The national vacancy rate for multifamily properties across Reis’s largest metro markets did not budge from it 4.4% in Q3 2016.
Close to 40,000 new units came online in Q3 2016.
Demand remained robust enough to absorb the amount of units that are coming online.
Asking and effective rents grew by 1%.
Year-over-year asking rents grew by 3.9% and effective rents grew by 3.8%.
Most expensive coastal markets’ highest priced properties are showing weakness.
Q3 2016 Office Trends
The national office vacancies remained moored flat at 16% in Q2.
Year-over-year office vacancies have declined 40 basis points.
Rents began to accelerate but fell back to its average quarterly level at .4% respectively for both asking and effective rents.
Year-over-year rents are seem to be healthy, pulling at 2.7% and 2.8%.
U.S. economy creating fewer jobs than in 2015 and 2014.
Upcoming November elections a determining factor for firms holding off long-term commitments.
Q3 2016 Retail Trends
Regional malls showed some improvement with vacancies declining 10 basis points to 7.8%.
Relatively strong asking rent growth at 0.5%; between 0.3% and 0.5% on a quarterly average asking rent growth.
Neighborhood and community shopping centers vacancies rising by 10 basis points ending Q3 at 10%.
Asking and effective rents both grew by 0.4%
Businesses are pulling back on capital spending and long-term investments, waiting on results of upcoming elections.
Q3 2016 Industrial Trends
Warehouse and industrial subsector vacancies remained stuck at 10.5% in Q3.
Year-over-year vacancies for warehouse and distribution declined by 20 basis points.
Asking and effective rents grew by 0.4% and 0.5% respectively, growing 2.1%-2.3% on a year over year basis.
Flex/RD showed more activity in Q3, falling 20 basis points to 11.4%.
Year-over-year Flex/RD has declined by 70 basis points.
Asking and effective rents grew by 0.4%, year-over-year growth in the low 2% range.
75,000,000 SF of new construction for warehouse and distribution for all of 2016.
Coldwell Banker Commercial Real Estate
A subsidiary of Realogy Corporation, Coldwell Banker Commercial (CBC) is a worldwide leader in the commercial real estate industry. The CBC brand has its roots in the oldest and most respected national real estate brand in the country. Coldwell Banker Commercial has the largest commercial real estate footprint with over 3,500 professionals nationally, over 16,000 listings, nearly double that of the nearest competitor, averaging 13,000 transactions annually valued at over $4 Billion. Providing comprehensive Commercial Real Estate Services to the Greater Chicago Area and Nationally through our vast network of professionals and Global Client Services team.
Apartment Cap Rates Drop to Historically Low 5.6% Time to Sell
In a show of strength, cap rates reached new historically low levels during the first quarter. We observe that the mean cap rate, illustrated by the dark blue line in the chart, declined by 40 basis points to 5.6% during the first quarter. As mentioned, this is a record low.
Moreover, it is first time that we have observed a mean cap rate less than 6%. It is important to emphasize that this is the mean cap rate for properties that actually traded during the quarter, not the cap rate for all properties. Nonetheless, a 40-basis-point decline is a surprise. And while I will always caution reading too much into one quarter’s worth of data, this development is noteworthy.
Not only are we at a relatively late juncture for apartments (measured by both the fundamentals space market and capital market cycles), but we haven’t seen a movement nearly this strong since the market was climbing out of the recession; and of course such a strong downward movement should be expected during such an environment. The strong downward movement is far rarer at this relatively late stage of the game.
This downward trend continues to pull down the 12-month-rolling cap rate, depicted as the red line in the graph. That metric now stands at a scant 6%, also a record low for apartment cap rates since Reis has been tracking the market. Like with most data points, a little context is important. If you look at the dashed, light-blue line in the graph above, you can see the average 12-month rolling cap rate since 2005 is 6.6%. That means that the current 12-month rolling cap rate is now 60 basis points below the average. While that is significant, it is not egregious. And as we have discussed in past capital markets briefings, this is a consequence of continued low interest rates, not of irrational exuberance. And while it is difficult to envision apartments cap rates continuing to compress at a rate anything like what transpired during the first quarter, we should also not expect cap rates to expand much in the near -term based on the outlook for apartment fundamentals. Therefore, cap rates are likely to remain in the high-5% to low-6% range over the next year or so.
Source: REIS Ryan Severino on Jun 1, 2016
Contact Coldwell Banker Commercial to List your Multifamily Property For Sale in this unprecedented Low Cap Rate Market!
Coldwell Banker Commercial® (CBC®) multi-family professionals are well-versed in the unique elements and trends that shape successful multi-family transactions. With access to local, national, and international market data and industry trends, CBC professionals can provide the knowledge to help you make informed decisions and design the ideal real estate solutions that meet your needs. In addition, professionals can leverage their relationships with fellow CBC professionals in over 250 companies around the world to access a larger pool of potential investors and.
CBC professionals will help you maximize the value of your assets prior to sale through property rehabilitation and marketing. If you are purchasing a property, they will assist you in making an informed and profitable purchase. For owners of multiple properties, CBC professionals can help evaluate each property based on current market conditions and future trends for each specific location. By completing transactions in nearly every US state last year, CBC multi-family professionals are well versed in the anomalies of every market and are ready to assist with your transaction.
CBC professionals will assist you in any of these services:
Appraisal and other Valuation Services
Architectural Planning and Design
Property and Facilities Management
Strategic Real Estate Planning
Market Surveys and Analysis
Due Diligence and Feasibility Studies
All multi-family accounts are handled through a single point of contact and use web-based project management technology that allows access to your projects anytime, 24 hours a day, seven days a week.
During the fourth quarter the mean office cap rate increased very slightly, but when rounding to tenths of a percent remained unchanged at 6.9%. This is actually up 10 basis points from the level during the fourth quarter of 2014. Meanwhile, the 12-month rolling cap rate was also essentially unchanged versus last quarter at 6.8%. These signals are largely the same ones that we received last quarter. Over the last year cap rate compression for office has slowed. We all know that the in-quarter mean cap rate can be a bit volatile, but the 12-month rolling cap rate is clearly showing some signs of stalling. While this merely looks like a pause, it is important to note that office fundamentals continue to offer attractive upside. In many markets across the country the outlook is brighter over the next five years than was has transpired over the previous five years. But is this true for all markets? Is it impacting transactions and pricing at a more micro level? For now it is important to note that in the historical context, cap rates remain near historically-low levels.
When we compare the current 12-month rolling cap rate to the mean 12-month rolling cap rate, we find that it is under by about 40 basis points. This is roughly in line with the difference from last quarter and 10 basis points narrower than what we observed in the apartment market. We mentioned last quarter that the shifting pool of properties traded from quarter to quarter could cause cap rates to rise in short term. While that is what we observed (albeit slightly), the market nonetheless remains incredibly pricey.
The mean retail cap rate decline by 30 basis points during the quarter to 7.2%. Despite this, the 12-month rolling cap rate was unchanged at 7.4%. This is the first time in about a year that the mean cap rate has fallen below the 12-month rolling cap rate, indicating some recent pricing momentum in the market and intimating that the 12-month rolling cap rate could be heading lower in the coming quarters.
Moreover, the 12-month rolling cap rate remained roughly 70 basis points below the historical average of that metric. This is a bit wider than what we observed for apartment and office although it is roughly in line with the difference from the last two quarters. Over time, retail properties continue to get more expensive, with all of the aforementioned cap rate measures at or near post-recession lows.
Ongoing improvements in the labor market and consumer spending are slowly translating into more demand for retail goods and space while supply growth remains muted. That doesn’t mean that this property sector isn’t without its challenges, but that despite the obvious headwinds investors are finding some value in retail centers. And this is an interesting point – vis-à-vis the other major property types, it is not a stretch to say that retail (in our case here neighborhood and community centers) faces the most serious structural challenges such as the inexorable rise of e-commerce and the proliferation of new retail subtypes complicates the landscape. Yet, investors are finding enough value that cap rates are at these levels today.
Reis Cap Rate Proforma
Cap rates are a measure of a property’s investment potential, independent of the specific buyer.
Investors, lenders, and appraisers use the current cap rate from Reis to estimate the appropriate purchase price for different types of income producing properties.
Cap Rate = Net Operating Income / Purchase Price
To give our clients a complete picture of the income value of a specific property Reis evaluates three cap rates in our proformas, which are included in our sales comps, and can be seen in the cap rates proforma example above.
Estimated Going-In Cap Rate
An overall capitalization rate obtained by dividing the projected net operating income for the first full calendar year of ownership by the purchase price
12-Month Rolling Cap Rate
The 12-Month Rolling Metro Cap Rate is calculated from the average of the metro’s mean cap rate from the previous four quarters and provides a benchmark rate of comparison
Reported Cap Rate
The Reported Cap Rate (per sale) is reported directly by the buyer, seller or other party to the transaction, and is calculated by dividing reported net operating income by the purchase price
The capitalization rate is a fundamental concept in the commercial real estate industry. Yet, it is often misunderstood and sometimes incorrectly used. This post will take a deep dive into the concept of the cap rate, and also clear up some common misconceptions.
Cap Rate Definition
What is a cap rate? The capitalization rate, often just called the cap rate, is the ratio of Net Operating Income (NOI) to property asset value. So, for example, if a property was listed for $1,000,000 and generated an NOI of $100,000, then the cap rate would be $100,000/$1,000,000, or 10%.
Cap Rate Example
Let’s take an example of how a cap rate is commonly used. Suppose we are researching the recent sale of a Class A office building with a stabilized Net Operating Income (NOI) of $1,000,000, and a sale price of $17,000,000. In the commercial real estate industry, it is common to say that this property sold at a 5.8% cap rate.
Intuition Behind the Cap Rate
What is the cap rate actually telling you? One way to think about the cap rate intuitively is that it represents the percentage return an investor would receive on an all cash purchase. In the above example, assuming the real estate proforma is accurate, an all cash investment of $17,000,000 would produce an annual return on investment of 5.8%. Another way to think about the cap rate is that it’s just the inverse of the price/earnings multiple. Consider the following chart:
As shown above, cap rates and price/earnings multiples are inversely related. In other words, as the cap rate goes up, the valuation multiple goes down.
When, and When Not, to Use a Cap Rate
The cap rate is a very common and useful ratio in the commercial real estate industry and it can be helpful in several scenarios. For example, it can and often is used to quickly size up an acquisition relative to other potential investment properties. A 5% cap rate acquisition versus a 10% cap rate acquisition for a similar property in a similar location should immediately tell you that one property has a higher risk premium than the other.
Another way cap rates can be helpful is when they form a trend. If you’re looking at cap rate trends over the past few years in a particular sub-market then the trend can give you an indication of where that market is headed. For instance, if cap rates are compressing that means values are being bid up and a market is heating up. Where are values likely to go next year? Looking at historical cap rate data can quickly give you insight into the direction of valuations.
While cap rates are useful for quick back of the envelope calculations, it is important to note when cap rates should not be used. When properly applied to a stabilized Net Operating Income (NOI) projection, the simple cap rate can produce a valuation approximately equal to what could be generated using a more complex discounted cash flow (DCF) analysis. However, if the property’s net operating income stream is complex and irregular, with substantial variations in cash flow, only a full discounted cash flow analysis will yield a credible and reliable valuation.
Components of the Cap Rate
What are the components of the cap rate and how can they be determined? One way to think about the cap rate is that it’s a function of the risk free rate of return plus some risk premium. In finance, the risk free rate is the theoretical rate of return of an investment with no risk of financial loss. Of course in practice all investments carry even a small amount of risk. However, because U.S. bonds are considered to be very safe, the interest rate on a U.S. treasury bond is normally used as the risk-free rate. How can we use this concept to determine cap rates?
Suppose you have $10,000,000 to invest and 10-year treasury bonds are yielding 3% annually. This means you could invest all $10,000,000 into treasuries, considered a very safe investment, and spend your days at the beach collecting checks. What if you were presented with an opportunity to sell your treasuries and instead invest in a Class A office building with multiple tenants? A quick way to evaluate this potential investment property relative to your safe treasury investment is to compare the cap rate to the yield on the treasury bonds.
Suppose the acquisition cap rate on the investment property was 5%. This means that the risk premium over the risk free rate is 2%. This 2% risk premium reflects all of the additional risk you assume over and above the risk free treasuries, which takes into account factors such as:
Age of the property.
Credit worthiness of the tenants.
Diversity of the tenants.
Length of tenant leases in place.
Broader supply and demand fundamentals in the market for this particular asset class.
Underlying economic fundamentals of the region including population growth, employment growth, and inventory of comparable space on the market.
When you take all of these items and break them out, it’s easy to see their relationship to the risk free rate and the overall cap rate. It’s important to note that the actual percentages of each risk factor of a cap rate and ultimately the cap rate itself are subjective and depend on your own business judgement and experience.
Is cashing in your treasuries and investing in an office building at a 5% acquisition cap rate a good decision? This of course depends on how risk averse you are. An extra 2% yield on your investment may or may not be worth the additional risk inherent in the property. Perhaps you are able to secure favorable financing terms and using this leverage you could increase your return from 5% to 8%. If you a more aggressive investor this might be appealing to you. On the other hand, you might want the safety and security that treasuries provide, and a 3% yield is adequate compensation in exchange for this downside protection.
Band of Investment Method
The above risk free rate approach is not the only way to think about cap rates. Another popular alternative approach to calculating the cap rate is to use the band of investment method. This approach takes into account the return to both the lender and the equity investors in a deal. The band of investment formula is simply a weighted average of the return on debt and the required return on equity. For example, suppose we can secure a loan at an 80% Loan to Value (LTV), amortized over 20 years at 6%. This results in a mortgage constant of 0.0859. Further suppose that the required return on equity is 15%. This would result in a weighted average cap rate calculation of 9.87% (80%*8.59% + 20%*15%).
The Gordon Model
One other approach to calculating the cap rate worth mentioning is the Gordon Model. If you expect NOI to grow each year at some constant rate, then the Gordon Model can turn this constantly growing stream of cash flows into a simple cap rate approximation. The Gordon Model is a concept traditionally used in finance to value a stock with dividend growth:
This formula solves for Value, given cash flow (CF), the discount rate (k), and a constant growth rate (g). From the definition of the cap rate we know that Value = NOI/Cap. This means that the cap rate can be broken down into two components, k-g. That is, the cap rate is simply the discount rate minus the growth rate.
How can we use this? Suppose we are looking at a building with an NOI of $100,000 and in our analysis we expect that the NOI will increase by 1% annually. How can we determine the appropriate cap rate to use? Using the Gordon Model, we can simply take our discount rate and subtract out the annual growth rate. If our discount rate (usually the investor’s required rate of return) is 10%, then the appropriate cap rate to use in this example would be 9%, resulting in a valuation of $1,111,111.
The Gordon Model is a useful concept to know when evaluating properties with growing cash flows. However, it’s not a one-size fits all solution and has several built in limitations. For example, what if the growth rate equals the discount rate? This would yield an infinite value, which of course in nonsensical. Alternatively, when the growth rate exceeds the discount rate, then the Gordon Model yields a negative valuation which is also a nonsensical result.
These built-in limitations don’t render the Gordon Model useless, but you do need to be aware of them. Always make sure you understand the assumptions you are making in an analysis and whether they are reasonable or not.
The Many Layers of Valuation
Commercial real estate valuation is a multi-layered process and usually begins with simpler tools than the discounted cash flow analysis. The cap rate is one of these simpler tools that should be in your toolkit. The cap rate can communicate a lot about a property quickly, but can also leave out many important factors in a valuation, most notably the impact of irregular cash flows.
The solution is to create a multi-period cash flow projection that takes into account these changes in cash flow, and ultimately run a discounted cash flow analysis to arrive at a more accurate valuation.
Source: PropertyMetrics June 3, 2013 By Robert Schmidt
Given our understanding of apartment market fundamentals, it should come as no surprise that this property type also continues to be the strongest performer on the capital markets side. In the graph below, we observe that the mean cap rate, calculated on a dollar-weighted basis by quarter and illustrated by the dark blue line in the chart, declined by 20 basis points to 6.0% during the third quarter.
If we look at the 12-month rolling cap rate, shown as the red line in the graph, it declined by 10 basis points to 6.1%. Once again, these metrics have hit post-recession lows and the small 10-basis-point spread between the two continues to tell us that apartment cap rates are not just low today but have been consistently low.
Although it seems like apartment cap rates cannot continue to fall, they continue to defy some expectations. Over the last year, the mean cap rate and the 12-month rolling cap rate are both down 40 basis points. While fundamentals have remained strong in this sector as we previously discussed, such low cap rates continue to prompt speculation that the market is either in a bubble or nearing a bubble. So let’s examine this empirically.
Take a look at the calculated mean 12-month rolling cap rate over the last ten years or so, which is shown on the graph above as the dashed light-blue line. The current 12-month rolling cap rate is roughly 50 basis points below the mean 12-month rolling cap rate. That is another 10 basis points wider than it was last quarter. 50 basis points, while not enormous, is substantial and is beginning to push into territory that we rarely see.
With interest rates remaining at such low levels, it is easy to see how this is fueling speculation about a bubble. But remember, low cap rates only portend a bubble if fundamentals don’t justify valuations. And in the case of the apartment market, fundamentals remain strong through the third quarter of this year which is driving ongoing demand for apartment properties.
Over the last 12 months, effective revenue in the apartment sector has grown by roughly 4.3%. That’s roughly 60 basis points ahead of the year-over-year growth rate from last quarter demonstrating strengthening in the market. Until we see that growth rate slow, which we forecast will occur over the next four to five years, expect demand for apartments to remain robust and cap rates to remain low, even in the face of rising interest rates.
Interest Rates and Cap Rates Aren’t Always Correlated
Cash Flow, CRE Fundamentals Pose Strong Counter Punch to Potential Rate Increase Impact on CRE Values According to Accounting Firm
As the Federal Reserve readies an expected decision this week on whether to begin raising interest rates, common assumptions among some commercial real estate investors, developers and lenders are that CRE values will take a hit when interest rates are raised.
The basis for this assumption appears intuitive at first. Rising benchmark interest rates, like Treasuries, should tend to make all yield-oriented investments to be less attractive,
However, according to a new report issued this week by accounting firm EY, the relationship between interest rates and CRE values is much more nuanced. While the Fed’s initial policy adjustments likely will have a marginal impact on CRE valuations and investment momentum, interest rates and cap rates aren’t always correlated, the EY report authors claim.
Several factors affect the trajectory of capitalization rates and real estate values, such as demand and supply changes, transaction activity and trends in the overall economy. An in the current market, CRE fundamentals are strong.
At the worst, EY predicts, an uptick in the federal funds rate may make it more expensive to develop new projects and refinance certain debt, and possibly cause a reactionary sell-off in publicly traded real estate investment trusts (REITs).
However, as it currently stands, relative to historical averages over the last 30 years, the spread between the 10-year Treasury and CRE yields appears to allow for further compression. This suggests that CRE values are not immediately threatened by rising interest rates, EY said.
The EY report was authored by members of EY’s real estate M&A advisory team led by Steve Rado, a principal in Ernst & Young LLP’s Transaction Advisory Services practice, with contributing author Dr. W. Michael Cox, the former chief economist of the Dallas Federal Reserve Bank and a professor at Southern Methodist University’s Cox School of Business.
EY noted several drivers that are expected to buttress real estate values, including record amounts of inbound capital, available private equity ‘dry powder’ for investment, a generally positive economic outlook with some obvious caveats, and relatively strong CRE fundamentals.
A 25 to 50 BPS Jump Doesn’t a Spike Make
A shock to the U.S. CRE investment environment from a 25 to 50 bps increase in the overnight lending rate seems unlikely in light of the forecasted environment for the sector, according to EY. With vacancies trending down in office, retail and industrial properties and hospitality and multifamily exhibiting increased rents, the report’s authors expect the effect of contractionary monetary policy and rising interest rates on real estate values and cap rates to be mitigated in the near term, especially for investors focused on cash flows from higher lease rates and strengthened property operations.
While many observers purport a negative outlook for CRE based on the premise of a spike in long-term interest rates, the possibility that long-term interest rates will see only moderate increase over the near term is more likely given the slower pace of the U.S. economic recovery, the EY analysts said.
They also expect CRE will continue to be an attractive investment on a risk-adjusted basis in the near-term, given current conditions of increased capital supply and strong fundamentals, along with room for compression in the spread between cap rates and interest rates, according to the report.
However, EY cautioned investors on underwriting risk as trophy assets in gateway markets appear to be fully priced with new supply is coming on the market at a faster pace.
Finally, the EY report authors urged investors to see the glass as half-full rather than half-empty.
“Actions of the Fed to normalize interest rates should not be seen as a bane for the industry, but rather should instill confidence that their efforts are a proactive measure to provide stability in the future,” the EY report concluded.
Any seasoned real estate professional should be familiar with the term Capitalization Rate or Cap Rate for short. The cap rate is a measure of a property’s investment potential, independent of the specific buyer. Regardless of who is evaluating the property, the cap rate will remain the same, and therefore two investors can do an apples-to-apples comparison of the same property using this measure. Investors, lenders, and appraisers use current cap rates to estimate the appropriate purchase price for different types of income producing properties.
What is a market Capitalization Rate?
Market cap rates are determined by evaluating the financial data of similar properties which have recently sold in a specific market. In short, the cap rate is equivalent to the return on investment you would receive if you were to pay all cash for a property, and therefore, it is our way of making the complexities of property investment more transparent. By definition, the capitalization rate is a ratio used to estimate the value of income producing properties.
Cap Rate = Net Operating Income / Property Price
For example: Purchase Price: $500,000 Income Per Month: $15,000 Expenses Per Year: $100,000 NOI = Annual Income – Annual Expenses or (12 x $15,000) – ($100,000) or $80,000 Cap Rate = NOI / Property Price or $80,000 / $500,000 or 16%
Types of Cap Rates
Three different cap rates per property in our Sales Comps module:
The Estimated Going-in Cap Rate
The 12-Month Rolling Metro Cap Rate
The Reported Cap Rate
The Estimated Going-in Cap Rate is obtained by dividing the projected net operating income for the first full calendar year of ownership by the purchase price. Our analysis projects income and expenses for the first full calendar year of ownership of the property after the indicated sale date, and results in a projected net operating income that is then divided by the sale price to obtain an estimated going in cap rate. The projection of revenue relies largely on a rent roll that estimates based on rents, vacancies and expenses observed during several years of surveys at the property or at nearby properties.
The 12-Month Rolling Metro Cap Rate is calculated from the average of the metro’s mean cap rate from the previous four quarters and provides a benchmark rate of comparison.
The Reported Cap Rate (per sale) is reported directly by the buyer, seller or other party to the transaction, and is calculated by dividing reported net operating income by the purchase price.