Investors both large and small remained intently focused on commercial real estate last year, as pricing levels rose in tandem with occupancies, vacancies remained near cyclical lows, and rent growth posted healthy gains across property sectors and regions.
Those were among the findings in the February 2015 CoStar Commercial Repeat Sale Indices (CCRSI), which analyzed commercial property sales through December 2014, providing one of the broadest measures of commercial real estate repeat sales activity.
The value-weighted U.S. composite index in the CCRSI increased 11% in 2014 to 5.7% above the previous peak in 2007, as investors continued to pour money into commercial property.
While investor demand for core assets remains high, the CCRSI also reflected the trend among investors increasingly moving to secondary markets in quest of higher yields. The equal-weighted U.S. composite index, in which each sale transaction is weighted the same regardless of sale price, increased 13.3% in 2014. This index, which more readily reflects the influence of smaller transactions and those in secondary markets, is still 14% below its prior peak, suggesting that there is more room for price appreciation as the cycle matures.
Capital Markets Are Highly Liquid
In a repeat of the seasonal sales pattern seen over the last several years, transaction activity spiked in the final month of the year as investors rushed to close deals prior to year-end. Commercial property sales in December 2014 helped lift the total number of repeat sales in 2014 to a record high of more than 16,000, an increase of 7.3% from the 2013 total.
The low cost of debt throughout the year also contributed to the record deal volume, while low interest rates have kept spreads over the risk-free rate wide, despite historically low cap rate levels.
Pricing Gains Seen Across Property Types and Regions
This month’s release included the quarterly property type and regional indices. The CCRSI Multifamily Index had already reached its prerecession peak earlier in 2014. During 2014, the Multifamily Index moved up another 11.7% and is now 3.5% above its 2007-high. The other major commercial property type indices also saw strong growth in 2014, although they are all still more than 10% below previous peak levels. Pricing grew 13.9% in the Retail Index in 2014, 11.9% in the Industrial Index, and 9.5% in the Office Index.
Among the CCRSI regional indices, the South Index led the nation in terms of price appreciation in 2014, with price growth of 15.1%.
Closer Look at Property Type Pricing Trends
OFFICE: Pricing in the Office Index increased 9.5% in 2014. Overall office market fundamentals improved significantly in 2014 as office vacancy decreased to 11.3%, from 11.9% in 2013. Despite a moderate pickup in development, net absorption grew even more strongly, up 40% from 2013 levels, suggesting diminishing headwinds from both shadow supply from the last recession and the trend among employers to reduce office space per employee.
MULTIFAMILY: Having reached its prerecession peak in the second half of 2014, multifamily pricing continued to expand, growing 11.7% in 2014. The Multifamily Index was the first property segment to begin its recovery, driven by a greater availability of debt financing and investor demand for well-leased assets in core coastal markets. However, most apartment markets are now in the expansionary phase of the cycle, where construction will begin to exert pressure on occupancies and rent growth.
RETAIL: CCRSI’s Retail Index posted a 13.9% increase in 2014, the largest annual gain among the four major property types, as pricing ramped up in response to improving market fundamentals. With development largely quiet, retail demand outpaced supply by a two-to-one margin in 2014. This dropped vacancies 20 basis points, to 6.3% in the fourth quarter of 2014, the lowest rate in more than six years, while annual rent growth remained steady at nearly 3%.
INDUSTRIAL: The Industrial Index advanced by a solid 11.9% in 2014. Because of the segment’s low vacancy level and relative lack of supply, industrial rent growth, usually unremarkable, remained the strongest of the four main property types throughout 2014, posting a 4.3% increase for the year.
HOTEL: The CCRSI Hospitality Index surged upward by 17.7% in 2014 after relatively flat growth of just 0.6% in 2013. National hotel occupancies have reached their highest level since the mid-1990s, fueling room rate and RevPAR growth as well as investor demand.
LAND: The Land Index gained 19.9% in 2014, driven by increased demand for development sites across all property sectors. Despite strong gains over the last year, the Land Index remains 28.9% below last cycle’s peak since reaching its most recent trough in 2012
Closer Look at Regional Pricing Trends
NORTHEAST: Thanks to its strong concentration of top-tier markets that were a magnet for investment early in the cycle, pricing in in the Northeast Composite Index rebounded in 2014 to within 1% of the prior peak reached in 2007. This outperformance can be largely attributed to the strong rebound in the Northeast Multifamily and Retail Indices, which soared past their prior peak pricing levels in 2014 by 25.2% and 8.4%, respectively.
However, as the cycle has matured and prices have risen rapidly across the primary Northeast markets, the region is no longer outstripping price gains in the rest of the country. In 2014, growth in the Northeast regional index of 10.5% was the slowest of the four major regions.
WEST: The West Composite Index recovered to within 12.1% of its previous peak reached in 2007, the second-strongest price recovery after the Northeast region. In 2014, the West’s multifamily and office segments posted the strongest price gains, of 15.6% and 13.7%, respectively. Demographic trends and employment growth in tech-driven markets, including Seattle, San Francisco and San Jose, have driven recent exceptional price growth in this index.
SOUTH: The South Composite Index increased by 15.1% in 2014, driven by strong growth across all property sectors. Price growth has rebounded in fast-growing markets like those in Texas and North Carolina that have benefited from exceptionally strong demand growth, falling vacancies and solid rent gains. The South Multifamily Index posted the strongest annual growth in the composite index, of 14.6% in 2014.
MIDWEST: The Midwest has lagged behind the other regions in the recovery, with most property type indices here bottoming out in 2012, nearly two years later than those in the Northeast or West regions. As capital has moved to secondary and tertiary markets over the last year in search of higher yields, Midwest markets have benefited, with a surge in investment activity and price growth. In 2014, the Midwest Composite Index expanded by 12.8% annually, the second-strongest growth after the South region. However, the Midwest Index has the most ground to make up in the recovery, with current pricing down 23% from its prior peak.
Distress Sale Transactions Continue To Wane
The percentage of repeat sales transactions involving distressed assets fell to 9.7% in 2014, its lowest rate since 2008.
