By Jim Costello on April 16th, 2020
Signs of the COVID-19 crisis are starting to appear in the U.S. market for commercial property assets. Deals are falling apart and the number of participants is thinning. This weakness accelerated throughout the first quarter, but the worst is likely yet to come.
Price discovery in the market for commercial real estate assets can be a long process. There are a number of steps that buyers and potential sellers will go through before adjusting their expectations in the light of an economic shock. Deals that fail to close and a reduction in market players are leading indicators for changes in market pricing.
There are always a number of deals in contract that, for one reason or another, fail to complete. Except for periods of crisis, cases where these deals collapse are a small portion of the market. On average from 2016 to 2019, such deals were only 0.4% of the total number of deals that closed in a single month. In March, this figure climbed to 1.3%.
Granted, this 1.3% figure is not huge, and it was not just about a rise in the number of deals falling out of contract. It also came about also because of a decline in the number of deals that closed. But the writing on the wall signals changes in price expectations. A rising number of busted deals shows that participants saw the growing economic calamity and realized that the assumptions they had in place for transactions no longer worked.
In addition to the busted deals, another growing signal of weakness in the market is the shrinking of the buyer pool. On average from 2016 to 2019, the U.S. market saw 2,100 unique buyers of commercial property each month. This figure retreated throughout Q1 2020 and stood at only 790 buyers in March.
This count of the number of unique buyers in the marketplace is one of the components of the RCA Capital Liquidity Scores and the drop in this figure points to a decline in market liquidity. With fewer participants to look at a deal when it is brought to market, a seller is less likely to achieve the pricing they were hoping for in a transaction, as bidding simply will not be as competitive.
The US Capital Trends report to be published next week will show a decline in deal activity for both March and for Q1 2020. Aside from the hotel sector, however, we are unlikely to see big moves in prices for the quarter. Buyers and potential sellers are moving apart on price expectations, but unless and until owners are forced to sell because of financing challenges or other outside events, prices will not budge. Deal volume will continue to retreat in the coming months until participants adjust their price expectations.
US Capital Trends will be released April 22. Highlights of this edition include rankings of buyers, sellers and deals for the first quarter, as well as a close examination of deal activity and pricing across the property types. In the Big Picture we report on trends in construction across U.S. markets.
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