Investors are expecting a widespread rebound in U.S. commercial real estate markets, according to an analysis published Monday by the San Francisco Federal Reserve Bank.
With the two most widely followed measures of commercial real estate prices showing divergent trends since early 2010, economists at the San Francisco Fed turned to capitalization rates as an indicator of expected returns on commercial properties.
“Recent declines in these cap rates appear to be signaling a commercial real estate rebound, indicating improved investor expectations of price growth in the market,” said the San Francisco Fed’s economic letter.
The cap rate measures the ratio of net operating income to the price of a property and serves as a rough approximation of expectations regarding return on a property investment.
It can also be looked at as the commercial real estate equivalent of the price/earnings ratio of a stock, according to the San Francisco Fed: “The rent/price ratio is largely a function of interest rates and expected increases in the property’s price.”
After declining from 2004 to 2007 as investor expectations for price appreciation rose, cap rates jumped in 2008. “During the financial crisis, CRE prices dropped about 40% and the market for financing CRE transactions was severely disrupted, resulting in very high CMBS (commercial mortgage-backed securities) yields,” said economists Bart Hobijn and John Krainer in the economic letter.
After the crisis, “yields for top-rated credits more or less returned to normal,” they said. But since the summer of 2010, cap rates have dropped half a percentage point as high-rated CMBS yields have risen about 30 basis points. A basis point is one-hundredth of a percent.
“The decline in cap rates despite the slight increase in interest rates suggests that investor expectations for CRE price appreciation have strengthened,” the letter said.
Thus, the behavior of cap rates indicates that the market has priced in a slight rebound in CRE prices,” it continued. “This could reflect improved fundamentals, such as expectations that rents will increase, or improved investor sentiment, such as an ebbing of investor risk aversion.”
Price appreciation in Kansas City, Minneapolis, Salt Lake City and Austin, Texas, is expected to be about 2% higher than national trends would indicate, said Hobijn and Krainer.
Please feel free to contact me today for free counseling at(619)540-5811 .
By the way…if you know of someone who would appreciate the level of service in real estate weprovide, please call me or have them go to and I’ll be happy to follow up and take great care of them.