Cooling Market: Deal Volume Flat In Q2, Here’s How The 5 Major Sectors Fared

In a sign that the market may be cooling, commercial real estate transaction volume came in nearly flat in the second quarter of the year, with sales up 1% to $118.1B in Q2 year over year. Year-to-date commercial asset sales reached $233.3B, according to data from Real Capital Analytics. 

“Flat is not necessarily a bad thing,” RCA Senior Vice President Jim Costello said, adding that in 2015 the market slipped and many awaited the inevitable correction, but it never came. “They kept waiting and it didn't happen and now volume has sort of stabilized. Every down cycle has some characteristics that are the same, but every one is different. What we’re going through now is something unique and it’s tied to all of the factors involved in the market today."

The slowdown was largely expected as the industry continues to grapple with high asset prices, compressed cap rates and a frustrating bid-ask spread leaving hundreds of billions of dollars in dry powder still sitting on the market in search of deals. Real estate firms had $278B in dry powder available in June, down from May's $284B, according to Preqin.

In addition, investors are cautiously monitoring a number of potential risk factors including the possibility of a trade war and the fast pace of rising interest rates, both of which have had little effect on the commercial real estate market or capital market fundamentals as of yet, according to LaSalle Investment Management’s annual Mid-Year Investment Strategy report. 

In a survey of 100 U.S. real estate experts conducted by real estate database company Zillow Group, more than half believe that monetary tightening — when the Federal Reserve boosts interest rates to make it more expensive to borrow money — will likely trigger the next downturn. About 48% of those surveyed expect that downturn to hit in 2020. 

“I will say that real estate will do a lot better the next downturn than the last one. The real estate market is moderated and has not been in a boom-bust cycle in the last few years,” LaSalle Head of North America Research & Strategy Bill Maher said. “We’ve been targeting 2020 internally as something to be ready for; until this recent trade war tiff erupted you were seeing more and more forecasters pushing 2021 [as the next downturn]. There’s really no warning signs in terms of excesses or things that would turn a recession.”

Slowdown In Single-Asset Sales

While private real estate markets have remained relatively calm this year, the stock market experienced some volatility in response to policy changes and reservations regarding certain global economies. REIT stocks in particular underperformed much of this year, trading at a 5% to 10% discount to net asset value. 

Those discounted share prices have led to REIT market consolidation through mergers and acquisitions as investors search for cost-effective ways to increase market share and expand their presence both domestically and globally. The globalization and institutionalization of real estate has aided the aggressive M&A market as deep-pocketed institutional investors, private equity giants and sovereign wealth funds look to get into the commercial real estate space.

Single-asset sales fell 6% during Q2 to $85.9B, while portfolio deals accounted for $32.2B of total deal volume, up 27% year over year, according to data from RCA.

“One thing interesting to me is even though [sales volume is] flat, when we dig beneath the numbers it’s a little dicier. Look at the sale of individual assets … that kind of activity is down. What’s up is deep-pocketed investors coming in and buying entire portfolios or whole companies at once,” Costello said. 

Retail To Rebound?

Investors were particularly bullish in the office, retail and industrial sectors, according to RCA data, closing $28.4B, $20.3B and $17.1B in deal volume in Q2, respectively. 

Retail sales were up 38% year over year in Q2 to $20.5B, and up 1% year to date to $34.2B. But Unibail-Rodamco’s acquisition of Westfield accounted for the majority of retail sales volume in Q2, Costello said.

“When you strip all that out, single-asset sales were down,” he said. 

Paris-based Unibail completed its $16B purchase of Westfield earlier this year and the combined company, dubbed Uniball-Rodamco-Westfield, is now one of the largest shopping center owners in the world. Its portfolio is valued about $72B. The mall owner now has a portfolio of roughly 104 properties, including some of the most high-end, well-known assets across the globe, including New York’s Westfield World Trade Center and the Les Quatre Temps in Paris. 

Though the sector continues to suffer from retailer bankruptcies and store closures, some believe its strong fundamentals in certain coastal markets, lack of new supply and steady absorption rate could bode well for retail transactions in the second half of the year, JLL reports.

Grocery-anchored centers, in particular, are stable, and demand for these assets continues to outpace supply. Cushman & Wakefield reports that neighborhood grocery-anchored properties accounted for the majority of Q2 retail absorption, with tenants occupying 3.7M SF during the quarter. 

“Sellers are under more pressure to sell, than buyers are to buy. There is tremendous opportunity unfolding to buy quality retail at a discount to historical values — at the asset level and in the public markets — REITs are trading at 2008 levels,” JLL President of Retail Advisory Services Naveen Jaggi said in a recent report. 

Industrial Booms

Industrial real estate remains a favorite among investors, even at this late stage in the cycle. Investment sales volume for industrial assets rose 16% in Q2 to $18B; year-to-date industrial transactions have reached $39.2B. 

The industrial market continues to benefit from demand from retailers and e-commerce players in need of distribution and warehouse facilities close to densely populated city centers. The goal is to reach that last mile, enhancing operators' ability to get more products to more people in less time. 

Prime logistics rents for top-quality warehouse and distribution space across the world increased 3.2% in Q1, and in the Americas prime rents were up 3.8% year over year in the first quarter, according to data from CBRE. 

“In the Americas, supply chain and e-commerce dynamics have fueled rent growth at different rates across the region," CBRE’s Global Industrial & Logistics Prime Rents report states. "The U.S. and Canada have led the way, with users aggressively leasing space in response to both persistent economic and structural shifts brought about by e-commerce."

Some experts caution that the looming trade war could pose risks for the sector, though that has yet to materialize. 

And Then There Were Three …

While hotel transactions were up 18% to $9.1B in Q2, office and multifamily transactions declined during the quarter. 

Office sales fell 17% to $28.8B in Q2 ($11.1B CBD; $17.8B suburbs), and apartment sales were down 7% to $34.2B during the quarter. 

The hotel market is pacing well this year, having adjusted to the threat of high new supply levels and growing competition from home-sharing companies like Airbnb. 

Investors transacted about $24B in hotel deals last year — down significantly from the 2015 peak of nearly $45B. Halfway through the year, investment activity has almost exceeded 2017’s levels; year-to-date hotel transactions increased 39% to $20B. 

The sector broke its 100-month record for consecutive monthly revenue per available room growth in June, and other key performance indicators such as occupancy levels and average daily rates were growing as well. 

Office sales, on the other hand, are lagging. Several factors have led to a pullback in investment activity in the sector, including employers' more enhanced focus on efficiency in space usage.

“[This] is limiting demand and causing vacancy rates to creep higher,” LaSalle reports.

Multifamily investment has slowed, despite new deliveries tapering off this year. After a six-year streak of nearly record-level completions, only 283,000 new apartment units are expected to deliver this month, according to data from Yardi Matrix, down 11% compared to last year.