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U.S. Commercial Property Values Surge in Niche Sectors

July 17, 2018

https://www.wsj.com/articles/u-s-commercial-property-values-surge-in-niche-sectors-1531825204

 

Student housing, manufactured homes and industrial property were the top performing commercial real-estate sectors in the past 12 months, according to new data from Green Street Advisors.

 

These three sectors outperformed the broader commercial property market, which saw values remain flat between June 2017 and the end of the first half of this year. Meanwhile, values fell 10% in the hard-hit retail sector during the 12-month period, according to Newport Beach, Calif.-based Green Street, which tracks the market with its Commercial Property Price Index.

 

The index monitors office buildings, malls, warehouses and other commercial property owned by real-estate investment trusts. REITs tend to own larger and higher quality properties than many private landlords.

 

The latest data provides a window into the large rise in real-estate values since the recession, as well as investor sentiment about different types of property as the current business cycle moves into its ninth year of growth.

 

The Commercial Property Price Index was at 100 in August 2007, its pre-2008 crash high. It hit a low of 61.2 in May 2009.

 

Since then, the index more than doubled as the improving economy pushed rents and occupancies higher and demand strengthened from yield-hungry investors who could borrow money easily due to low interest rates.

 

Ahead of the PackTop-performing U.S. commercial propertysectors over the past year through July 1,compared with the industry average andslumping retailChange from previous yearSource: Green Street Advisors*Weighted averages for the five major propertysectors (apartment, mall, industrial, office and stripcenter).

 

But broad market values plateaued at the end of 2016 and have hovered at that level since then. In June, the broad index remained unchanged from the month before at 126.9.

 

The plateau is partly due to rising interest rates, said Peter Rothemund, a senior analyst at Green Street. Rising interest rates make it more expensive finance purchases and make the bond market relatively more attractive compared with property.

 

Investor demand for commercial real estate has also begun to slow as their concern rises that the economic expansion may be running out of steam. In the first five months of 2018, investors bought $176 billion worth of U.S. commercial real estate, down 2% from a year earlier, according Real Capital Analytics.

 

But there are exceptions to these broad market trends. Investor appetite has remained strong for industrial property, which has experienced a 12% increase in value since June 2017, according to Green Street. Rents and occupancy rates have been particularly strong in this sector—which includes warehouses and distribution centers—thanks to growth in e-commerce.

 

Big industrial deals this year include Prologis Inc.’s agreement to buy logistics-property owner DCT Industrial Trust Inc. for $8.4 billion including debt. Also, private equity giantBlackstone Group LP is buying industrial and office REIT Gramercy Property Trust for $7.6 billion, including debt. Blackstone’s offer represents a 15% premium over Gramercy’s closing stock before the deal was announced.

 

“The general thesis around future property values increases [is] that industrial rents are growing at an especially fast pace above inflation throughout most of the U.S.—even with a healthy amount of new construction,” said Eric Frankel, a senior Green Street analyst in an email. “Investors generally assume this will continue as e-commerce sales grow.”

 

Student housing also performed well over the past 12 months, chalking up a 10% increase in value, Green Street said. These properties are considered to be more recession-resistant than other asset classes because even in an economic downturn, college enrollments are expected to remain steady.

 

Manufactured-home parks also remained a popular niche sector among investors. They require low capital costs and tend to be supply-constrained because community groups and local governments in recent years have slowed permitting processes.

 

According to Green Street, manufactured-home values rose 10% in the past 12 months. The firm’s index tracking only that sector hit 178.3 at the end of June, compared with 158.5 in June 2017.

 

“You wind up increasing rents 3% a year regardless of what the economy is doing,” Mr. Rothemund said.

 

But conditions aren’t as sunny in other sectors. Values of malls and other shopping centers have stayed under pressure as consumers shop more online.

 

Mall values in June have fallen 9% over the last 12 months and 18% since the end of 2016, according to Green Street.

 

Merger-and-acquisition activity and portfolio deals, rather than single-property transactions, have driven most of the value changes for malls, said DJ Busch, Green Street’s lead retail analyst.

 

In one of the biggest retail deals this year, Brookfield Property Partners LP said it would buy the remaining stake in mall owner GGP Inc.  that it didn’t already own. The price that Brookfield is paying is lower than some analyst expected, a sign of pressure on even top-quality mall portfolios. GGP shareholders are expected to vote on the merger proposal on July 26.

 

Determining values for retail properties has become somewhat of an art because there haven’t been many sales transactions, analysts have said. Some owners are sitting on the sidelines, choosing to refinance their properties instead of trying to sell, said Jim Costello, a vice president at Real Capital Analytics.

 

“Why bother if I have the best mall and I’m still cash flowing?” Mr. Costello said. “Why sell and test the market price when everybody is trying to bid you down?”

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