West rose by a cumulative 11.4%.

The Northeast Composite Index also saw strong pricing gains as the second-best performing region in the second quarter. After bottoming two years ago, Northeast commercial property pricing has risen by a cumulative 16.6%. All major property sectors except industrial have experienced pricing recovery, putting this region closest to its peak level.

The Midwest and South Composite Indices main near the trough of their pricing cycles. Prices in both regions did not change significantly from the same period last year. Contrarily, in the Midwest region, the industrial sector was the only sector with positive quarterly gains, while in the South region multifamily and office sectors posted only modest positive gains.

Prime Retail Markets Show Solid Increase

While all property types showed gains in CoStar’s new CCRSI Prime Market Index, prime retail markets showed the strongest increase, with pricing of shopping centers and other retail property in the prime markets appearing to have finally entered recovery.

The Prime Industrial Markets Index rose 5.4% during the second quarter reflecting the outsized investor interest in big-box distribution centers in major logistics hubs. The overall U.S. Industrial Index of all U.S. industrial property, by contrast, retreated in the second quarter, suggesting that prices remain bifurcated by asset class.

Pricing in prime office markets ended the first half of 2012 on a positive note after retreating slightly in the first quarter. Despite an overall decrease in office pricing and transaction volume for the U.S. as a whole at midyear 2012, these metros, primarily coastal gateways, continued to attract investor interest with their stronger economic activity and supply constraints.

Likewise, prime multifamily markets – which have led the recovery of all commercial real estate – again registered pricing gains in the second quarter after retreating in the first three months of 2012. Prime multifamily rose by a cumulative 35.7% through the first half of 2012, placing it the closest since the trough of the downturn to its peak 2007 level.

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