CRE investors are stepping up their efforts to find value outside the best buildings in the top U.S. metros, casting their nets in a growing number of secondary markets and asset types as price growth slows for the highest-end properties, according to this month’s CoStar Commercial Repeat Sale Indices (CCRSI) report.
For the past two years, pricing gains in the value-weighted composite index have been consistently stronger than its equal-weighted counterpart, suggesting that prices have recovered more rapidly among the larger and more expensive assets. Market fundamentals have also recovered more quickly at the top end of the market, where demand for Four-Star and Five-Star office buildings, luxury apartments, and modern big-box warehouses has outpaced the overall market.
However, the most recent data shows that the pricing momentum appears to be shifting from the larger, more-expensive buildings to the broader market, dominated by smaller, less-expensive properties.
The value-weighted composite index’s 6.5% year-over-year gain in April slowed from its double-digit growth rate throughout 2011.
The April pricing data, based on 774 repeat sales during the month and more than 100,000 repeat sales since 1996, included the public release for the first time of analysis of CoStar’s value-weighted U.S. Composite Index, which provides additional insight into CRE price movements, especially for larger institutional transactions.
The value-weighted composite index, along with the equal-weighted U.S. Composite Index — the two broadest measures of aggregate CRE pricing within the CCRSI — posted a decline of 2.2% and a 1% gain from the previous month, respectively, in April. Although the two indices reflected a mixed picture for prices in April, both improved from the same period a year ago.
CoStar has been tracking price changes on both an equal-weighted and a value-weighted basis since developing the CCRSI in 2010. While both indices include the same repeat sale transactions, the different weighting methods offer deeper insight by analyzing price movements in different ways.
The equal-weighted index weighs each repeat sale equally and is heavily influenced by the more numerous smaller deals. The value-weighted index weighs each sale by transaction size or value and is heavily influenced by larger transactions.
While an equal-weighted index is considered more relevant for measuring the performance of average commercial properties, a value-weighted index correlates better to marketplace capital flows necessary for larger transactions.
For the first time in the current recovery cycle, the equal-weighted index has accelerated its year-over-year growth over the past six months, showing that investors have begun to look beyond large, core properties to the lower end of the market.
As CRE prices rise, transaction volume and many other measures of liquidity are also improving. Over the past 12 months ended April 2012, sale-pair counts increased by 19% over the previous 12-month period ended in April 2011. The growth was slightly tilted toward the investment grade segment of the market, which posted a 25% increase in pair counts over that period.
In other CCRSI findings in April:
- Transaction data shows that European investors have played a key role in improving liquidity. The share of commercial property purchases by European buyers in 2012 has more than tripled from 2011 levels, a signal that investors may be seeking safe havens in the midst of the Eurozone economic turmoil.
- Commercial property sellers are finding a more accommodating market in 2012. Average time that properties are on the market prior to sale has decreased this year for the first time since the start of the Great Recession. Also, the gap between the initial asking price and final sales price narrowed over the first four months of 2012 at its fastest rate since 2006.
- The level of distress property sales has been generally declining as a percentage of property sales volume over the past 12 months. Only 24.3% of observed trades in April 2012 were distressed, 12.2% lower than the peak level observed in March 2011.
In related news, the Federal Reserve announced that the June 7 release of the U.S. Flow of Funds (FOF) Z.1 Statistical Release, which measures aggregate assets and liabilities for the nation’s financial and non-financial sectors, now incorporates the CCRSI as a measure of value of the nation’s CRE and apartment buildings.
The Fed decided to drop the index from NCREIF (National Council of Real Estate Investment Fiduciaries) in favor of the CCRSI, saying in its release that the CoStar indexes “offer much broader coverage of these markets” than either the NREI (National Real Estate Investor) or the NCREIF indexes.”
Randyl Drummer, Costar Group