The Upward Pressure on Cap Rates

As things slow and credit becomes harder and harder to obtain, there's no doubt that buyers are in the driver's seat and will probably remain there for quite some time. As commercial property continues to experience depreciation, investors are demanding better cap rates. Not rocket science, obviously. I don't see this changing for the foreseeable future. From CRED..read on.

With sales activity throttled, property investors expect capitalization rates for the transactions that do close to significantly increase through early next year.

All property types will experience cap-rate gains over the next six months, exceeding the gains of the past year, according to the investors who participated in the latest PricewaterhouseCoopers Korpacz Real Estate Investor Survey. The survey polls REITs, pension funds, mortgage bankers, developers, insurers and other institutional investors.

Regional malls, with a current average cap rate of 6.78%, will see the biggest gain at 47.5 basis points, or 7% of its current base, and suburban office, with a 7.34% average, will see an increase of 44 bp, or 6% of its base. Since last year's third quarter, the suburban office rate increased just 10 bp, while the regional mall rate dropped 8 bp.

The cap rates of all other sectors are expected to increase by 5% each over the next six months.

Office cap rates are expected to increase in all 24 markets covered by the Korpacz study. But in six markets, the expected increase is less that the cap rate gains that occurred over the past year.

The office market with the biggest projected cap-rate gain is Houston, whose 7.27% average is expected to increase 79 bp over the next six months. Its average dropped 45 bp over the past year.

The Manhattan office market's average cap rate, which grew 18 bp to 5.7% over the past year, is expected to increase another 33 bp in the next six months.

While investors surveyed predicted cap-rate gains, they also said their confidence in a near-term recovery of real estate markets is diminishing. The survey's general consensus is that buyers and sellers will remain on the sidelines until credit-markets turmoil subsides.

They also expressed a strong sense that in the coming months, sellers will emerge with properties that are backed by maturing loans and are unable to find new financing. That could be significant since the head of CMBS research at JPMorgan recently noted that the emergence of such forced sellers may be a key factor in helping commercial-property prices fully adjust.

The Korpacz survey respondents also expressed a general sense that the investment slowdown induced by the credit crunch is lasting longer than most expected. "Our six-month recovery projection has been derailed by complete complexity and doubt," said one person surveyed.

The slowing economy and its potential to weaken demand for commercial space is further dragging down investor confidence. "Even all-cash buyers are hesitant about buying because no one is sure about near-term demand," said one respondent.

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