Is This Normalcy?

The Latest Transaction Data Show a Healthy Commercial Investment Real Estate Market in 1996.

If there were any question in the minds of the public about the return of investor interest to the commercial property realm, the data compiled for the first two issues of the new CCIM/Landauer Investment Trends Quarterly should surely lay to rest such anxiety. With the compilation of statistical information just beginning in January 1996, by late May the size of the database had risen to more than $13 billion in transaction volume with 1,432 deals represented in the sample.

This information offers a unique opportunity to understand the dynamics of the property markets in the United States and Canada and could soon become the standard for interpreting the behavior of investors at all levels of the real estate industry. The sheer size of the statistical set is eye-catching, even in its infant stage. For example, 79 million square feet of office transactions that have closed since January 1, 1995, are contained in the database, as are 24 million square feet of stores and 24 million square feet of industrial properties. Other property types are equally well represented. More than 31,000 units of multifamily residential transactions and 22,000 hotel rooms have been posted already, as have land transactions covering 7,500 acres.

What are the results discernible in early 1996, and how do they compare with the activity in the investment markets during 1995? Who are the players? What are they buying? What are the trends?

Investment Jockeying
Offices repeated their standout performance as the leading property sector, with 23.4 percent of the total deal count and 41.3 percent of U.S. dollar volume. The 101 office acquisitions entered into the database for the first quarter amounted to more than $1.3 billion. While less dramatically dominant than the 34.7 percent deal share and 50.5 percent of dollar volume registered in the revised 1995 totals, the first-quarter data resoundingly confirm investors' choice of offices as a preferred real estate vehicle in the current industry cycle. In a mere 15 months, deals submitted to the CCIM/Landauer database add up to more than $6.2 billion of investment in the office sector.

Multifamily investments ranked second in terms of both number of sales (18.1 percent of all deals) and in amount invested ($544 million, or 16.9 percent of total) during the early months of 1996. Apartments stepped up in rank, compared with the previous year's totals, when multifamily properties were fifth in the number of sales and fourth in total dollar volume. Broad-based buying activity characterized apartment investments for the first quarter, with virtually all buyer groups committing funds. Private investors led the list of purchasers, with more than $200 million in acquisitions for the three months, but real estate investment trusts (REITs) and other capital intermediaries were also active. Insurers were the biggest net sellers of apartments, followed by pension funds.

Challenging the proposition that shopping centers face a moribund future, investors committed more than $506 million in transactions logged for the first quarter, ranking just behind apartments in dollar volume. With 16.7 percent of the deal count, retail properties slipped a slight amount-two percentage points-in their slice of the national pie when compared with 1995's revised totals. The market does appear to be acknowledging the greater perceived risk in this sector, as both the mean and median cap rates rose 30 basis points, to 10.9 percent and 10.6 percent respectively. However, this statistical rise primarily reflects the higher weighting of neighborhood and strip centers represented in the first-quarter sales. Land sales recorded into the database indicate that retail-oriented development has not fully run its course. Chains such as Home Depot and Payless Shoe Source, as well as fast-food companies like McDonald's and Burger King, continue to lock up sites as they seek even greater market saturation.

The industrial sector, which includes warehouses, light manufacturing, and research and development facilities, ranked fourth in the number of firstquarter 1996 transactions (70, or 16.2 percent of total) and fifth in dollar volume ($333 million; 10.3 percent of total). By both measures, industrials increased their share of national activity when compared with the 1995 benchmark data. Sales of large facilities of 100,000 square feet or more factored more heavily into the first-quarter data, but even adjusting for the change in the mix of properties sold, capitalization rates for industrial registered a distinct drop. The median cap rate for this property type was 10.1 percent for the first quarter. Not long ago, U.S. industry had been given up for dead. Now, surging exports, soaring industrial production, and a rapid inventory cycle are pumping up interest in this once-bland part of the investment real estate market.

Capital commitments to the hotel sector were a solid $312 million (9.7 percent of total) in the quarter, impressive given the small deal count (24 transactions, or only 5.6 percent of all deals submitted). At $86,772, the weighted average price per room rose 6.5 percent above the 1995 average. Cap rates appeared to remain fairly steady, with the first-quarter median of 10.0 percent very close to the 1995 midpoint of 10.1 percent. Hotels were a stunning $1.6 billion component of the 1995 sales profile. There may be some seasonality to the transaction patterns for this property type, and the severe 1996 winter may be affecting deals this year. Many properties suffered as travel was impeded, and sellers may be inclined to let the slack occupancy statistics age a bit before marketing hotel/ motel properties. For now, the activity is largely in resort areas or in cities with vacation appeal to supplement their business travel customers. Hotel professionals, including the major chains and REITs, are big players.

Where the Action Is
The geographic distribution of the first-quarter transactions shifted noticeably from the 1995 pattern. The leading regions of the nation are still the Southeast and the Pacific, both by deal count and by dollar volume. The Southeast defended its top ranking, posting 123 first-quarter sales with an aggregate price of $945 million, or 29.3 percent of the total dollar volume. As in the 1995 totals, the West Coast ranked second by both measures, with 84 deals totaling $727 million, or 22.5 percent of the national total prices. In fact, these leading regions actually increased their capture rate of the overall dollar amount of sales. Of particular note is the return of foreign investment as a significant share of Pacific regional property buyers and the intense focus of REITs on the Southeast. Some will see a case of "the rich get richer," or investor herd instinct. Others will note that the geographic allocations are a rational bet on future growth prospects.

Those opting for the latter reasoning will find support in the step-up of investment flows into the Mountain states. The revised 1995 data measured regional activity here at 9.0 percent of total deal count and 6.9 percent of aggregate national sales prices. The comparable first-quarter 1996 figures are 12.3 percent of the number of transactions and a robust 15.5 percent of dollar volume. Regardless of the outcome of the classic debate about whether jobs follow people or people follow jobs, real estate investment dollars now are following both to the fast-growth states of Colorado, Nevada, Arizona, and Utah. At present, the buying activity here appears to be more entrepreneurial than institutional.

At the other end of the scale, the Mid-Atlantic and Great Lakes states are ceding share in reported first-quarter sales. With only $235 million and $162 million, respectively, in total transaction volume, these regions are far below their proportionate levels based on population and employment. For the Mid-Atlantic states, the sluggish results simply reflect fewer deals, as average prices for the region remain high and activity is concentr ated in the relatively richly priced office and hotel property types. The Great Lakes region, however, recorded 12.5 percent of the national deal count but only 5 percent of U.S. dollar volume, as the reported sales were concentrated in lower-priced industrial and land deals. New England, too, registered disappointing results, although a major mall transaction lifted the regional dollar volume considerably.

Who's Buying?
All categories of buyers and sellers recorded at least minimal participation during the first quarter, but the distribution of market operations was decidedly concentrated. Private investors and owner-users were by far the most frequent actors by deal count. But dollar volumes told a vastly different story.

In fact, REITs deserve prime attention in this quarter's analysis, because they posted nearly $1 billion in acquisitions, 31 percent of the total, on only 28 deals (6.5 percent of the deal count). The investment trusts went strongly upmarket in early 1996. If the national data favored the office sector, REITs were an important element in the story as they committed $473 million-nearly half their acquisition capital-to the office sector. Suburban office properties were favored, with prices typically ranging between $100 and $160 per square foot. Retail acquisitions were fewer, but the inclusion of a major mall in the REIT acquisition list ranked the retail sector a second focus of REIT spending in the first quarter. Seven apartment acquisitions were reported into the database with REIT buyers. In the multifamily sector, the trusts preferred complexes of approximately 200 units, buying at cap rates in the low 9 percent range, at prices typically in the realm of $55,000 to $65,000 per unit.

Funds pooled in limited partnership vehicles accounted for $330 million of the buying activity in the quarter, with an average purchase price of $10 million per deal. Sun Belt suburban offices were also favored by these buyers, who allocated $179 million to the office property type. The limited partnerships placed a heavier bet on future capital appreciation, accepting a comparatively low 9.5 percent average cap rate for their office buys, but hedging the risk in a $79 per square foot weighted average price in a "return to replacement cost" strategy. The partnerships also committed a comparatively economical $35,608 per unit average price for their multifamily acquisitions, but demanded better going-in returns, at an 11.1 percent median rate. In industrials, the limited partnerships bought research and development facilities on the West Coast and in the Mountain region, at prices around $60 per square foot.

Pension funds were the most one-dimensional of the buyer groups represented in the first-quarter data. The tax-exempt investors accounted for $263 million in acquisitions, and 80 percent of that amount flowed into office-related deals. The deals tended to be large and cap rates low. Suburban properties at prices averaging $105 per square foot were the typical pension fund acquisition. Industrials garnered $27 million in pension fund purchases, and retail was a distant third choice for these institutional investors.

For the private investor, apartments retained their traditional allure. Approximately $200 million of the $383 million spent by the class of individual investors was directed to multifamily properties. While their per-unit prices and capitalization rates were close to the national norm, deal size for the private investor was typically in the 100-to-120 unit range, or about half the size of the standard institutional purchase. Individual investors were underweighted in the office sector in the first quarter, with only $71 million committed to that sector. The office deals that were undertaken were small, economically priced at about $52 per square foot, and conservatively capitalized at 10.9 percent. The retail and the industrial property types each saw about $40 million in purchase money from the private-investor group. For industrials, private-investment interest was roughly proportional to the overall allocation from all buyer groups during the quarter. For retail, on the other hand, the individual investors displayed less-than-average interest. In fact, with the exception of multifamily properties, private investors were net sellers of property in early 1996.

Owner-users were very well balanced in buy-and-sell distribution in the first quarter, with purchases of $225 million and sales of $224 million. Industrials and offices accounted for the majority of the owner-user deals and dollar volume. As was the case for 1995, owner-users dealt in small properties fitting their immediate functional needs. Contrary to some perceptions that such buyers will pay a premium for the "right" space, the data indicate that such purchasers know the market quite well and pay prices close to the national norms as measured by price per square foot and capitalization rate.

Looking to the seller side of the market, the unwinding of the real estate cycle can be discerned in bold relief. The highest ratio of dispositions to acquisitions was posted by developers, whose sales of property represented eight times the volume of their purchases. Developers captured $424 million, more than 13 percent of all purchase prices received, versus acquisitions of $52 million. The only property type in which developers were net buyers was in land, and then only marginally so. Builders now appear able to move product that has remained in their inventories through the industry down cycle, as the spectrum of buyers has broadened. And, with the exception of offices, developers in the first quarter realized above-average prices when compared with the national means measured on a per-unit basis. These were not "fire sales," but properties emerging in an orderly disposition process.

Insurers and joint ventures each had a five-to-one ratio of sales to purchases, when measured by dollar volume in the first quarter. For each, offices were the primary components of their asset sell-offs. This concentration of property type looks shrewd, as offices continued their very high share of total investment commitments from 1995 into early 1996. However, while the joint ventures were able to realize a premium of 40 percent above the national average price per square foot for offices, the insurer deals show a subpar price per unit. Insurers were able to record better results in their multifamily dispositions, with a price per unit of $56,144, nearly 50 percent above the national mean for apartments.

Banks were the only other investor group to fall into the net seller category, with approximately $95 million in dispositions. Offices and apartments were the most commonly sold assets, at discounts to the national average prices of 10 percent and 20 percent respectively. These properties were typically real-estate-owned assets that lenders needed to get off their books. The geographic spread of the sales was very wide, with the Mid-Atlantic, Great Lakes, Southeast, and Pacific regions all significantly represented. Sales of foreclosed-upon assets truly appears to be winding down for the depository institutions, though, as reflected in banks' comparatively small 3 percent share of total disposition dollar volume.

Capitalization Rates
The distribution of capitalization rates showed signs of shifting in the first quarter when compared with 1995's evidence, with the greatest movement in the industrial and apartment sectors. A simple comparison of median cap rates by property type merely points the way to more-meaningful analysis. Industrials, for example, saw their median cap rate drop from the 1995 level of 11.0 percent to the 10.1 percent mark in the first quarter. The increased share of total sales volume represented by industrials has already been noted, and greater capital flows would be expected to drive down going-in rates of return. Even more interesting is the very narrow range for industrial cap rates displayed in the "box and whisker" graph above. Only 180 basis points separate the 25th percentile (at 9.8 percent) from the 75th percentile (11.6 percent) in the range of cap rates. This is the narrowest of the ranges among the property types. Thus, the range of rates has tightened and shifted to the left as investor interest intensified.

The apartment market moved in the other direction. Its range of rates has broadened and shifted to the right. The median cap rate for multifamily deals in the first quarter of 1996 was 10.4 percent compared with the 1995 midpoint of 9.4 percent, with 220 basis points separating the 25th and 75th percentile rates. The rise in rates is consistent with the profile of buyers and sellers. Insurance companies and pension funds were net sellers of apartment assets, while private investors were net purchasers. Typically, small investors have higher going-in return requirements than do institutions, so a period in which private investors are primary purchasers and institutions are disposing of properties should see upward movement in rates. Changes in median cap rates for offices, hotels, and retail properties were not significant, given the size mix of the sample and the volume of transactions recorded.

Bigger and Better
There is tremendous potential for ever more sophisticated analysis as the CCIM/Landauer database matures. The two collaborating organizations foresee the potential to gather information on 5,000 sales exceeding $25 billion in aggregate price annually. Familiarity with and insight into the trends, motivations, and preferences demonstrated by the buyers and sellers in the marketplace, especially the nuances of pricing parameters like the relationship between cap rates and property sizes, or the geographic preferences of national and international institutions, should position real estate professionals to take advantage of market movements previously shrouded in the mists of mere rumor or vague intuition. More and more, clients can look for guidance to deals done "by the numbers."

Hugh F. Kelly, CRE

Hugh F. Kelly, CRE, is chief economist at Landauer Realty Group/a Grubb & Ellis Co. in New York. Contact him at (212) 326-4950 or Portions of this article were excerpted with permission from the 2001 Landauer Real Estate Market Forecast. 2001 Legislative Preview Several important legislative issues likely to be debated in federal and state governments in 2001 could affect the way commercial real estate professionals conduct business. This outlook offers information on a few relevant initiatives regarding business practices, tax issues, and telecommunications. Professional Appraisal Practices The Uniform Standards of Professional Appraisal Practice details requirements for professional appraisal practice, which includes appraisal, appraisal review, and consulting. In July 2000, the Appraisal Standards Board approved a draft of proposed USPAP changes. The resulting 2001 document may be problematic for commercial real estate professionals involved in practices that include some component of value. For example, the new definition for valuation services states that they “pertain to all aspects of property value and include services performed both by appraisers and by others.” States use USPAP as a foundation to draft legislation. Thus, state real estate boards may consider adopting all or part of the 2001 USPAP. The USPAP definitions are broad enough that if a state were to adopt its language, commercial real estate professionals could be required to obtain an additional appraiser license to complete tasks involving the determination of value. These could include market and financial analyses, litigation support, feasibility studies, and acquisition or disposition analyses and due diligence. Taxation Depreciation. The U.S. Treasury Department released a long-awaited report on the depreciation system in July 2000 as directed under the Tax and Trade Relief Extension Act of 1998. The study is considered a starting point for discussing improvements to the U.S. cost-recovery system. Under current law, the investment cost of commercial real estate may be recovered over 39 years, which the study concluded is unnecessarily long. Congress could draft legislation this year to adopt a shorter recovery period, which would make commercial real estate a more economically viable option for potential investors. While the study does not include legislative recommendations, it does identify issues for a more-workable system and fleshes out possible improvements. Suggested improvements include devising a system based on economic depreciation, indexing depreciation deductions for inflation, and updating the asset classification system. Congress likely will debate these issues and draft legislation updating the depreciation rules. Tenant Improvements. Commercial real estate professionals can expect to see legislation reintroduced this year regarding tenant leasehold improvements. Two companion bills were held back in 2000 awaiting the outcome of the depreciation study. Currently, the cost of improvements that a landlord makes for a tenant must be amortized over the life of the property, which is 39 years for depreciable commercial real estate. The depreciation study notes that these cost-recovery rules for tenant improvements are economically unrealistic and should be reviewed. Legislation introduced last year permitted the costs of tenant improvements to be amortized over 10 years; therefore, it is likely tenant improvements will continue to be debated along with other depreciation issues in 2001. Telecommunications Mandatory telecommunications access to buildings continues to be an important issue to property owners. In October 2000, the Federal Communications Commission ruled against forcing nonresidential building owners to provide unrestricted access to all telecommunications service providers. Instead, the FCC will monitor the real estate industry\'s pledge to promote competition among telecommunications companies. The FCC\'s ruling leaves open the possibility of future requirements if it finds that the real estate industry\'s plan isn\'t working. In addition, individual states are considering other regulations, including rules for satellite dish placement and unfettered access to inside wiring. While state initiatives have been defeated in the past, telecommunications issues will continue to draw debate at both the state and federal levels. Legislative ResourcesCommercial real estate professionals can learn more about these and other issues in the Legislative News Library on the CCIM Institute\'s Web site (, which includes Legislative Bulletin issues and a Statement of Policy and Current Positions. — by Cheré LaRose-Senne, the CCIM Institute\'s legislative analyst. Contact her at (312) 329-6033 or