Commercial Real Estate Deal Volume Edges Down In Q4 2017 - KSWO 7News | Breaking News, Weather and Sports

Commercial Real Estate Deal Volume Edges Down In Q4 2017

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SOURCE Ten-X Commercial

Annual transaction volume falls 6.9 percent as pricing gap between buyers and sellers persists amidst lingering uncertainty

IRVINE and SILICON VALLEY, Calif., Feb. 27, 2018 /PRNewswire/ -- Ten-X Commercial, the nation's leading online, end-to-end transaction platform for commercial real estate, today released its latest Commercial Real Estate Volume & Pricing Trends report, which reveals that CRE transaction volume edged down to $117.4 billion in Q4 2017. This represents a 0.5 percent decline from the prior quarter, according to Real Capital Analytics.

Coming after two quarters of growth, the minor quarter-on-quarter decline is attributable to a $6.7 billion drop in deal volume in the industrial sector. Compared to the year-ago period, fourth-quarter investment activity plunged by 13.2 percent, while the annual figured dropped a more modest 6.9 percent to $445.2 billion.

Deal activity may have been slowed by the looming specter of tax reform, which prompted investors to delay transaction closings until the new, advantageous legislation took effect in 2018. Persistent concern about the age of the U.S. economic expansion, which is now in its 104th month, also hampered deal flow as it's approaching the second longest expansion period in modern U.S. history. This concern has created a pricing gap between sellers and the many buyers who are wary about purchasing property at tight cap rates so late in the real estate cycle.

The changing of the guard at the Federal Reserve, with Jerome Powell taking over as Fed Chairman from Janet Yellen, is yet another source of uncertainty for buyers and sellers. Powell is expected to follow a similar path as his predecessor, but investors will observe his initial actions closely to see if interest rate expectations remain in place. 

"Uncertainty around tax reform-related policy undeniably weighed on deal volume late last year, but the legislation that eventually passed is expected to be beneficial to the real estate industry," said Ten-X Chief Economist Peter Muoio. "The main question on everyone's minds now is whether the delayed closings and optimism about the new tax regime will be enough to offset other headwinds and fuel deal volume growth in the first quarter of 2018 and beyond. The run up in interest rates since the start of the year is a potential downdraft on deal closings as financing costs increase and cap rate expectations change."

CRE Transaction Volume Remains Muted  

Fourth-quarter deal volume continued to recover from a downturn at the beginning of 2017, but remains far off its cyclical peak. However, the overall loss was diluted by gains in the office and apartment sectors, in which deal volumes grew $6.2 billion and $1.4 billion from the prior quarter, respectively. As a result, overall deal volume is down just 0.5 percent from Q3.  

The apartment sector's share of total deal volume rose for the third consecutive quarter, reaching 37.1 percent - its highest level on record and more than 800 bps above its 10 year average. The industrial sector saw the sharpest quarterly drop in deal volume share, down 560 bps, but that figure was on par with its 10 year average. After rising 550 bps in Q4, the office sector's share of deal volume is at 30.6 percent, in line with its historical average.

Property Pricing Weakness Continues in New Year

Property valuations are now up just 0.4 percent year-over-year as of February, per the Ten-X All Property Nowcast, which gauges national pricing through a combination of proprietary and third-party data. This marks the weakest year-over-year gain for the index in its seven year history. Month-to-month, the Nowcast edged up by 0.1 percent in February - the index's first increase in 10 months.  

Pricing in three of the five major property segments increased in February, while office and hotel both declined.

The Ten-X Industrial Nowcast posted the largest increase in February, with pricing rising by 1 percent. This reversed a January decline, and narrowed the segment's year-over-year pricing decline to 3.3 percent. The strengthening of the industrial economy in recent months has given investors renewed confidence that demand will continue. Still, threats about tariffs and other trade barriers remain a risk for this segment.

Pricing in the apartment sector edged up in February, according to the Ten-X Apartment Nowcast, posting a 0.4 percent increase after seven consecutive months of contraction. In the past year, apartment prices have remained essentially flat, with pricing just 0.2 percent higher than a year ago.

The Ten-X Retail Nowcast continues to chug upward, increasing 0.1 percent in February, even as the sector's headwinds – the rise of e-commerce and shifting consumer spending preferences – remain in place. The index is now a solid 6.0 percent above year-ago levels, far outstripping the annual gains of any other segment. Nevertheless, the sector seems vulnerable to additional retail bankruptcies and store closings, especially if the U.S. economic expansion slows.

The Ten-X Office Nowcast saw a 0.3 percent decline in February. Office pricing is essentially unchanged since early 2017, as fundamentals paint a mixed picture, and year-over-year gains are at a paltry 0.1 percent. All regions saw declines in February, except for the Southeast, which climbed to its highest mark on record.  

The Ten-X Hotel Nowcast posted its seventh decline in ten months, falling 0.4 percent in February. Hotel pricing is now 0.9 percent lower than a year ago. On an annual basis, the Southwest, Southeast and Midwest are down sharply, while the two coasts remain positive from a year ago.

Risk Premiums Hold Fast Despite Slight Uptick in Interest Rates

Following a bump up in December 2017, 10 year U.S. Treasury rates rose 20 bps quarter-over-quarter to 2.4 percent. This led to a minor rise in cap rates across most sectors, while risk premiums largely held their ground. Retail risk premiums are flat from the prior quarter, while office and hotel premiums are up a respective 10 bps and 20 bps. Industrial and apartment premiums edged down 10 bps and 20 bps, respectively. Risk premiums are clearly going to be pressured by the sharp jump in treasuries so far this year.

The hotel sector's risk premiums have been trending in line with their 10 year averages for five consecutive quarters, while other sectors' premiums are still below historical figures leaving some room for cap rates to resist the updraft in interest rates. Hotel risk premiums remain high because the hotel market appears to have hit a ceiling. Investors' rate of return has diminished as occupancy and RevPAR growth has slowed.

Cap Rates Across Sectors Below 10-Year Average, Hotel Has Smallest Gap

The cautious uptick in treasury yields in the fourth quarter prevented any significant movement in cap rates and cap rates increased minimally in all five sectors. Cap rates are currently holding below their 10 year averages in each property segment, ranging from hotel's 10 bps gap to industrial's gap of 100 bps. Retail, apartment and office cap rates are all in the ballpark of 60-70 bps below their historical averages. The key question is whether the jump in interest rates since the new year has a bigger impact on cap rates.

"The slowdown in transactional activity reflects the fact that many buyers remain wary that the current business cycle may be coming to an end and are shifting to more conservative strategies," said Muoio. "In the fourth quarter specifically, uncertainty around tax policy clearly had a negative impact on deal volume. The new wrinkle is whether the jump in interest rates suppresses deals in the first quarter."

About Ten-X Commercial

Ten-X Commercial is the nation's leading online, end-to-end transaction platform for commercial real estate. Since 2009, the company has sold more than $18 billion in commercial real estate. The company blends data-driven technology with industry expertise to accelerate close rates and streamline the entire transaction process. Ten-X Commercial and its parent company, Ten-X, are headquartered in Irvine and Silicon Valley, Calif., with offices in key markets nationwide. Investors in the company include Thomas H. Lee Partners, L.P., CapitalG (formerly Google Capital) and Stone Point Capital.



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