The West Most Improved As Office & Apartment Properties Record Strong Pricing Recovery

As Distress Eases Most Property Types Swing Upward In 2011, Despite Seasonal End-Of-The-Year Price Softening
Powered by continuing gains in apartments and growing momentum in the office sector, the CoStar Commercial Repeat Sale Indices (CCRSI) National Composite Index ended 2011 significantly above its cyclical low last March, despite a relatively flat fourth quarter for pricing.CRE sale prices stalled a bit in December as heavy year-end trading kept pricing stable in the fourth quarter, a trend CoStar has observed in each of the past two years, according to this month’s release of the CCRSI, which tracks sale pair transaction data through Dec. 31. The National Composite Index ended 2011 up a flat 0.2% from year-ago levels, but 5.5% above its low point in March 2011, thanks to a mid-year surge.The Investment Grade and the General Commercial indices of the CCRSI both followed a similar trajectory in 2011, with prices declining in the first quarter, rallying at midyear and coasting during the flat final quarter. Highlighting the investor flight to safety to major markets and core assets, the Investment Grade Index finished December up a cumulative 14.6% from its March 2011 trough, while the recovering General Commercial Index ended the year up 3.5% from March. 


CoStar’s Multifamily Index continued to lead all property sectors, with prices rising by 6.8% in the fourth quarter and increasing a total of 15.3% in 2011. After several quarters of relative weakness, the West regional index recorded the largest overall gain in the country, helped by outsized growth in office and multifamily pricing. In total, the Northeast regional index has continued to see the largest cumulative pricing gains since the trough of the real estate cycle.
Lone among commercial property types, the Retail Index lost ground in the fourth quarter of 2011, falling to its lowest value since 2003.

The impact of distressed property transaction on pricing levels was blunted by a surge in non-distressed property trading in the fourth quarter, although the volume of distressed trades remains high.

CoStar this month also introduced new quarterly pricing indices for hospitality properties and commercial land in addition to office, industrial, multifamily and retail, the four major CRE properties types. Both hotels and land ended 2011 near cyclical lows.

Reflecting a disproportionate level of distress, the Hospitality Index remained 47.6% below its third-quarter 2007 peak — the widest gap among the six property types — despite improving occupancies and revenue per available room (RevPAR). As a percentage of the total sales pairs, the level of distressed hotel property transactions ranks at the top among all commercial property types and has not yet begun to decrease significantly, tamping down average hotel sale prices.

Likewise, the Land Index finished 2011 down a cumulative 41% from the peak of the last cycle, and has not shown any tangible recovery to date following three years of quarterly declines, although losses appear to be easing.

The multifamily index has now grown by a cumulative 21.6% since the bottom of the cycle, outperforming the second-ranked office sector by more than 400 basis points. Renter demand has eclipsed supply, causing vacancies to contract by 170 basis points over the past two years, prompting rental rate gains. Strong property level income growth expectations by investors appear to be baked into the heightened pricing of current transactions.

Investor interest in office property also rebounded in 2011, with the office property index increasing by 17.3% since the end of March 2011. Like the recovery of the broader economy, the office rally has proved to be volatile and uneven despite the significant firming up of prices.

“Pricing gains have proven to be more explosive in tech-centric markets than in the overall market,” according to the CoStar CCRSI report. “The office index will likely continue to vacillate between gains and losses until office demand growth becomes more evenly dispersed across markets.”

Industrial property pricing increased by just 4.4% since March 2011, and was down slightly in the fourth quarter compared to year-ago levels.

Retail is the notable exception to the recovery story to date. Shopping center fundamentals remain soft despite an improving economy and a burst of pent-up consumer spending that has pushed retail sales above the peak of the last cycle. Bucking the trend, power centers and super regional malls have seen gains in tenancy gains over the past year, which could signal a coming turnaround in retail pricing, according to the CoStar report.

Larger and higher-quality properties generally outperformed the market in timing and magnitude of prices improvement, mirroring the growth in CRE fundamentals over the past year. Prices for investment grade properties stabilized at the end of 2009, more than a year ahead of price stability in the general commercial properties. The Investment Grade Index gained 3.4% in 2011, compared with 0.2% for the General Commercial segment.

While the volume of distressed transactions in December remained well above the monthly average for the year, the percentage of distressed trades fell from 35.4% in March 2011 to 24.8% in December, helping push up the National Composite Index.

Hampering the market recovery is the continued softness in levels of real estate lending. Mortgage originations fell by 7% in the fourth quarter from the previous quarter, according to the quarterly survey by the Mortgage Bankers Association (MBA).

The Northeast Composite Index, powered by the exceptional rebound in multifamily and office pricing, gained 12.3% from the market bottom, ending 2011 only 14.3% below the peak of the last boom cycle, reflecting an investor preference for the best assets and densely populated coastal markets. Pricing in the South, Midwest, and West regions is recovering at a more moderate pace, with the indices for each region finishing December 2011 down between 34% and 39% from the market peak.

However, the West won as the most improved region of the country, with the composite index advancing by 5.8% in 2011, compared with a 4% gain in the Northeast, a 2.2% gain in the Midwest, and a 6.9% loss in the South.

“Barriers to supply in the West have improved the marketability of CRE assets in this region as investors branch out to seek opportunities beyond the core coastal Northeastern markets,” CoStar said in the report.

In other CCRSI regional results among specific property types:

    • Apartments were the only index to record positive gains in 2011 across all regions, while office recorded the second-best growth rate in 2011, with regional gains ranging from 8% in the West to 11% in the Midwest and Northeast.
    • The South, the only region to record a loss on the overall composite index in 2011, recorded a 4% pricing loss in office.
    • Retail, universally the worst performer, experienced losses ranging from 1.2% in the West to 10.3% in the South in 2011 prices.
    • Fourth-quarter results in the Top 10 Largest Metro indices reflected the investor preferences for the best properties in the top markets. The Office Top 10 Largest Metro Index gained 23.8% since the trough of the last cycle as of the fourth quarter, significantly outperforming the 17.3% of the National Office index.
    • The Multifamily Top 10 Index recovered 25.6% from its trough, compared with 21.6% in the overall multifamily index.
  • The industrial and retail Top 10 Largest Metro Indices, however, underperformed their national counterparts. The Industrial Top 10 index declined by 11% compared with a 2.9% decline in the national index, while the retail top 10 metros also proved to be drag on the National Retail Index, with quarterly and annual losses nearly double the national average. (credit to R, Drummer-Co-Star)
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