Monthly Archives: February 2013

Commercial Real Estate Sales Surge 22% In 2012 As Pricing Recovery Spreads To More Markets

CRE Sales Surge 22% In 2012 As Pricing Recovery Spreads To More Markets – CoStar Group.
Aided By Improved Liquidity and Buoyed By Improving Conditions, Investors Move Into Other Property Types and Into More Markets Driven by Multifamily Gains.

By Randyl Drummer

February 13, 2013

Sales of U.S. 
commercial real estate reached nearly $64 billion in 2012, jumping 22% from the previous year to the highest annual total since 2004, according to the latest findings from the CoStar Commercial Repeat Sale Indices (CCRSI). 

The analysis of sales data through December caps a year in which the recovery in CRE pricing rippled beyond the apartment market into office, industrial and even retail property, to a greater or lesser extent. Meanwhile, the level of distressed property sales fell to just 11.5% of transactions noted in December 2012, the lowest level since the end of 2008, which also helped put a solid foundation under prices. 

Even commercial land prices showed signs of recovery in the last quarter of 2012, mostly due to strong developer demand for apartment sites. The CCRSI Land Index gained 3.6% in the last quarter of 2012, although it still remains 39.9% below the frothy December 2007 peak.

Capping a steady increase over the past four years, sales activity spiked in December as investors hustled to close deals prior to year-end, driven in part by concern over anticipated tax hikes and the restoration of previous tax rates for capital gains.

Pricing and market fundamentals of larger, more expensive Four- and Five Star office, apartment and big-box warehouse properties located in prime markets were the first to recover. With increased competition and smaller yields now found in the upper end of the market, however, gains in the value-weighted U.S. Composite Index — which began earlier in the recovery — are expected to moderate after years of stronger gains relative to smaller and lower-end properties, represented by the equal-weighted U.S. Composite Index.

Investment momentum now appears to be shifting to the broader market dominated by smaller, less-expensive properties. The value-weighted U.S. Composite Index gained 4.3% year-over-year gain in December 2012, slowing from the double-digit growth rate throughout 2011.

Year-over-year growth in the equal-weighted U.S. Composite Index took off in the second half of last year moved up to 8.1% for 2012.

“Taken together, the two trends signify that investors are moving beyond core properties and driving up pricing at the lower end of the market,” Dr. Ruijue Peng, author of the CCRSI, validating data and insights presented during the company’s fourth-quarter and yearend 2012 review and outlook for each of the major property types.

While the single-family housing market’s burgeoning recovery has grabbed the headlines of late, the apartment sector has led the recovery in commercial property pricing in terms of both timing and magnitude.

The brisk pricing gains in apartments — where the multifamily property index advanced by 11.2% in 2012, with the 10 markets in the prime multifamily index again hitting pre-recession peak pricing well ahead of the other major property types – attracted developers and millions of dollars in investment to respond to the increased demand and limited supply.

Developers delivered double the number of new multifamily units in 2012 than in the previous year, and construction in 2013 is on pace to bring an bigger increase. Further pricing gains are needed in other property types before we see significant development in the office, industrial or retail sectors, however.

“As the pricing recovery expands beyond multifamily, this sector’s stellar pace of growth is beginning to moderate,” Peng said. The multifamily sector recorded only a 1.4% gain in the fourth quarter, the lowest percentage increase among all major property types, even though annual pricing gains for the apartment sector topped all others.

As multifamily prices soared higher, the end of the year saw more investor capital pushed into other property types in search of higher yields. Pricing gains have proven to be more robust in the core office coastal metros and in tech-centric markets than in the overall market, with the Prime Office Index advancing by 14.4% for the yearend in December 2012 while the broader office index expanded at a more modest 4.6% pace.

The Industrial Index, the only major property type index to continue to post mild pricing losses into early 2012, also saw pricing pick up by the end of the year. The pricing recovery among industrial property so far has centered on big-box distribution facilities in primary logistics hubs, as seen in the 20.4% increase in the Prime Industrial Metros Index for the year, while the broader industrial property type index advanced just 8% from a year ago.

While retail investors remain cautious, pricing rose by 6.8% during the year ended December 2012, according to the quarterly CCRSI results. The retail prime markets index advanced by a stronger 15.7% over the last year indicating, investors may yet still be hesitant to venture too far out on the risk

The Hospitality Index also made promising gains last year, increasing by a cumulative 22.2% in December 2012 since December 2011. The sector was slow to recover after suffering the steepest cumulative price losses among all the property types.

Among CCRSI’s four major U.S. regions, the West Composite Index was the only region with negative quarterly pricing movement in the fourth quarter. Despite a 1.1% decline in the last three months of 2012, the West had the strongest recovery on an annual basis, rising 9% in 2012.

The Northeast region, which led the CRE pricing recovery for the past two years thanks to its above-average concentration of prime markets, saw its pace of improvement slow as pricing recovery expanded from core coastal markets to second-tier metros. The Northeast region posted the slowest annual gain of 5.5% over the last year.

The CCRSI South Composite Index continued a moderate pace of recovery at 6.7%, led by strong performance in the industrial and multifamily sectors, while the Midwest Composite Index expanded in the last half of the year, advanced by a cumulative 6.5% in 2012, led by exceptional increases in the office and multifamily.

Cap Rate Analysis

The Ivy Group - Cap Rate AnalysisWhat is Cap Rate?
The capitalization rate (aka cap rate) is defined as the first year “stabilized” net operating income (NOI) divided by the present value (or purchase price).

What is the Advantage of Using Cap Rate to Analyze an Investment? What is the Advantage of Using Cap Rate to Analyze an Investment?
The cap rate is a convenient and quick method to determine if the value or purchase price of an investment meets the investor’s criteria. The cap rate alone, however, should not be the sole reason to purchase a property. Investors must perform proper due diligence and consider other factors such as location, demographics, growth, supply vs demand, loan-to-value and debt coverage ratios to determine if an investment is worth the risk.

What are the Disadvantages of Using Cap Rate to Analyze an Investment? What are the Disadvantages of Using Cap Rate to Analyze an Investment?
The main disadvantage in using the cap rate to analyze an investment property is that the cap rate only shows the value of a property based on the first year’s stabilized net operating income. If the NOI of a property changes in subsequent years, the cap rate changes, therefore the value. The cap rate has an inverse relationship to value. Assuming the NOI remains the same, if the cap rate increases, the value decreases and vice versa.

Is it Better to Have a Low or High Cap Rate? Is it Better to Have a Low or High Cap Rate?
The answer to this question depends on who is evaluating the property. Investors (buyers) want a high cap rate, meaning the value (or purchase price) of the property is lower. Conversely, landlords (sellers) want to see a low cap rate which reflects a higher selling price.

Cap Rate Example (Which is a better deal?) Cap Rate Example (Which is a better deal?)
In the example below, which is a better deal?

Property A has a cap rate of 8.74% and Property B, 8.06%. Clearly, the return on equity is higher for Property B. Why is that so?

Let’s take a look. Even though Property A has a higher net operating income (NOI), the interest is higher. Many factors affect the interest rate which results in a lower investment equity return.

Factors such as loan amount, property type, age of the property, tenant, location, credit history, economic condition, etc all play a significant role in determiningg appreciation rate, and ultimately value, of commercial properties.

Therefore, The Ivy Group recommends that before investors rush out to purchase a property, do not just analyze the investment based on the cap rate. Give us a call and we will perform the proper due diligence so that sound decisions are made based on real data.

Property A
$3M, 8.74 % cap rate
Property B
$3M, 8.06 % cap rate
Net Operating Income (NOI) $251,940 $241,680
Loan Amount (60% LTV) $1,800,000 $1,800,000
Down Payment (40%) $1,200,000 $1,200,000
Loan Interest Rate 7.00 % 6.00 %
Annual Payment (P & I) $152,664 $139,169
Income Before Tax $99,276 $102,511
Investment Equity Return 8.27 % 8.54 %


Types of Commercial Real Estate Lease

Have you ever wondered what type of commercial real estate leases are best for the landlord? What about the tenant? Below are the different types of leases for your consideration.

Fixed – Full Service – Flat Lease Tenant pays a base rent only, all expenses, including the tenant use of utilities, are paid by the landlord. Typically used in large office buildings.
Gross Lease Tenant pays a base rent and all expenses are paid by the landlord. However, tenant pays its own use of utilities, like gas and electric. Typically used for office/retail buildings.
Modified Gross Lease As name implies, a modified lease is a Gross Lease but “modified” to pass-through certain expenses to the tenant, like janitorial and repairs, or others negotiated before signing the lease.Modified Gross lease is also used when landlord bills tenant for “increases” of expenses from base year. Typically used in medical and industrial buildings.
Net Lease Tenant pays a base rent plus some or all operating expenses for its percentage share of property (prorata).If it is a Single Net Lease (N), tenant pays base rent plus one of the operating expenses, either property tax, Insurance or CAM charges.In a Double Net Lease (NN), tenant pays base rent plus two of the operating expense, usually Property Tax and Insurance.In a triple Net Lease (NNN), tenant pays for all operating expenses. Most of the time, in a NNN lease capital improvements, such as new roof, will not be billed back to tenants. Typically used in retail shopping centers.
Absolute Triple Net (NNN) Tenant pays base rent and pays all the operating expenses including capital improvements. In this type of lease, landlord doesn’t even see the bills; tenant pays the property tax, insurance, CAM and capital improvements directly to vendors. Typically used in Single Tenant properties and Sale-lease back transaction with long leases.
Ground Lease Another version of Absolute Triple Net Lease where the landlord leases the ‘grounds’ only, technically the building belongs to the tenant, when lease is over the building “reverts” back to the landlord. In this scenario, the tenant gets to depreciate the building not the landlord. Typically used for single tenant property.