Scratch August as the hottest month of the year. With $28.2 billion in closedlast month, September 2005 now stands as the high-water mark for monthly investment sales volume of apartment, retail, industrial and office properties. That record monthly total also represented an $8.8 billion increase over September 2004 sales volume, reports Real Capital Analytics (RCA). The previous record was December 2004, when sales volume hit $25.4 billion.
“We saw a deluge of offerings come to market in August, and buyers aggressively pursued them in September,” says Dan Fasulo, director of market analysis at RCA. He adds that August saw $15 billion in sales volume, or roughly half that of September.
One recent closed deal in Venice, Calif., illustrates the lengths that investors will go to buy properties in hot markets such as Southern. The Lincoln Rose Shopping Center fetched $12.7 million in a competitive auction, but the more surprising bit is the cap rate. According to the buyer’s agent, the property will yield only a 2.61% return over the next few years.
To be sure, the strip center is 100% occupied by a tenant roster that includes Sav-on, Big Lots and Foot Locker. Los Angeles-based Combined Properties was apparently comfortable with such a puny yield on this value-add deal. The property will suffer from a combination of low market rents and lease expirations over the next two years.
“Although the buyer will get a low return for the next few years, Lincoln Rose Shopping Center offers an intrinsic long-term play with a significant potential upside one to three years down the road,” says Richard Walter, president of Irvine, Calif.-based salesFaris Lee Investments.
With sales volume rising, cap rates continue to fall. Average cap rates for all U.S properties above $5 million have fallen from 10% to roughly 7% over the past 19 months, according to RCA. The question is when will cap rates stabilize or actually begin moving up.
Fasulo says that investor optimism — which remains strong — is playing a part. “Most real estate investors are expecting higher returns in the future. That’s not entirely because of improving fundamentals, which have been sporadic between markets,” he says.
While skeptics fear that low cap rates are a byproduct of unbridled speculation, Fasulo says that some logical forces are really at work. First, the re-allocation of capital into real estate continues unabated. What began four years ago as a smaller pool of investors eyeing real property assets has mushroomed into institutional and foreign investors clamoring to increase their stake in real estate. That trend has shown no signs of slowing down, and the bench of investors looking to allocate funds into real estate has never been deeper.
The second most important factor may be an improving real estate market. In both the apartment and office market, vacancy continues to fall. Reis, Inc. reports that national apartment vacancy dropped from 6.9% to 6.4% between mid-year 2004 and 2005. The national office market, which has benefited from choppy job growth, also saw its vacancy rate fall from 17.8% to 15.6% over that period — a three year low, according to Grubb & Ellis.
“There’s just so much capital coming from so many different sources. If you go back 10 years, a trophy property listed at $100 million would only attract a handful of players,” says Fasulo. Nowadays that trophy has multiple bids on it before it even hits the market. Rational or not, this widespread demand may be persuading investors to offer up properties while steep returns are still possible.
Joseph Genovesi, chief executive officer of national real estate services firm NAI DG Hart, equates this “heavy froth” to growing anxiety that the market is turning. “I think people are getting anxious, and not just the sellers either,” he says. He believes that fundamentals have less to do with low cap rates than other factors such as the rush to catch this market while it’s hot.
Genovesi, of course, isn’t too upset about that trend. His firm has closed 10 major investment sales deals in the retail and industrial markets so far this year, double their number of transactions in 2004. “I wouldn’t be that surprised to see a stabilization in the market over the next few months,” Genovesi says. “But real estate continues to look pretty good versus the equities market.”