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Economic Growth, Abundant Capital and Favorable Supply-Demand Dynamics to Keep Cap Rates stable

3/25/19

Strong economic growth, abundant capital, and a favorable supply and demand environment led to broadly stable capitalization rates for U.S. commercial real estate assets in the second half of 2018, according to the latest research from global property advisor CBRE.

The CBRE North America Cap Rate Survey provides insights on movements for the major property asset classes. Cap rates remained generally unchanged across the sectors in H2 2018, except for some retail segments. Industrial cap rates tightened marginally across all segments, while office, multifamily and hotel cap rates were stable. Continued cap rate stability is expected in H1 2019.

“Investment activity remains robust, driven by a strong economy, significant amounts of capital, and a sense that supply and demand in real estate markets is very well balanced. The U.S. remains the best performing of the advanced economies, due to job growth and earlier tax cuts. Cap rates were very stable in 2018, and pricing firm. We see this situation continuing in 2019, with a weaker global economy putting downward pressure on the 10-year treasury. Real estate spreads remain very competitive,” said Richard Barkham, Global Chief Economist, CBRE. Among the major commercial real estate sectors:

• Office cap rates increased by a greater amount for CBD properties than suburban in H2 2018, especially in Tier I markets. Suburban cap rates were relatively flat across all classes and investment strategies. Cap rates are expected to remain unchanged in approximately three-quarters of CBD markets and two-thirds of suburban markets in H1 2019.

• Orange County came in in 4th and Los Angeles in 5th for Class A office properties located in central business district, featuring cap rates between 4.5% to 5.5%, following San Francisco, New York City and Seattle. Class A suburban office properties cap rates placed the OC in 3rd and Los Angeles in fourth place.

“Cap rates remain relatively flat in both suburban and core locations as investors are now capitalizing higher net incomes, which is pushing up the prices per square foot for all assets,” said LA-based Executive Vice President Todd Tydlaska. “The availability of capital remains robust and cap rates are tied more closely to liquidity than the cost of capital, meaning interest rates. Los Angeles and Orange County remain the #1 target market for capital for the fourth year in a row. This should continue to push values up as fundamentals remain strong.”

• Industrial and logistics cap rates declined by 7 bps to 6.34% for acquisitions of stabilized assets in H2 2018. Cap rates for stabilized properties of all classes fell, with Class A industrial properties declining 7 bps to 5.07%, Class B falling 13 bps to 5.98%, and Class C down 2 bps to 8.02%. Expected returns on cost for value-add assets decreased 2 bps overall to 7.45%.

• High demand for industrial space, driven in large part by ecommerce and logistics providers, continued to keep cap rates in the area among the lowest in the country, with Orange County in 4th place, Los Angeles in 6th and the Inland Empire in 7th place. Last year’s biggest industrial leases clustered in leading logistics hubs, with California’s Inland Empire topping the list, according to a recent CBRE report.

“The Greater LA region combines some of the key requirements of today’s ecommerce and logistics providers,” said Los Angeles-based Vice Chairman Barbara Perrier. “It’s in proximity to a huge population base as well as near ports; and it is ideal for companies that seek a coastal strategy, meaning having a presence on both U.S. coasts. This demand in turn has continued to attract money from local investors, national institutions and foreign buyers.”

• Multifamily cap rates and returns on cost remained at historically low levels in H2 2018. Cap rates for infill stabilized assets averaged 5.26% and expected returns on cost for infill value-add acquisitions averaged 6%. Suburban stabilized assets priced at 5.56% on average, while expected returns on costs averaged 6.3%. Cap rates and returns on cost edged up slightly from H1 2018.

• Most Southern California markets boasted cap rates of sub-5% for Class A infill, including Los Angeles, Orange County and San Diego.

“In core in-fill Southern California markets where job growth has been strong and absorption is steady, cap rates continue to compress to the low 4% range, or even lower for the most desirable coastal markets,” said Executive Vice President, Dean Zander. “Capital is attracted to dense urban locations, in spite of the supply pipeline, in part due to extremely positive demographics and meaningful job creation.”

• Hotel cap rates were mostly stable in H2 2018, with increases of only 3 bps or less on average for all CBD and suburban submarkets. The CBD hotel cap rate remained below 8% (7.97%) and was under the long-run average. Suburban cap rates moved up 1 bp to 8.49%. Most market segments and geographic areas had quite modest, single-digit upticks or downticks in cap rates ranging from minus 2 to plus 9 bps.

• Luxury hotel cap rates were the lowest in Los Angeles, Orange County and Boston at 6.75%.

“Hotel sector fundamentals have offered few, if any, surprises. This combined with continued high liquidity in the debt markets has allowed for relative stability in cap rates. While one might anticipate upward pressure because of late cycle fundamentals and some volatility in the capital markets, the weight of capital focused on the sector has kept cap rates in check,” said Kevin Mallory, Global Head and Senior Managing Director, CBRE Hotels.

• Retail cap rates for both stabilized and value-add properties increased for all retail segments in H2 2018. Recent store closure announcements have disproportionately affected the power center segment, with the average cap rate increasing by 13 bps to 8.42% in H2 2018. Demand for high-quality assets was strong, with cap rates for Class A product in all three retail sectors the lowest, ranging from 4.83% to 8.42%. Cap rates for both power and neighborhood/community center stabilized properties are expected to remain unchanged or increase slightly in H1 2019.

• Well-managed stabilized shopping centers in affluent suburban communities in Orange County and Los Angeles boasted the lowest cap rates in the nation in this category at 4.88%, while high street retail in LA featured the second-lowest rates in the country at 4.13%, following San Francisco.

“There remains a significant amount of capital and debt available for retail investment properties. However, buyers and lenders are becoming more conservative on their underwriting assumptions and expecting higher yield due to more supply on the market,” said Senior Vice President, Patrick Wade. “Prime LA County submarkets such as the beach cities, West LA, West Hollywood, Santa Monica, Studio City and Silverlake, among others, continue to see the strongest rent appreciation and tenant/investor demand. The high-barriers-to-entry and density are strong value drivers.”






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