Mixed Reviews: Though Pricing Is Up This Year, Transaction Volume Is Lagging

Though industry experts forecast slow-and-steady economic growth for 2018, drop-offs in commercial real estate transaction volume have some questioning if and when investment activity will advance.

Economic stimulation, powered by recent tax cuts, historically low unemployment levels and the fastest pace of wage growth in nine years has sparked fears of rising inflation and more aggressive interest rate hikes than the Federal Reserve initially forecast.

There is enough cautious optimism in the market that property valuations rose in February for the first time in nine months. But transaction volume fell 0.5% quarter-to-quarter in Q4 to $117.4B, according to data from Real Capital Analytics. In January, transaction volume fell 3% from a year earlier. 

“The main question on everyone’s minds now is whether the delayed closings and optimism about the new tax regime will be enough to offset other headwinds and fuel deal volume growth in the first quarter of 2018 and beyond,” Ten-X Chief Economist Peter Muoio said. “The run up in interest rates since the start of the year is a potential downdraft on deal closings as financing costs increase and cap rate expectations change.”  

Wage gains and a jump in inflation have stirred concerns about upward cap rate movement, but CBRE Head of Americas Research Spencer Levy said cap rates will likely remain flat or edge upward minimally this year. 

“The recent spike in inflation and anticipated higher interest rates this year will add upward pressure on cap rates, offsetting the downward forces of expected strong institutional and global capital flows,” Spencer wrote in CBRE’s North America Cap Rate Survey.

Industrial's Massive Decline? 

Commercial real estate transactions dropped 13.2% year-over-year in Q4 to $445.2B for the year. This slowdown came after deal volume rebounded in the third quarter and economists projected investment activity would pick up in the new year. 

Part of the drop-off in deal volume last quarter is due to the massive $6.7B decline in industrial transactions.  Ten-X Quantitative Strategist Matt Schreck said this slowdown had nothing to do with a pullback in industrial investment, but rather speaks to the strength of industrial transactions in Q3. 

“Industrial is currently the best-performing CRE sector, and was the only sector to see full-year 2017 deal volume grow from its 2016 total. We expect transaction volume to be healthy going forward,” Schreck said. “Even when looking at things on a year-over-year basis, industrial’s 5.3% decline in Q4 2017 from Q4 2016 was the most minor decline among the five sectors. Hotel volume, in contrast, was down nearly 40% year-over-year.”

Pricing Fluctuations And The 'New Paradigm'

Nationwide commercial pricing continues to fluctuate.

Commercial real estate valuations rose minimally by 0.1% month-to-month and 0.4% year-over-year in February. This represents the first uptick in pricing in nine consecutive months, led by gains in the industrial, multifamily and retail sectors, Ten-X reports.

“This slight increase is noteworthy because it occurs amid sharply rising interest rates and dramatic gyrations in stock prices, which real estate investors seem to have shrugged off to some degree,” Muoio said.

As commercial pricing continues to fluctuate, the industry's aggressive fundraising efforts have left an abundance of dry powder — cash reserves set aside for investment purposes — in the market.  A lack of attractive investment opportunities is keeping billions in capital from being invested.

Another factor contributing to pricing fluctuations and the falloff in transaction volume is the widening divide between seller asking prices and buyer expectations. 

“This widening of the bid-ask spread was sourced over doubts over the continuation of the cycle on the buy-side, a rise in interest rates heading into the year and seller expectations for robust pricing increases. We believe this gap will begin to close in 2018, and it will do so due to sellers accepting the new paradigm,” Muoio said in a statement. 

CORRECTION, MARCH 9, 1:19 P.M. ET: A previous version of this story did not properly contextualize when deal volume fell in relation to recent pricing growth. The story also misstated by how much deal volume fell quarter-to-quarter. The story and headline have been updated.