If you noticed some slowdown in investment sales activity this year, you are correct. Well, partly.
Last year marked a banner year for capital investment in commercial real estate. But 2015 was also flush with portfolio and entity-level deals that are not easily replicable year-over-year.
"The actual flow of capital is down but still at quite an elevated level. We haven’t had the major portfolio deals of 2015. In a way, the lower volume for 2016 is not necessarily a story about a weak 2016, but an unusual 2015," says Jim Costello, senior vice president with Real Capital Analytics (RCA), a New York City-based research firm.
Portfolio deals were down 39 percent in the first half of this year compared to the same period in 2016, RCA found. In the second quarter alone, portfolio deals showed a 47 percent year-over-year slide.
Meanwhile, single-asset deals dropped by only 1 percent in the second quarter compared to the year before, while deals in the first half of 2016 declined by about 4 percent. “Single-asset volume, while not down nearly to the extent of portfolios, is still down as investors are cautious,” Costello says.
According to RCA data, all investment transactions totaled $219.2 billion during the first half of 2016, representing a decline of 16 percent compared to last year. And according to data from research firm CoStar, there were approximately $250 billion in investment deals done during the first half of 2016—a 20 percent drop compared to the same period in 2015.
The biggest loser so far this year has been the hospitality sector, with deal volume down 57 percent, says Rene Circ, director of research with Costar Portfolio Strategy.
Meanwhile, multifamily properties continue to lead in popularity with buyers. Costello says apartment properties performed the best in the first six months of 2016, with a 10 percent increase in investment volume compared to the same period in 2015.
Investors are demonstrating more discipline (and are more risk-averse) this year as the effects of global shakiness and stricter U.S. financial regulation play out.
“Many of the cross-border investors active in 2015 are facing more scrutiny in their investments today,” Costello says.
According to Circ, “New bank regulations and the resulting CMBS shake-up was the biggest disruptor of this year. Capital has been more careful in this cycle. Today you can make a bad deal. In 2012, you couldn’t.”
But this is no doomsday story. Investment volumes in the second half of the year are expected to be stronger as portfolio deals currently in the pipeline close, Circ says.
Cap rates have trended downward for most property types (excluding hotels) since 2012. They have mostly flattened out this year.
“We expect cap rates to remain flat for the rest of the year; class-A has compressed as much as it can, but there is possibility for cap rate compression in B markets,” Circ says.
Almost a record spread exists between interest rates and cap rates right now, according Costello. “Investors continue to look at commercial real estate for yield,” he says. “Although cap rates are low, they are still delivering."
Where are we now?
New York Fed President William Dudley said in a recent Fox News interview that it “is possible” the Federal Reserve would increase the interest rate in September. But market sources say investors should not lose sleep over a possible increase.
"If the Federal Reserve does hike, a quarter point is expected. There is enough room in spreads to accommodate it. There is easily 100 basis points in spreads to absorb an interest rate increase,” says Circ.
On the other hand, the issue of where we are exactly in the current real estate cycle might be a bigger concern.
“More and more investors think this is the peak of the market, with cap rates low and pricing rich,” Circ says. “We are not expecting price declines until the next recession. At the same time, we are not expecting much price appreciation. We are forecasting low single-digit price growth.”
The property-price relationship will factor more seriously into investment deals made 2017. “The biggest challenge for 2017 will be in underwriting the rent growth and yield needed to make deals work, especially as construction begins to pick up,” says Circ.