First Quarter Commercial Real Estate Sales Statistics

Perhaps the commercial real estate market is releasing a collective sigh of relief over the successful sale of the GM building by the struggling Macklowes to an investor consortium led by Mortimer Zuckerman over Memorial Day weekend. However, a few enlightening statistics representing the true state of the commercial real estate market were presented in the Wall Street Journal's Property Report this morning. First quarter sales of apartment buildings have declined over 40% from the first quarter of 2007. Office and retail building sales have dropped by 80% and 70% respectively. Meanwhile, capitalization rates (rental income in the first year of ownership divided by the purchase price) have increased for most commercial real estate sectors. In April, the average cap rate for apartment buildings rose to 6.19% from a revised 6.15% the previous month. The average cap rate for office properties in central-business districts rose to 6.25% from a revised 6.0% in March. Although an increase in cap rates is a sign that property values are finally beginning to reflect current market conditions, the average cap rate is still very low compared to historical levels. At the beginning of 2002, cap rates were over 9% and have steadily declined, hitting lows of around 5.75% in the first quarter of 2008 before ascending again. It seems inevitable that cap rates will continue to march higher. Although easy monetary policy has nearly always caused cap rates to decline in the past, it seems unlikely to happen this time around. Sales activity in the commercial property market has declined so significantly that it may take several quarters for a true clearing price on property values to emerge. Exacerbating the problem is a dramatic increase in properties offered for sale in addition to significantly tighter lending standards from banks that are unlikely to offer any new financing until they can successfully clear their books of all crap they currently own at inflated prices. The only thing the commercial real estate market can hope for is a return to spiraling inflation, which always increases the value of hard assets. Investors under that scenario, however, would be looking at financing rates of 20% and grinning with joy. Given the Fed's genuine attempts to bring back 1970's style inflation, that situation may not seem so far-fetched.