Commercial Development News - Appraisal Development International

CRE Pricing Volatility Continues; Assets Attracting Higher Prices Remain Exception Rather Than the Rule
By Randyl Drummer
CoStar Group
Published: Jan 12, 2011

The three national commercial real estate repeat sales indices released in this week's CoStar Commercial Repeat-Sales Indices (CCRSI) were down for the month of November -- the second consecutive month of decline for the trio of "headline" indices measuring the investment sales market -- despite a significant boost in prices for high-profile core deals in Washington D.C. and New York City.

While the disparity between "troubled and trophy" assets continued to contribute to overall volatility in commercial property pricing in fourth-quarter 2010, the pricing volatility typically accompanies market transitions and does not necessarily constitute a setback in the pace or strength of the CRE recovery, CoStar Group analysts said.

The index measuring investment-grade sales of commercial properties was down 4.1% for the month, giving back some of the 8.1% net gains observed over August, September and October. Despite the November decline, the Investment Grade Index, comprised of the largest transactions in terms of dollar volume, is still up 7.6% since its cyclical low earlier this year, according to CoStar Group's newly released Commercial Repeat-Sale Indices (CCRSI).

Though the general real estate index fell 1.8% for the month, price declines for non-investment grade commercial property decelerated in November. The November decline puts the General Real Estate Index, which represented smaller transactions that comprise the largest number of real estate deals, at its lowest point since 2004. The index is 3.9% below its level three months earlier and 11.7% below November of 2009, in large part because smaller and mid-sized regional banks, which normally make up the bulk of lending for smaller, more local real estate, continue to struggle with distressed inventory and have yet to significantly resume lending.

Quarterly market-level indices suggest large gains over the past several quarters in Washington D.C. and moderate gains in the most recent New York data. But these markets have been the exception rather than the rule. Strong and increasing interest in trophy properties within core markets, where prices continued to climb during 2010, stand in contrast to the overall negative trends nationally.

"Collectively [the national trends] show a market that is not just bifurcated but possibly trifurcated, with trophy assets commanding bidding wars, smaller assets languishing, particularly in secondary and tertiary markets; and distressed properties trickling onto the market as banks recycle assets at a relatively measured pace," said Dr. Norm Miller, vice president, analytics for CoStar Group.

Miller wouldn't describe the November report as a setback for the commercial real estate recovery.

"It looks like the longer term trend for investment grade real estate is now heading in a positive direction, and this is merely expected volatility which happens when you get a mix of properties with such a range of prices, from trophy to troubled, in one basket," Miller said. "For smaller properties, I do see it as a decline, and we cannot make the same claim about being at the bottom."

CoStar Senior Real Estate Strategist Chris Macke noted that pricing volatility the last 12 months in the investment grade index is an improvement over its previously steady downward decline. Secondly, similar drops in investment grade pricing have been followed by increases in what Miller characterizes as a "see-sawing" market, Macke said.

"Third, at this point in the cycle, national trends mask material underlying variations by property size, quality, location, property type, etc., which are critical differences for investors," Macke said. "Fortunately, CoStar has that information for our clients."

The monthly CoStar Commercial Repeat-Sale Indices (CCRSI) include the national composite index along with 32 sub-indices, including breakdowns by property sector, region, transaction size and quality, and by market size, including a composite index of the 10 largest metro areas in the country.

The repeat sales methodology measures price movement of commercial properties by collecting data on the actual sales prices in commercial property transactions. When a property is sold more than one time, a sale pair is created. CoStar then uses the prices from the first and second sale to calculate price movement for the property, and creates a price index by aggregating all the price changes from all of the sale pairs.

The CCRSI January 2011 release is based on pricing data through the end of November 2010, when 605 pair sales were recorded compared to 596 in the prior month and 685 in September. Several of the later recorded transactions were distressed sales, forcing the indices down from the prior two months.

Investment-grade pair counts have been increasing modestly while the general pair count has been steady. Investment-grade transaction volume for November continued to be steady compared to October, and general real estate pair volume is up significantly.

There has been a significant upward trend in sale pair volume since January 2009, which appears to have been the low point of the downturn in sale pair volume, when 376 transactions were recorded. Sale pair dollar volume has since increased overall, as have the average deal sizes for both general and investment-grade sales.

By transaction count, general CRE sales accounted for 70% of the sale counts in November, but only 28% of the total sales by dollar volume. CoStar observed a spike in investment-grade sales volume in September, with nearly double the volume observed in October. The average deal size within the investment grade index was more than $23 million in September, compared to $11.4 million in November and $11.8 million in October.

The general real estate index saw higher average prices in November of about $1.9 million, compared to $1.3 million in October. Distress continues to be a significant factor in the index results with about one fifth of all transactions being distress sales and one fourth of the investment-grade transactions.

Miller pointed out that the current market is dominated by smaller, slower-reacting banks and investors that don't anticipate market conditions as far ahead as the institutional world.

"REIT prices, for example, can lead the changes in fundamentals like positive absorption and increasing rents by several quarters, so this is more indicative of the larger institutional investment world. Our general real estate index will likely lag the investment grade index by a few quarters, especially this cycle, based mostly on the size of banks involved," Miller said. "These smaller banks are not 'too big to fail' and they still have a ways to go to get balance sheets cleaned up."