Examining Y-O-Y Deal-Volume Patterns

IRVINE, CA—Slow starts to 2016 and 2017 for different reasons are responsible for lagging year-over-year CRE deal volumes, but this pattern should begin to reverse itself in 2018, Ten-X's chief economist Peter Muoio tells GlobeSt.com. According to a recent real estate capital trends research report from the firm—which describes critical shifts across the five CRE asset classes (multifamily, hotel, industrial, office and retail) as it pertains to deal flow, cap rates, pricing trends and more—commercial real estate investment activity increased for the second straight quarter in Q4. However, the report also cautions that a variety of factors, including rising interest rates and the prospect of wholesale policy changes on the federal level, could mean that the growth period is ending.

Other notable findings from the report include:

• The apartment sector led the way in Q4, accounting for 34.7% of transactions, and apartment pricing has increased by a strong 16.2% over the past year. That said, in several major cities, the threat of oversupply has begun to lift vacancies and cool rents.
• With rising Treasury yields, cap rates increased in each sector except for apartments, whose cap rates ticked down by 10 basis points. Retail and hotel pricing are lagging, since they deal with lasting shifts in consumer behavior; retail, in particular, saw price declines in three of the past five months.

We spoke with Muoio about the growth period, whether it's really ending and on what investors and brokers will focus if deal volume continues to slow.

GlobeSt.com: What will the impending end to the growth period mean for the industry?

Muoio: The perspective is we had this run-up in transaction volume that was really robust; then, the recession hit and there was very little deal volume. Then we had a nice growth period; then, 2016 was the first year we had a drop-off from the previous year, but it was still a healthy year from a deal-volume and liquidity perspective. The thought process is, with what happened in 2016, what will happen in the future? We had the financial-market turmoil and shutdown of the CMBS market in early 2016, and we dug out of that hole; then, deal volume increased over the rest of the year and we ended the year with the strongest quarter. Because of early-year weakness, numbers were down year over year. In 2017, we had a similar thing happen, but for a different reason. Right after the election, we had a pop-up in interest rates. For a lot of people who are active in CRE, their deals got recalibrated with the new interest scenario. Deals are getting done, but the interest rates threw a monkey wrench into the market as everything recalibrated. There are policy changes in the works, too, and what this might mean from a tax perspective. We're starting '17 similar to '16, with a slow start to the year, but the market will adjust and build from there. Looking to 2018, expect a pick-up after two years of drop-off in transaction volume.

GlobeSt.com: Where will investors and brokers focus their time and energy if deal volume is low?

Muoio: Deal volume isn't low; it's still very strong—it's just off from where it was. It was down in 2016; it will be down in 2017, but up in 2018. There's plenty for everyone to do. Investors look for where can they invest, where can they put their money to work. What happens at this part of the cycle for investors is if they've been focusing on certain property segments and focusing on certain types of markets, it's time to re-strategize and look at other property segments and other markets with more return potential today than they had a few years ago. For investors, it's a matter of re-strategizing and recalibrating based on the best potential returns. For brokers, on the other hand, it's a volume play. It just becomes a more competitive situation for them in a situation where deal volume is off. It's better if the pie is growing; it's different if the pie is shrinking.

GlobeSt.com: Where are the new areas for growth?

Muoio: There are tidbits of interesting movement. One of the things we're looking at is the degree to which transaction volume and pricing have focused on major markets versus non-major markets. There was a stronger comeback in major markets earlier, while non-major markets were lagging, but now they're growing at about the same pace with valuations. This is reflective of the fact that major markets have been bid up; they're richer and more vulnerable to interest rates. I'm not surprised to see that non-major markets are getting more attention and valuations are increasing at a faster pace because investors are making those kinds of shifts. Also, there was a trend in office to CBD, but now we're seeing the reverse. The CBD/urban distinction is a little artificial because you can have urban-like campuses in a suburban setting, so we have to start looking at things differently. There are urban-suburban markets with good return potential and new areas for growth. Those are the kinds of shifts we're seeing. In addition, the apartment market has by far been the gangbuster segment in terms of deal volume and price run-up, but I wouldn't be surprised if you see a shift to industrial.

IRVINE, CA—Slow starts to 2016 and 2017 for different reasons are responsible for lagging year-over-year CRE deal volumes, but this pattern should begin to reverse itself in 2018, Ten-X's chief economist Peter Muoio tells GlobeSt.com. According to a recent real estate capital trends research report from the firm—which describes critical shifts across the five CRE asset classes (multifamily, hotel, industrial, office and retail) as it pertains to deal flow, cap rates, pricing trends and more—commercial real estate investment activity increased for the second straight quarter in Q4. However, the report also cautions that a variety of factors, including rising interest rates and the prospect of wholesale policy changes on the federal level, could mean that the growth period is ending.

Other notable findings from the report include:

• The apartment sector led the way in Q4, accounting for 34.7% of transactions, and apartment pricing has increased by a strong 16.2% over the past year. That said, in several major cities, the threat of oversupply has begun to lift vacancies and cool rents.
• With rising Treasury yields, cap rates increased in each sector except for apartments, whose cap rates ticked down by 10 basis points. Retail and hotel pricing are lagging, since they deal with lasting shifts in consumer behavior; retail, in particular, saw price declines in three of the past five months.

We spoke with Muoio about the growth period, whether it's really ending and on what investors and brokers will focus if deal volume continues to slow.

GlobeSt.com: What will the impending end to the growth period mean for the industry?

Muoio: The perspective is we had this run-up in transaction volume that was really robust; then, the recession hit and there was very little deal volume. Then we had a nice growth period; then, 2016 was the first year we had a drop-off from the previous year, but it was still a healthy year from a deal-volume and liquidity perspective. The thought process is, with what happened in 2016, what will happen in the future? We had the financial-market turmoil and shutdown of the CMBS market in early 2016, and we dug out of that hole; then, deal volume increased over the rest of the year and we ended the year with the strongest quarter. Because of early-year weakness, numbers were down year over year. In 2017, we had a similar thing happen, but for a different reason. Right after the election, we had a pop-up in interest rates. For a lot of people who are active in CRE, their deals got recalibrated with the new interest scenario. Deals are getting done, but the interest rates threw a monkey wrench into the market as everything recalibrated. There are policy changes in the works, too, and what this might mean from a tax perspective. We're starting '17 similar to '16, with a slow start to the year, but the market will adjust and build from there. Looking to 2018, expect a pick-up after two years of drop-off in transaction volume.

GlobeSt.com: Where will investors and brokers focus their time and energy if deal volume is low?

Muoio: Deal volume isn't low; it's still very strong—it's just off from where it was. It was down in 2016; it will be down in 2017, but up in 2018. There's plenty for everyone to do. Investors look for where can they invest, where can they put their money to work. What happens at this part of the cycle for investors is if they've been focusing on certain property segments and focusing on certain types of markets, it's time to re-strategize and look at other property segments and other markets with more return potential today than they had a few years ago. For investors, it's a matter of re-strategizing and recalibrating based on the best potential returns. For brokers, on the other hand, it's a volume play. It just becomes a more competitive situation for them in a situation where deal volume is off. It's better if the pie is growing; it's different if the pie is shrinking.

GlobeSt.com: Where are the new areas for growth?

Muoio: There are tidbits of interesting movement. One of the things we're looking at is the degree to which transaction volume and pricing have focused on major markets versus non-major markets. There was a stronger comeback in major markets earlier, while non-major markets were lagging, but now they're growing at about the same pace with valuations. This is reflective of the fact that major markets have been bid up; they're richer and more vulnerable to interest rates. I'm not surprised to see that non-major markets are getting more attention and valuations are increasing at a faster pace because investors are making those kinds of shifts. Also, there was a trend in office to CBD, but now we're seeing the reverse. The CBD/urban distinction is a little artificial because you can have urban-like campuses in a suburban setting, so we have to start looking at things differently. There are urban-suburban markets with good return potential and new areas for growth. Those are the kinds of shifts we're seeing. In addition, the apartment market has by far been the gangbuster segment in terms of deal volume and price run-up, but I wouldn't be surprised if you see a shift to industrial.