Transaction Volume at Mid-Year Trending Lower

Real estate investors have responded to an especially disappointing year economically (i.e., market uncertainty, sluggish GDP growth, and the lackluster job market) by curtailing their buying activity—or waiting on the sidelines entirely. Consequently, transaction volume during 2Q 2012 has retreated back to near the level observed in 3Q 2010. This reverses the trend seen over the last few years, where sales volumes increased throughout the calendar year. If this trend persists over the second half of 2012, transaction volume will come in below last year’s levels. A definite indicator of lukewarm investor sentiment.

Cap Rates on the Rise

Cap rates have been trending slightly upward for office deals and remain essentially unchanged from one year ago for apartments, while cap rates for retail have been declining. Still, cap rate spreads—calculated as the difference between the 12-month rolling cap rates and the 10-year Treasury yield—for all three sectors have been rising (though the spread in apartment and office are rising faster than the spread in retail). Why? Blame the global phenomenon of investor flight to quality and the safety in capital markets for the record-low levels reached by U.S. Treasuries during the second quarter.

Who’s buying what, where

Investors continue to be a discriminating bunch. Apartment deals this past quarter tended to show a preference for high-priced, high-quality assets primarily focused in a relatively small number of primary gateway markets. However, high prices have some investors shying away from buying existing apartments and considering other alternatives, such as development. Office pricing has also become expensive over the last few years, and it’s likely this development along with the fact that economic growth continues to disappoint and uncertainty in the marketplace persists that investor behavior is being affected. Because of the weakness in retail property fundamentals, selection bias is even stronger for retail than the other major sectors, with a select few high-quality properties trading.

Investments in Top Markets Come at a Price

A comparison of the volume-weighted 12-month rolling cap rate for the top 10 markets by transaction volume and the volume-weighted 12-month rolling cap rate for all other markets clearly shows that investors are willing to pay a cap rate premium to be in the markets with the largest volumes. This premium has been fairly consistent over the last five years. Therefore, although risk aversion persists in the current transactions market, investors prefer deals in these high-volume markets during all types of economic environments, not just the distressed environments of today. The top 10 retail markets present a somewhat different picture, however. The risk premium for high-volume retail markets is not only inconsistent; it is actually negative during certain periods, including the most recent quarter. Local factors– the trade area, the economic and demographic make-up of the consumers in the trade area, and often the characteristics of the property itself—are most important. Consequently, investors focus on local factors while less-important metro-level factors will be largely ignored and do not translate into a transaction premium. What distinguishes a top 10 market? Generally, they have better liquidity—they are large, institutional markets with many properties and a large number of market participants. They also have better market fundamentals and economic prospects.





The Year Ahead

Little is expected to change this year, particularly since continued slow economic growth is forecast. Selection bias in the market should remain as entrenched as ever, even with cap rates ticking up slightly. And, with the recovery in fundamentals failing to spur an interest in a wider swath of the market, expect the transaction volume to remain restrained over the latter half of the year.

Source: ReisReports Connie Vitucci