Cap Rates Follow Vacancies Upward

RCA explains that the correlation of market cap rates to vacancy is well established. "When leasing trends are positive, buyers will accept lower initial yields, banking that rents will increase as vacancies decline," it states. But now that vacancies are rising and rents are more likely to fall, the yields that investors expect on property acquisitions are rising.

Although this principle holds true across virtually every market, the amount by which cap rates have risen does vary from market to market, a situation that reveals "some interesting investment opportunities," according to the Real Capital Analytics report. It points out, for example, that rates have risen more in London--where cap rates were among the lowest anywhere in the world in 2007.

In general, cap rates are remaining slightly lower in European cities and occupancy is remaining stronger in those European cities than in some US cities. Nonetheless, Manhattan still holds its position as the US market with the lowest cap rates in this country, although the report points out that Manhattan now "appears expensive relative to its vacancy issues." Investors who are willing to buy in other US markets where the vacancy is comparable to that in Manhattan may find that they can find higher initial yields in those other markets.

On the worldwide scene, Tokyo appears to be the strongest majormarket, but the low cap rates there may reflect the big investment sales of early 2008, which drove down the average cap rate. While Tokyo's rates vary more sharply from those in the US, cap rates in Singaporeand Hong Kong have converged more closely to US and European levels.

RCA cites at least two markets worldwide where it sees "defensive" investment opportunities: Paris and Washington, DC. "Both of these markets offer relatively high yields compared to their vacancylevels," the report states. Investors in Washington believe that the market holds potential because of the growth of government and the attendant demand for office space created by that growth, while in Paris the defensive play is based on "a diverse business base that is not nearly as reliant on the financial sector as other global gateways," the report says.Other cities similarl to Paris and DC that may also attract investor interest due to relatively higher returns and lower vacancy include Edinburgh, Hamburg, Sydney, Vienna and Oslo.

The RCA report points out that many investors now have their eyes on distressed assets, and it makes the distinction between distress at the entity level and distress affecting individual properties. "Approximately 44% of the documented distress globally is caused by an entity-level failurewhere the properties may still be performing well, but are now valued far lower than before," the report states. It notes that approximately 40 majorcommercial property investment and development firms around the world have failed, leaving outstanding debts currently totaling $67 billion.

That $67 billion figure does not include "far more situations" where companies have revealed doubts about their survival but have yet to file for bankruptcy. When those failures emerge, the cap rates and yields will reflect yet another impact from the global economic downturn.