Commercial property sales accelerated in 2013, continuing a years-long recovery after activity came to a near-halt during the financial crisis and recession.
Buoyed by steadying job growth, improving real estate fundamentals and eager capital, buyers throughout the first 11 months of 2013 ponied up more than $305 billion to acquire office buildings, industrial properties, retail centers, hotels, apartments and development sites around the U.S., according to Real Capital Analytics, which tracks commercial real estate sales of more than $5 million.
The dollar volume already had outpaced sales in all of 2012 by about $5 billion, Real Capital notes. The firm is scheduled to release final 2013 sales numbers later this month, but it anticipated close to $360 billion in total dollar volume for the year.
Before The Crises
That would approach the sales activity level of 2005, when investors poured nearly $362 billion into commercial real estate. And noteworthy for the first time in several years, more buyers in 2013 explored smaller markets for opportunities, says Dan Fasulo, a managing director with Real Capital.
"Capital really began to spread out around the country and to different property sectors in 2013," he said. "That was different than previous years.
Coming out of the recession, investors initially focused on major markets such as New York and Washington, D.C., which were considered safer because of population density and robust job engines. Rising prices in those cities and an expanding recovery finally pushed buyers into other markets.
Interest Rate Question
Fasulo and Hessam Nadji, a managing director with property brokerage Marcus & Millichap (MMI), predict that commercial real estate investment will stay strong in 2014, with the dollar volume surpassing that of 2013.
Rising interest rates could spoil that notion, however. The benchmark 10-year bond yield has ballooned to nearly 3% from a low of 1.63% in early May 2013. Among other consequences, the increase initiated a sell-off of real estate investment trusts: Shares of Vanguard REIT ETF (VNQ), which tracks the MSCI U.S. REIT Index, have slid 16% over the last eight months.
REITs were among the most prolific investors in 2013, occupying seven spots in Real Capital's top 10 buyer rankings by dollar volume in the first 11 months of the year. In all, Equity Residential (EQR), Spirit Realty Capital (SRC), Essex Property Trust (ESS) and other REITs in that group shelled out $34 billion to acquire more than 1,900 properties.
Lawrence Raiman, CEO and portfolio manager for LDR Capital Management, which invests in REIT preferred securities, suggests that REITs will rein in acquisitions in the short term.
What Investors Want
Generally, he said, REITs want a clearer picture on the economy and more favorable "capitalization rates," an expression of a property's initial cash yield that decreases as prices rise. As interest rates go up, the spread that real estate buyers can capture between interest expense and the cap rate compresses.
The average cap rate for downtown office buildings, for example, fell to 5.7% in November from 6.8% two years earlier, according to Real Capital's data.
"I don't think REITs are going to be as aggressive as people expect," Raiman said, "because they want to see what happens with cap rates and the economy before deploying capital.
Nadji is quick to point out that rising interest rates are indicative of an improving economy. December's job numbers come out early Friday, but in just the first 11 months of 2013 employers hired more than 2 million workers, and Nadji says real estate fundamentals such as vacancy rates largely continued to improve. With the exception of apartments, new commercial property construction remains muted, he adds, aiding demand for existing properties.
"If interest rates were going up and job growth was flat, then we'd have dislocation and investment sales would drop off," Nadji said. "But I don't expect to see that. I think job growth will surprise to the upside in 2014.
Additionally, after waiting on the sidelines for years, private investors are now coming back into the market, Nadji and Fasulo maintain. Private buyers are more likely to take on more risk, such as adding value to older properties through rehab, to capture the upside of an improving economy, they add.
Global private real estate funds raised $77 billion in 2013, according to a report released this month by private fund researcher Preqin. Not only did that represent a 17% increase over 2012 fundraising, but it also marked a five-year high.
Some $53 billion is focused on investments in North America, and funds concentrating on riskier opportunistic and value-added strategies raised $51 billion, Preqin said. The firm also noted that 151 funds were still in the market seeking $151 billion.
Fasulo says the amount of capital flooding the market is reminiscent of 2006 and 2007, an easy-money period marked by loose underwriting that fueled nearly $1 trillion in property sales across the two years.
"When capital starts to pile up and there are 20 buyers for every property and 10 lenders for every loan," he said, "that kind of demand tells me that investment is going to increase and prices are going to continue to move northward.
Unlike the reckless behavior exhibited just before the crash, however, lenders today require more equity from borrowers and are largely focused on conservatively underwriting sound deals, Nadji says. In 2006 and 2007, investors could typically borrow 80% or more of an asset's purchase price. That has dropped to a range of roughly 60% to 75%, depending on the property, size of transaction and buyer, he says.
"We don't have out-of-control-lending like in 2007," Nadji said. "We have job growth, construction that's in check, and pricing that's lined up well with underwriting."