Commercial real estate markets nationally have continued to recover, according to Integra Realty Resources’ (IRR) Mid-Year Viewpoint 2014, an update of the industry’s annual compendium of real estate valuation, investment and leasing trends and forecasts. The report, published July 17, indicates that none of IRR’s 66 local offices forecast material value deterioration over the coming year or over the next three years and finds that all five key property types — office, multifamily, retail, industrial and lodging — are generally undergoing a shift from the recovery to the expansion phase of the market cycle, with decreasing vacancy rates, moderate/high new construction growth, high absorption rates and medium/high rental rate growth.
IRR Mid-Year Viewpoint 2014 finds that this year to date, the industrial market sector experienced the strongest improved prospects of any property sector. Nationally, 97 percent of industrial markets are now reported to be in the recovery or expansion phase of the real estate market cycle, and 51 percent are observed to be in an expansionary cycle, up significantly from 22 percent in this phase as of yearend 2013.
The 24th annual edition of IRR Viewpoint, published in January, forecast that improved property fundamentals would drive the upward trend in real estate values, and would be likely to offset any potential increases in cap rates over the next three years. IRR Mid-Year Viewpoint 2014 confirms IRR’s prediction that strong recovery of property fundamentals would continue to make the real estate sector a safe harbor for investors in search of yield in the current low interest-rate environment. The IRR Mid-Year Viewpoint 2014 data also suggests that investors are increasingly willing to invest in markets that were previously considered too small to attract significant institutional investment capital, and that these dynamics will add to favorable value appreciation during the next three years across a broad range of U.S. real estate markets.
Key findings of IRR Mid-Year Viewpoint 2014 include:
Capitalization Rates
- Since January, capitalization rates remain largely unchanged or are decreasing slightly, while operating fundamentals remain steady or are slightly improving in most markets.
- The real estate risk premium, the difference between the 10-year U.S. Treasury yield and the capitalization rate or expected investment yield on real estate, has contracted significantly over the previous two years, indicating that the real estate sector remains an investment of choice.
Office
- Recovery in the office sector has been more gradual than the other national property types, with less than 25 percent of suburban office properties in the expansion phase of the market cycle.
- Average cap rate contraction was most muted in the office sector across all regions, perhaps indicating that stagnant job growth is having an impact on investment demand within the sector.
- Year-to-date value appreciation in many markets, combined with gains from 2012-2013, has largely erased losses from the 2008-2010 recession in many markets. In fact, only five smaller markets nationally — Greensboro, N.C.; Hartford, Conn.; Jackson, Miss.; Sacramento, Calif.; and Wilmington, Del., — indicate that central business district (CBD) office assets have at least held or appreciated in value over the previous three years.
Multifamily
- Nearly 94 percent of all urban multifamily properties are in the expansion phase of the market cycle, and IRR predicts that this situation should continue nationally for at least the next six months.
- Multifamily cap rate contraction was material in the Central and South regions while remaining notably flat in the East and West regions. Some secondary markets like Cleveland, Minneapolis, and Phoenix reported material decreases in cap rates of 50 basis points or more over the past six months.
Industrial
- Industrial property types saw cap rate contraction for Class A industrial product in more than 80 percent of U.S. markets. This cap rate contraction was especially notable in the following markets: Boston; Cincinnati; Columbia, S.C.; Dallas; Fort Worth, Texas; Greenville, S.C.; Louisville, Ky.; Memphis, Tenn.; Miami; New York; Orange County, Calif.; Philadelphia; and Phoenix.
- The strong year-to-date performance of the industrial market sector tends to support the claim that the industrial sector has the greatest chance for value appreciation in the 2014- 2016 time period.
- Both industrial and office properties experienced vacancy contractions in more than 60 percent of U.S. markets.
Retail
- There was only a relatively small cap rate contraction in retail properties, with less than a 20-percent contraction in the community retail sub-property type. This trend was largely bifurcated on a regional basis, as the East region reported strong retail capitalization compression year to date, especially in the neighborhood retail space, while the Midwest, South and West regions reported flat compression trends year to date.
- IRR reports that more markets (41 percent, up from 29 percent at yearend 2013), have shifted from recovery mode into an expansionary retail cycle. This is not unexpected, as values have recovered previous losses over the past three years in every reported market except Jackson, Miss.
Lodging
- The lodging sector experienced capitalization rate contraction in the first six months in 2014. Full-service lodging properties are experiencing occupancy rates above the national average of 66.8 percent. IRR expects the Southern U.S. markets to have the highest increase in ADR annually for the next 36 months.