Commercial real estate pricing has been a tale of two worlds, with the largest metropolitan markets attracting significant institutional capital and forcing prices upward over the first two quarters of 2010, while the broader market has continued to soften, according to the first monthly CoStar Commercial Repeat-Sale Indices (CCRSI), produced by CoStar Group, Inc.
This divergence may soon change, however, with the indices, compiled over the last 10 months, now indicating a pause and softening in overall investor activity, even within the primary markets for investment- or institutional-grade property.
Over the past 10 months, the overall composite CCRSI oscillated from positive to negative and back again, with preliminary July figures very likely to be down for investment-grade property markets. From May to June, the composite CCRSI was down 7.78%, with the investment grade property declining by 4.83%, reversing previous positive gains.
The pause in some of the positive price trends corresponds to renewed uncertainty in the U.S. economy, persistent weakness in the housing market and concerns surrounding the European economy. In addition, financial reform has slowed commercial mortgage markets as lenders are now in the process of analyzing and interpreting capital requirements and "skin-in-the-game" provisions.
Many of the opportunity funds continue to seek out distressed properties, which are affecting the prices shown in the index. But the expectation of a "tsunami of opportunities" has not materialized and overall transaction volumes remain below normal, according to the CoStar indices.
Distressed sales as a percent of transaction volume are highest for hospitality at 35%, followed by multifamily at 28%, office at 22%, retail at just under 20% and industrial at about 17%. These volumes appear to be stabilizing and the "extend and pretend" behavior of some lenders is likely to continue for the next several months, according to index findings.
CoStar Group launched the Commercial Repeat-Sale Indices as a measure intended to provide consistent and timely information to help answer some of the fundamental economic questions regarding the commercial real estate industry, including, 'Are prices climbing or falling?' and 'On a month-to-month basis are property values going up or down?'
"Currently, there are no effective, non-biased indices to measure commercial real estate price movements, and even less comparative information by property type or geographies," said CoStar Group Chief Executive Officer Andrew Florance. "In response to this void, we've developed the CCRSI to provide a comprehensive set of benchmarks that investors and other market participants can use to better understand and predict CRE price movements."
CoStar has identified more than 85,000 repeat sale pairs in its U.S. database, which it believes is the largest and most comprehensive comparable sales database in the U.S. commercial real estate industry.
"An accurate measure of real estate price changes is a critical component to understanding investment or market performance. With commonly used average, median price and price per square foot indices, there are no controls for the ever-changing mix of properties sold during different time periods," added Florance. "Therefore, we do not believe average or median price indices per square foot are useful for rigorous analysis of market cycles. Appraisal-based indices are ineffective because they introduce lag and bias and minimum price cut indices are a circular reference in that they use price to define price."
"By covering all levels and all types of CRE transactions, and by using well-tested available methodologies, we believe that CoStar's indices will provide one of the most comprehensive benchmarks for tracking and analyzing CRE price movements to date."
Editor's Note: For more information about CCRSI Indices, please visit www.costar.com/ccrsi/.
The development and release of the CCRSI is important for two significant reasons, Florance said.
"First, this will come out a month earlier than any other index out there, so when the market is in flux like right now or is going to turn, this information provides a leading indicator of how the other larger property indices will be turning," Florance said.
"Second, this is the only set of indices really reflective of the broader market. In terms of sales volume, the existing indices ignore 70% to 80% of the property transactions. So this really is more indicative of what the typical real estate owner is experiencing, and a better index for this broader market."
In addition to the overall CCRSI, CoStar has constructed more than two dozen sub indices using the unique breadth of CoStar's property and comparable sales data.
SUB-INDICES SHOW BROAD SOFTENING When all commercial real estate transactions are considered, every major property type appeared to soften in terms of prices in the last three months. However, the top-10 largest office markets posted a positive 6.2% price change as did the top-10 industrial markets which rose 2%.
Retail prices suffered the most in the second quarter of 2010 with a drop of 12%, in part because the top 10 retail markets had a -17% loss in prices.
By region, Northeast and West suffered more of a pullback than the South and Midwest, although both are coming off much higher peaks than South and Midwest.
The only positive price trends out of 16 regional indices provided below were Midwest office at 5.7%, Northwest apartments at 3.5%, West industrial at 1.8% and South apartments at 1%.
SALES PAIRS TREND UPWARD The CCRSI July report is based on data through the end of June. In June, 665 sales pairs were recorded, up significantly from May, during which 506 transactions occurred. Overall, there has been an upward trend in pair volume going back to 2009. February 2009 appears to have been the low point in the downturn in terms of pair volume, when 374 transactions were recorded. Since then, pair volume has increased overall, and beginning in November 2009, year-over-year changes in pair volume have been positive every month.
In terms of the mix of pairs that have sold, June saw an increase in the proportion of repeat investment grade properties trading hands. Investment grade sales amounted to 31% of the total number of sales in June, the highest level it has been going back to January 2008. This indicates an increased mix of larger properties changing hands, which had been at decreased levels since the beginning of the recession.
Prior to June, 24% of sales pairs in 2010 were considered investment grade. This compares to an average of 33% of sales pairs being investment grade in 2006 and 2007, before the start of the downturn.
Distress is also a factor in the mix of properties being traded. Since 2007, the ratio of distressed sales to overall sales has gone from around 1% to above 23% currently. Hospitality properties are seeing the highest ratio, with 35% of all sales occurring being distressed. Multifamily properties are seeing the next highest level of distress at 28%, followed by office properties at 21%, retail properties at 18%, and industrial properties at 17%.
CoStar Group said it plans to provide CCRSI updates on the first Wednesday of each month to serve as timely indicators of the overall health of the commercial real estate industry.
