Insight

Midyear Surge: CoStar Repeat-Sale Index Shows Strong Growth in CRE Pricing

Smaller Properties In Secondary Markets See Largest Second-Quarter Gains While Retail, Office Pricing Leapfrogs Over Apartments

August 14, 2013
Pricing for "average" commercial properties outperformed institutional-grade assets while price gains in secondary U.S. markets eclipsed the top markets as buyers of commercial real estate increasingly expanded investment activity outside the handful of prime markets and core properties during the second quarter, according to the midyear CoStar Commercial Repeat Sale Indices (CCRSI) release. 

The gains in the CCRSI's repeat sale index are an inversion of trends earlier in the economic recovery when the best properties in primary markets dominated commercial real estate investment activity, signifying a further broadening and deepening in CRE fundamentals and property prices across the nation and among all product types. 

"The leap in [CRE] pricing in the second quarter was seen across all four major property types. Double-digit annual gains in nearly every property sector demonstrate the depth of the recovery," noted Dr. Ruijue Peng of CoStar's Property and Portfolio Research (PPR), author of the CCRSI. 

The value-weighted U.S. Composite Index, influenced by larger transactions and generally tracking high-quality core real estate transactions, gained 5.9% in the second quarter, its best quarterly showing since 2011. The equal-weighted Composite Index, comprised of smaller, more numerous deals in the lower end of the market, jumped by an even more impressive 9.1% in the second quarter, its strongest three-month gain on record. 

Within the Composite Index, the Investment Grade segment, which broadly encompasses upper-middle tier properties, continued moving steadily upwards, increasing 7.9% above the first quarter. 

Pricing in the General Commercial segment rose by a very strong 9.2% from the previous quarter and increased 11.7% over the last 12-month period, gaining momentum as investors comb secondary markets and property types in search of better pricing and yields. 

In a significant shift, both retail and office pricing growth vaulted past multifamily in the second quarter, reflecting the cyclical slowdown in fundamentals for the apartment market, which has led the recovery for several years.

With more consumer spending and virtually no new development in the pipeline, the CCRSI Retail Index led all four major product types, rising 10.2% from the previous quarter and 16% for the 12 months ending at midyear. It's the first double-digit annual price increase in the retail index since the sector's recovery began in 2011. 

In a departure from previous periods, the overall retail market index outperformed the Prime Retail Metros Index, comprised of higher-end malls and retail properties in top markets, as investors appeared to branch out beyond core assets in the primary markets and malls. 

The retail sector’s recent pricing rebound is encouraging because it suggests that the housing recovery may finally be spilling over to the broader economy, the CCRSI report stated. 

The Office Index advanced by 11.4% during the same period, while the Multifamily Index fell to third with a more modest 11.1% gain. 

While surpassed this past quarter by retail and office, the multifamily sector continued to post strong results, with overall pricing at midyear 2013 just 13.4% shy of the previous peak reached in 2007. Pricing in the other major property types, by comparison, is still more than 20% below their pre-recession highs. 

While the strong investor interest in multifamily has been attributed to relatively stronger fundamentals, the August CCRSI release also noted that the hot apartment investment market has benefitted from plentiful debt financing available for this property type following the downturn, led by the government-sponsored enterprises (GSEs). However, the CCRSI report also notes signs of a deceleration in multifamily fundamentals, mainly from a growing supply of new apartment units, especially in the primary markets where vacancies are at, or near, prerecession lows and pricing has already surpassed its prior peak level. The CCRSI Multifamily Prime Metros Index notched gains of 9.9% over the last year, which was lower than the 11.1% gain for the broader multifamily index. 

Among U.S. regions, the CCRSI Midwest regional index recorded the largest gain in the previous 12 months at 16.5%, helped by solid multifamily and retail pricing. The Northeast regional index continued to reflect the largest cumulative pricing gains since the recovery began. 

The percentage of commercial property selling at distressed prices dropped to just 13.6% in June 2013, down from nearly 24% a year earlier, the lowest level of distress recorded since the end of 2008. 

However, the recovery is still a work in progress since the long-term average for distress trading is less than 1% of total volume, but the recent declines have helped to boost liquidity and pricing by giving lenders more confidence to make deals.