Thursday, May 3, 2012

Cap Rate Weather Outlook: Trending Down With A Chance Of Bloodshed

The following graphic shows the recent movement in commercial real estate cap rates and where they stand today for the different sectors of the market.  The breakdown is composed as follows:

Apartment Garden: 6.4%
Apartment Mid and High Rise: 5.5%
Office City: 6.1%
Office Suburban: 7.8%
Retail: 7.4%
Warehouse: 7.8%

The historical average cap rates for apartments, before we entered the commercial real estate bubble in 2002, was 10%. Historically the other sectors of the commercial real estate market listed above averaged just higher than 10% cap rates.

The fundamentals for the office and retail market are horrendous. The current trend in the business world today is for more and more people to work from home or for companies to use virtual office space.

The retail sector faces an even greater problem. Not only do consumers continue to have less disposable money to spend, the trend continues to move more shoppers toward the internet vs. driving to a store. With gas prices rising this only amplifies this problem.

The apartment sector has strong built in fundamentals: a rising population with a declining home ownership rate. This means price declines should end around the historical 10% cap rate average and buyers today should only lose about 50% of their capital.

Retail and office buyers today will see no such good fortune. While apartment buyers today will be slaughtered in the years ahead, buyers paying ridiculous 7% cap rates for a retail strip will be completed decimated..

As optimism moves out of the debt markets and interest rates begin to rise you will see a collapse across the board in these asset classes. Significant capital has been bet with tremendous leverage that interest rates will fall forever and eventually go below zero.

They won't.

For a complete discussion on this market see 2012 Commercial Real Estate Outlook.

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