Large Commercial Properties Face Price Slowdown

Buyers balk at high price tags for Class A properties as cap rates begin trending up.

May 18, 2018

Commercial real estate has been buoyant the last few years, but larger Class A properties could soon see a slowdown in value as buyers balk at high price tags. Also, cap rates—which have been flat—could begin trending up for some property types.

That’s the forecast NAR Chief Economist Lawrence Yun gave at a commercial real estate economic forum May 17 at the 2018 REALTORS® Legislative Meetings in Washington, D.C. “Buyers and sellers are disagreeing more on price,” Yun said. “The challenge will be convincing owners to lower prices to get deals done.”

For buyers, capitalization rates are making deals harder to put together. For all property types, cap rates at the end of 2017 averaged about 5.1 percent, down from a high of 6.9 percent in 2009. In general, investors will demand a higher cap rate as inflation and interest rates increase.

Yun is anticipating transaction volume for large properties across sectors to fall this year, although smaller commercial properties—which NAR defines as those at $2.5 million or less—could see continued strong demand. He said trophy properties that attract global capital, mostly in large metropolitan areas, appear to be facing the biggest challenges. Smaller properties in secondary markets could escape a downturn in volume or prices in the next year. “Activity is still rising in smaller properties, so falling prices might be only for large properties,” he said.

Multifamily: The most recent NAR data shows the multifamily sector had 12-month net absorption of about 230,000 units, 12-month completions at about 260,000 units, and 5 percent vacancies. Rent growth in the first quarter of 2018 was a moderate 2 percent, year over year. Capitalization rates are currently at about 6 percent. [Vacancies at 5.5 percent last year, rising to 5.8 percent this year, then dropping back down to 5.5 percent in 2019.]

Office: Office vacancies were down slightly to about 14.5 percent, according to the latest data. Rental growth is at about 3 percent. Cap rates are at about 7 percent. [Vacancies 12.8 in 2017, dropping to 12.2 this year, and dropping further to 11.3 in 2019.]

Industrial: Industrial vacancies were at about 8 percent, and rent growth was just under 5 percent. Cap rates are trending down to less than 7 percent. [Vacancies at 8.8 in 2017, dropping to 7.7 this year, and dropping further to 6.9 in 2019.]

Retail: Store vacancies were holding steady at about 10 percent, while rent growth was easing just slightly from the previous year to about 2.5 percent. Cap rates are at about 7 percent. [Vacancies at 11.8 in 2017, rising to 12 percent this year, then falling back to 11.7 in 2019.]