Commercial real estate yields have been falling, especially in top-tier markets, as investors purchase properties in anticipation of economic recovery. Institutional investors are bidding up prices of quality properties, driving up values and pushing down cap rates. Institutions, including pension funds, life insurance companies and foreign investors, desire quality properties with predictable income streams in major markets.
Many secondary and even tertiary markets have also seen prices rise, but not to the same extent as top cities. Those locations, along with value-add plays, remain largely the realm of private investors with local market expertise.
“It’s a cyclical business,” says Mitch Roschelle, real estate business advisory leader with PricewaterhouseCoopers in New York City. “At this point of the cycle, values are going up and cap rates are going down.”
Cap rates across all properties in major markets declined significantly in the past few years. The average cap went from 7% in the fourth quarter of 2009 to 6.5% in Q4 2010, and then slid again to 6.3% in Q4 2011, according to Real Capital Analytics. In secondary markets, cap rates fell from 8% in Q4 2009 to 7.3% two years later. Meanwhile, caps in tertiary markets went from 8.3% in 2009 to 7.8% in 2011. The trend to higher prices and lower cap rates is especially pronounced in a handful of gateway cities, including New York City, San Francisco, Chicago, Los Angeles and Washington, DC. In some cases, prices for trophy properties in those central business districts are approaching peak levels seen before the recession.
Yet the pace of the declines may be slowing. In the Q1 2012 PwC Real Estate Investor Survey, the firm found that average cap rates decreased in 18 markets. Meanwhile, cap rates increased in seven markets and held steady in six. Over the past year, the number of cities posting quarterly declines has fallen while the number reporting either increasing rates or no change has increased…
…To read the rest of the story, go to the April 2012 issue of Real Estate Forum.
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