Small Cap Commercial Markets Maintain Momentum in 2016.Q1

Commercial sales transactions span the price spectrum, but tend to be measured and reported based on size. Commercial real estate (CRE) deals at the higher end—$2.5 million and above—comprise a large share of investment sales. Smaller commercial transactions tend to be obscured given their size. However, these smaller properties provide the types of commercial space where average Americans engage on a daily basis—e.g. grocery-anchored shopping centers, local warehouses, small offices, supermarkets, etc.  These are the types of buildings that are important in local communities, and REALTORS® are active in serving these markets.

The National Association of REALTORS® Commercial Real Estate Outlook: 2016.Q2 report focuses on market performance in both large (LCRE) and small commercial (SCRE) sectors.  The report provides an overview of economic indicators, investment sales and leasing fundamentals.

Investment Sales

The pace of commercial transactions dropped in the first quarter of 2016, following an upbeat 2015. The volume of commercial sales in LCRE markets totaled $111 billion, a 20 percent year-over-year decrease, according to Real Capital Analytics (RCA). The first quarter data saw yearly declines in both individual and portfolio transactions, of 11 percent and 24 percent, respectively.

Continuing the trends from 2015, apartment transactions comprised the largest share of first quarter volume, with $38.6 billion in sales, followed by office properties, which accounted for $31.2 billion. Retail and industrial sales totaled $17.9 billion and $12.6 billion, respectively.

In comparison, sales in SCRE markets rose 8.5 percent year-over-year during the first quarter, based on REALTORS® market data. The average sale transaction price totaled $1.1 million during the quarter.

Investment Prices

Even with declining sales volume, prices in LCRE markets rose. However, the advances moderated from the fast pace of the past two years. Prices in markets covered by Real Capital Analytics gained 8.6 percent during the first quarter of 2016, based on RCA’s Commercial Property Price Index. The advance was driven by strong appreciation in prices of retail and apartment properties, which advanced 11.8 percent and 11.2 percent, respectively.  Prices for office properties in central business districts (CBD) advanced 10.5 percent.

Separately, additional price indices also advanced. The Green Street Advisors Commercial Property Price Index rose 8.4 percent on a yearly basis during the first quarter, reaching a value of 123.4. The National Council of Real Estate investment Fiduciaries (NCREIF) Price Index increased 8.7 percent year-over-year in the first quarter of 2016, to a value of 257.3.

Capitalization rates in LCRE markets averaged 6.7 percent in the first quarter, based on RCA reports, 30 basis points lower compared with the prior year. Cap rate compression continued for apartment and office CBD properties, reaching values of 5.7 percent and 5.4 percent, respectively.

With inventory shortage continuing as a main concern, prices in SCRE markets rose a more moderate 5.1 percent year-over-year during the period. Average capitalization rates declined to an average 7.2 percent across all property types, a 60 basis point compression on a yearly basis. Apartments posted the lowest cap rate, at 6.9 percent, followed by hotel properties with average cap rates at 7.1 percent.  Office and retail spaces tied with cap rates of 7.3 percent. Industrial transactions reported the highest comparative cap rates—7.4 percent.  It is worth noting that these cap rates are higher than those in LCRE markets, reflecting activity in markets where REALTORS^® are more engaged.