Defining the New Normal in CRE Investment Sales

In the five years leading to the pinnacle of CRE sales in 2007, the dollar volume of sales in the four major property types nearly quadrupled to more than $500 billion. It is widely accepted that this high water mark was an unsustainable anomaly that should not be viewed as the bench mark to measure the market against. On the flip side, several structural changes have occurred in that last 10 years to 15 years that should lead to a higher baseline for CRE capital flows than the 2002 volume of $120 billion. In fact, in 2010, sales volume jumped 80% to $190 billion, already well above 2002 levels. However, investment sales activity is still far from normal due to the concentration of capital flows in to larger, higher-end assets last year. Sales volume in the $20 million price range last year jumped a staggering 151%, nearly twice the pace of the overall gains. Larger transactions had a bigger hole to climb out of, since in 2009 virtually all major sales came to a halt and only smaller transactions could get financed. Still, for the vast majority of investors that own Class B to B- assets in the $5 million to $15 million range that shape the bell curve of transactions, a “normal” environment has not been achieved. This suggests that a normalized sales volume would be somewhere between the 2010 level and 2007 unsustainable peak.

What will lead to higher sales volume in the market place?  
Structural factors that point to a higher water mark of sales activity than levels achieved in 2002 include:

1) The aging of baby boomers, which creates the need for more cash-flowing investments, especially given the shortfall of pension plans.

2) A reduction, but definitely not elimination, of habitual over-building of CRE as a major risk.

3) Increased allocations of institutional investors globally toward CRE, especially given the rise in equity markets lowering the percentage share of properties in institutional assets under management.

4) A savings glut and ongoing financial and political turmoil outside the United States leading to more demand for stable U.S. investments.

5) The lost decade for the stock market driving more private, individual investors to invest in alternative assets which is favoring direct ownership of CRE, participation in private CRE partnerships and private REITs. 

Cyclical drivers that support further increases from 2010 levels are low interest rates, lower alternative investment yields, conviction that occupancies are at or near bottom and that lender fire sales on quality assets (RTC II) is simply not in the cards. Over the next 12 months to 18 months, we expect to see more buyer demand for Class B and B- assets, gradually improving financing expanding outside of top-tier/best metro classification and value gains across a broader spectrum of properties than last year’s Class A-dominated flows.

As private investor activity in the $5 million to $20 million range increases, and institutional capital flows remain similar to 2010 levels if not higher, expect a 30% to 40% rise in sales volume this year, bringing total sales volume to $256 billion. While this is below levels observed in 2004 – a period that showed a healthy increase compared to 2002 – but far below those seen during the flipping froth of 2006 to 2007, the volume seems to fit the “new normal” for commercial property sales.

Hessam Nadji is managing director, research and advisory services, for Marcus & Millichap Real Estate Investment Services. Contact him at hessam.nadji@marcusmillichap.com or (925) 953-1700.