The Outlook's Bullish for Value Appreciation

NEW YORK CITY—Commercial property values are likely to continue trending upward as the five major food groups continue shifting from recovery to expansion mode. That's the key takeaway from Integra Realty Resources' "Mid-Year Viewpoint 2014," a series of reports on both the national perspective and 66 local markets.

Thus far in 2014, industrial has experienced the strongest improved prospects of any property sector, according to IRR. Nationally, 97% of industrial markets are now reported to be in the recovery or expansion phase of the real estate market cycle, while 51% are observed to be in an expansionary cycle. That's up sharply from 22% in this phase just six months earlier.

Enjoying a run similar to that of industrial, nearly 94% of all urban multifamily properties are in the expansion phase of the market cycle, and IRR predicts that this situation should continue nationally for at least the balance of 2014. That being said, the national report notes that the lowest cap rates achieved thus far this year have been in suburban multifamily, where they've gone as low as 3.7%. However, their urban counterparts still achieved the highest average at 5.6%, due to a smaller fluctuation between high and low caps.

Regionally, multifamily cap rate contraction was material in the Central States and the South regions, while notably flat in the East and West. IRR says some secondary markets such as Cleveland, Minneapolis, and Phoenix, reported material decreases in cap rates of 50 basis points or more over the past six months. However, on balance cap rates have changed little across the major property sectors since January, except to continue declining.

Among the major sectors, office recovery has been the most gradual, according to IRR. Less than one quarter of suburban office properties, for example, are considered to be in the expansion phase of the market cycle.

Average cap rate contraction was most muted in the office sector regardless of region, suggesting that stagnant job growth is having an impact on investment demand within the sector. On the other hand, year-to-date value appreciation in many markets, combined with gains from the previous two years, has largely erased losses from the 2008-2010 recession. Only in five smaller markets nationally—Greensboro, NC; Hartford, CT; Jackson, MS; Sacramento; and Wilmington, DE—have CBD office assets failed to appreciate or at least maintain their value over the past three years.

“IRR forecasts that on average, all major real estate sectors should increase in value over the coming 12-month period,” the report states. “Expectations for value appreciation are especially acute with respect to suburban multifamily product, while they are more muted for both CBD and suburban office product.”

In terms of value appreciation expectations, flex industrial and neighborhood retail product have seen the sharpest fluctuations, “perhaps indicating that investors are broadening their reach with respect to the subtypes of assets—in search of stronger potential yields. Because the real estate sector continues to attract new investment capital while its property fundamentals remain strong in the face of macroeconomic headwinds, IRR is overall very bullish in terms of near-term valuation appreciation trends.”