CRE Price Index Sees First Year-Over-Year Gain Since 2008

Fewer Distressed Sales and Solid Investment Grade Deal Activity is Driving Sustained Pricing Rebound

CoStar’s monthly National Composite Index of commercial real estate prices increased 2.2% in October from the same period a year ago, the first year-over-year improvement since the economy took a sharp downward turn in 2008.

The solid recovery of investment-grade property prices and the continued decline in distressed sales volume spurred the growth in commercial property pricing, lifting the index to an impressive 1.8% gain in October from the previous month and continuing its upward trend.

The year-over-year and monthly increases in October reflected long-awaited positive momentum in the composite index, which has now achieved a steady 1.3% average monthly growth rate over the six-month period between May and October 2011, according to this month's CoStar Commercial Repeat Sale Index (CCRSI), based on 743 repeat sale transactions recorded in October and more than 100,000 repeat sale transactions since 1996.

Other highlights from this month's CCRSI report include the following:

• The General Commercial Index continued its steady move upward, increasing by 1.4% in October, the sixth consecutive month of rising prices since reversing the 32-month downward trajectory in general commercial property pricing that began in September 2008.
• The Investment Grade Index gained a strong 3.4% in October from the previous month. After bottoming in late 2009, this index bumped along near the bottom around the same level for almost two years before beginning its recent climb in March 2011. Growth resumed in September following a brief pause in August, and CoStar analysts predicted sustained growth because it synchronizes with the price increase tracked by the General Commercial Index, an indication of an across-the-board recovery.
• Stable fundamentals across most commercial property markets and product types, including improving occupancy, and softening downward pressure from distress sales, supported the solid performance of both the investment grade and general indices. The level of distress sales as a percentage of general commercial repeat sales fell from 33% in March 2011 to 24% in October 2011. For investment-grade properties, this ratio dropped even more steeply, from 53% to 28% in the same period.

CoStar’s Investment Grade Repeat Sales Index increased by 3.4% in October and is now 6.9% above the same period last year, and 31.1% below its peak in August 2007. Despite the monthly and year-over-year increases, the Composite Commercial Repeat Sales Index remains 31.5% below the August 2007 peak.

The General Grade Commercial Repeat Sales Index rose by 1.4% in October and is now 1.1% above the same period last year, and 32% below the peak.

October's total of 743 sales pairs is on par with historical averages for transaction activity, according to the CCRSI December 2011 report. At the low point in the last downturn in January 2009, a total of 385 sale transactions were recorded.

Of the total sales pairs in October, 599 were general property sales and 144 were rated as investment grade. The sale-pair counts for both indices are likely to increase slightly in coming months as additional closings are recorded, CoStar analysts noted.

As the average transaction size increases, overall transaction volume continues to trend upward, increasing by 29.4% annually in October, while the average deal size increased by 23%.

Distress sales continued to decline from 35.4% of total repeat sales in March 2011 to 25.2% in October 2011. Although distress sales have gradually declined over the past seven months, the overall level is still high on an historical basis, suggesting that distress continues to be a significant factor of CRE pricing.

Also, by transaction count, General Grade sales pairs accounted for 80.6% of the total sales transactions, a ratio that has been stable over the past 12 months.

Market Trend: Orange County's Retail Vacancy Stays at 5.6%

The Orange County retail market did not experience much change in market conditions in the third quarter 2011.

The vacancy rate went from 5.6% in the previous quarter to 5.6% in the current quarter. Vacant sublease space decreased by 54,507 square feet.

Tenants moving into large blocks of space in 2011 include: Walmart moving into 100,320 square feet at 50 E Orangethorpe Ave; Forever 21 moving into 94,400 square feet at The Shops at Mission Viejo; and LA Fitness moving into 83,857 square feet at Alicia Towne Center.

A total of two retail buildings with 15,422 square feet of retail space <http://www.showcase.com/retail-space> were delivered to the market in the quarter, with 360,755 square feet still under construction at the end of the quarter.

This trend is compared to the U.S. national retail vacancy rate, which decreased to 7% from the previous quarter, with net absorption positive 18.85 million square feet in the third quarter.

The information in this news report is based on CoStar’s Third Quarter 2011 Market Report.

Single-Tenant Property Sales Surge To Record Numbers

July 6, 2011 by: Mark Heschmeyer, CoStar Group

Investors Turn to the Relative Safe Haven of Quality Tenants; (Part 1 of a 4-Part Series)

With money to burn but still having a strong aversion to risk, investors have increasingly turned single-tenant properties into one of the hottest commercial real estate plays in the country.

For the last quarter of 2010 and first two quarters of this year, CoStar Group shows that sales of single-tenant properties have averaged more than 10,000 transactions per quarter - the highest quarterly totals on record. And for third quarter comparable sales CoStar is showing that pace is continuing.

So far this year, CoStar has tallied more than 30,000 single-tenant sales valued at $29.2 billion in all property types. Retail sales have accounted for about half of the activity.

The single-tenant, net lease investment sales market is expected to continue growing, according to Jones Lang LaSalle.

"The low interest rate environment and the lack of safe-haven investment alternatives are driving new sources in build-to-suit and sale-leaseback activity, and investors have incredibly healthy appetites for stable and dependable income streams that single-tenant assets provide," said Guy Ponticiello, managing director Jones Lang LaSalle's Corporate Finance & Net Lease division.

Fully leased core properties have been highly sought-after by investors, often from overseas, and prices for these properties have been strong, according to Jane L. Mendillo, president and CEO of Harvard Management Co. in her most recent Harvard University Endowment report.

"We were able to sell some of our portfolio properties in this category at excellent values," Mendillo said. And now Harvard is ready to invest in new round of such properties.

Jones Lang LaSalle's Capital Markets secured $360 million in acquisition equity for a real estate investment vehicle to be managed by U.S. Realty Advisors LLC. The entity, called USRA Net Lease Capital Corp., will pursue the purchase of single-tenant net leased assets throughout the U.S. Harvard University's endowment is the main investor in the venture that could buy more than $1 billion of triple-net leased property.

Indeed, institutional and private equity interest in this property type is high.

"One way to hedge risks in today's highly volatile and lower-yield environment is to invest in net lease properties, ideally with credit tenants," said Tim Wang, Ph.D., senior vice president of Clarion Partners in New York. "Until recently, the most active net lease investors have been dominated by dividend-paying private REITs and 1031 exchange buyers. However, net lease investments are becoming increasingly attractive to institutional investors because of their longer lease terms, higher income, and lower operating expenses.

"For assets in primary U.S. markets on a long-term (10+ year) net lease to a nationally recognized company there is a highly disproportionate supply of money vs. supply of product. This has been a primary driver pushing yields down to levels not seen since prior to the credit crisis," said David B. Chasin, executive vice president of Pegasus Investments in Los Angeles. "Given the macro-economic uncertainty, historically low Treasury yields and breakdown of Wall Street equity markets, the net leased investment market provides an extremely attractive platform."

But big money isn't the only player in the market. Mike Eyer, senior advisor for Sperry Van Ness in Fort Collins, CO. said. "Recently individual buyers from the coastal markets are getting even more aggressive and are pricing the institutions out of the market."

The increasing demand for these investment leases isn't necessarily coming by choice, added Brian Merzlock, valuation manager at Williams Williams & McKissick auction house in Tulsa, OK.

"This is a market-forced move," Merzlock said. "When you are disheartened by the world markets time and time again, you become more restrictive with your capital, and the retail lease http://www.showcase.com/retail-space  market becomes a more appealing to risk appetite."

"With companies recording higher profit levels, there has to be some kind of tax shield in the capital fund creating a traditional solution to the nasty volatile bear market trends we are experiencing," Merzlock said. "We are seeing increased stability in those markets that have been traditionally strong and little demand in the newer 'suburbs' where you'll see numerous clusters of new, yet vacant, retail buildings haunting the markets long after Oct 31."

Jeffrey Rogers, president and COO of Integra Realty Resources in New York, said, "Investors are favoring this type of investment because capital for this property type has increased and demand for the property type is outpacing supply. There has been very little new development over the past three years and that has caused some pent-up demand."

Consequently, "any increase in demand for retail products will increase the desirability of net leased retail investments because demand leads to better tenant quality, which is one of the three metrics investors focus on to decide whether to invest. Increased sales and consumer sentiment leads to higher tenant credit ratings. The other two metrics are favorable lease terms and location of the asset," Rogers said.
Not All Retailers Are Created Equal

As the total numbers indicate, retail is the preferred property type for single-tenant investors, but there is a bifurcation within that segment, said Scott P. Lifschultz, president of SPL Realty Partners in Santa Monica, CA.

"It's important for an investor to identify solid performing retailers, such as Walgreens, Walmart, Whole Foods and other grocery chains, as well as other leading retail chains," Lifschultz said. "Consumer spending is a significant indicator as it relates to retail earnings, so again, identifying solid performing, "every day needs" tenants garner the most interest and highest pricing."

Rick Puttkammer, senior vice president of Flocke & Avoyer in San Diego said, "Much of the NNN leased product on the market is 'necessity based' (to borrow the widely used phrase in retail). Examples are banks, drug stores, food and price-oriented retailers. The NNN leased market is not as active for high end retail, home furnishings, sporting goods and other uses that consumers can take or leave."

In addition, freestanding medical uses such as dialysis (DaVita and Fresenius), automotive (Jiffy Lube and Valvoline) and some credit rated or creditworthy day care operators (KinderCare) are doing well, Puttkammer said.

The CRE Recovery Continues

July 6, 2011 by: Mark Heschmeyer, CoStar Group

The real estate market has now experienced eight quarters of positive net absorption, longer than the office or industrial markets, which have each experienced five consecutive quarters of positive net absorption.

Money for CRE Deals Starting to Flow

June 6, 2011 by: Mark Heschmeyer, CoStar Group

Numerous indications over the past few weeks point to an easing of investment capital for real estate deals. Life insurers have become more active lenders; new CMBS offerings are hitting the street; syndicators are starting to assemble new CDO offerings; and bank loan officers are reporting the first easing of lending standards in years.

Retail properties represent the highest concentration of the pool at 49.5%, including nine of the largest 15 loans. The retail concentration is composed of regional malls, local shopping centers and a few single-tenanted retail portfolios. Three of the four regional malls in the top 15 loans are backed by malls in secondary markets. Office properties represent 20.2%.