Cap Rates Edge Higher

Cap rates edged higher in the second quarter, but they remain low; economic growth should support demand for commercial properties, offsetting further cap rate increases, reported Wells Fargo Securities, Charlotte, N.C.

The company’s second quarter Commercial Real Estate Chartbook noted inflation is trending higher, which will likely encourage the Fed to continue increasing interest rates through 2019. “Higher interest rates tend to raise angst among property owners,” it said. “We expect cap rates to trend higher, reflecting stronger economic growth and rising interest rates.”

In addition, trade tensions could slow the U.S. economy and foreign demand for U.S. real estate. But the report said recent preliminary agreements with Mexico and Canada should help relieve some anxiety about international trade. “The trade war rhetoric with China continues to escalate, however, and remains a downside risk,” it said.

But for the moment trade policy uncertainty has not scared foreign investors from targeting American real estate; cross-border flows exceeded 12 percent of all transaction volume, a higher proportion than in the past three quarters. “In contrast to solid economic growth in the U.S., global growth has weakened somewhat, boosting the relative attractiveness of U.S. commercial real estate,” Wells Fargo said. “Investors from Canada, Singapore and France have recently filled the void left by tighter restrictions on Chinese outbound investment, which was a major source of inbound capital when transaction volumes peaked in 2015.”

Commercial property prices continue to rise and stand 25 percent above their pre-recession peak. “Apartment and suburban office prices have risen, while retail, industrial and central business district offices have seen moderation,” the report said.

Transaction volume grew 3.9 percent year-over-year in the second quarter to $121 billion, the report said, noting activity remains below the cycle’s peak seen in 2015 but should continue to improve because several large retail and industrial deals closed recently.

Commercial real estate credit markets remained tight during the quarter, Wells Fargo reported. More banks tightened their standards for nonresidential and multifamily lending, though standards slipped slightly for construction and land development loans. Demand for loans also waned, continuing a trend that started in early 2017.

“On balance, commercial real estate lending continues to moderate as the expansion matures,” the report said. “The total value of real estate loans outstanding grew 3.5 percent year-over year in the second quarter, the slowest pace since 2014.”

The report said most major investor groups increased their holdings of commercial and multifamily mortgages between April and June. Bank and thrift holdings rose 1.9 percent, while agency/GSE/mortgage-backed securities and insurance company lending grew 2.4 percent and 8.9 percent, respectively.