By Jim Costello on July 19th, 2018
Preliminary U.S. deal volume figures for the first half of 2018 indicate a slight increase in activity from the level set a year ago. Cap rates are largely unchanged from a year earlier as well, a combination indicative of a balance between buyer and seller expectations. On the surface it may seem that there is an equilibrium, but, digging deeper, there are signs of additional buyer caution.
While deal volume is up slightly from the pace seen in the first half of 2017, the composition of this volume has changed. Preliminary data shows that for commercial property investment overall, and the retail sector in particular, the sale of individual assets is falling and only portfolio and entity-level deals are providing a lift to deal volume.
The retail sector had posted a double-digit decline in deal volume as recently as May but is now unchanged from a year earlier and up sharply in Q2’18. One megadeal drove this growth in volume: the Unibail purchase of Westfield. Without this deal, investment volume for the retail sector would be sharply negative for the year to date. (The Brookfield purchase of GGP has not closed yet, but may also elevate the figures for the year.)
Declining deal volume for the sale of individual assets is an indicator of increased buyer caution. Changing credit market conditions in the face of expectations for higher interest rates may be driving some of this caution.
Yields on corporate bonds have been climbing in 2018 as investors expect higher rates of inflation soon. Cap rates and corporate bond rates are not linked in a one-to-one relationship, but if investors are pricing in more risk to bonds tied to corporate cash flows, they may eventually demand a higher risk premium for commercial property as well. The income from commercial property, after all, is also tied corporate cash flows and that higher risk premium would mean higher cap rates.
Still, it hasn’t happened yet. Cap rates for the apartment sector came in at 5.6% in Q2’18 which represents no measurable change from Q2’17. Likewise, commercial cap rates (office, industrial and retail weighted here by historic volume) stood at 6.4%, roughly the same as a year earlier. While buyers may want more cushion, they are still earning more of a spread between cap rates and corporate bonds than they have over most history.
On July 25 Real Capital Analytics will publish the new issue of US Capital Trends. This edition reports on pricing and deal activity across the property types for 2018 so far, and ranks the top deals and players.