Economy Watch: The Scoop on Upper-End CRE

By Dees Stribling, Contributing Editor

Low interest rates are still important to the continued growth of prices in the U.S. commercial real estate market, but they aren’t the only drivers. Along with the most recent CoStar Commercial Repeat Sale Indices, which were released on Friday, the company posited that upward price movements have also been possible recently because of strong market fundamentals and improving market liquidity. As of the end of July, the indices that the company calculates still showed growth in CRE prices, but the pace of growth slowed down slightly when comparing the average pace for the six months ending in June.

The moderation in the rate of price growth was especially pronounced at the high end of the market, the company noted, where pricing has already exceeded pre-recession peak levels by 13 percent. CoStar’s value-weighted U.S. Composite Index, which is mostly about high-value trades, advanced 0.3 percent in July 2015. That compares with a 1.1 percent average monthly pace from January through June 2015. On the other hand, the company’s equal-weighted U.S. Composite Index increased 0.9 percent in July 2015, down only slightly from the 1.1 percent average monthly pace during the first half of this year. The index has now advanced to within 7.5 percent of its prerecession peak, supported by increased investor interest beyond core properties in primary markets.

The same pattern is illustrated in another way by CoStar: Its General Commercial Index, which is weighted toward the sale of smaller, lower-end properties, has continued to gain momentum. Market market fundamentals are still strong, and there’s been strong capital flows across the size and quality spectrum of commercial property. The General Commercial Index increased by 1.3 percent in July 2015 and 12.2 percent for the 12 months ending in July. By contrast, the Investment Grade Index fell 0.9 percent for the month, though it grew 9.6 percent for the 12 months ending in July. The General Commercial Index has moved to within 8.1 percent of its prerecession peak. While recent price growth has slowed down in the Investment Grade segment, it is still within 5 percent of its prior peak.

These patterns probably indicate that investors are hitting a fair number of walls in their efforts to acquire the best core assets in gateway markets — an investng midset that began during the recession, and which still lingers to some degree. But as investors face even higher prices and harder-to-find product, they’re turning to other markets and to assets that are perhaps a step below the best, though still quite good. CoStar also reports that consistent with recent pricing gains, sales volumes increased faster at the low end of the market as investors broadened their search for investment yield. Transaction volume in the General Commercial Index for July 2015 was up 3.2 percent from the pace set from January to June 2015, while in the Investment Grade segment repeat-sale deal volume fell 12.4 percent during the same period.