As cap rates begin to stabilize, investors are showing more confidence in the commercial real estate market than at any point in the last two years, a new report from New York-based PricewaterhouseCoopers shows.

Although transactions are expected to be lower in 2010 than at the peak of the market, the report released today projects marked improvement over 2009, with the apartment sector leading the recovery effort.

Cap rates, which gauge expectations of property income and value, not only show signs of leveling off, they have even declined slightly in some markets for quality assets, according to the PricewaterhouseCoopers' Korpacz Real Estate Investor Survey.

As cap rates become more attractive to investors, that trend is expected to help stabilize commercial property values. Survey participants project that over the next six months, overall cap rates will hold steady in 19 of the 30 markets surveyed. Last quarter, the survey projected stabilization in only two markets.

“The worst seems to be over, according to survey participants, as investors suggest that the bottom is near, if not here, particularly for better-positioned markets and assets,” said Susan Smith, director of real estate advisory practice at PricewaterhouseCoopers, and editor-in-chief of the survey.

Commercial real estate fundamentals also are expected to moderate in the remainder of this year. Across property types, occupancy and rental rates have deteriorated significantly in the past 24 months, but the declines are not expected to be as severe in 2010 as they were last year, according to the survey.

“Following the onset of the recession and the credit crisis, underlying fundamentals were deteriorating and overall cap rates were expanding simultaneously and quickly, causing values to plummet,” said Smith.

Marketing pace quickens

In the apartment market, the low end of the range for overall cap rates decreased 75 basis points this quarter to 5%, as investors showed up to bid for quality assets in healthier markets. In another good sign, the average time it took to market the assets declined in two survey markets, indicating restored confidence among many investors, according to the report.

Investors forecast that the apartment sector will be the first to recover, noting that some multifamily assets already are showing slight value increases. The office and retail sectors, meanwhile, are more deeply mired in the economic doldrums, and affected by nationwide job losses.

Survey participants said that owners and lenders finally are coming to agreement on the value of properties, overcoming at least in part, the bid-ask stalemate over prices that has impeded many transactions for more than a year.

Because of the new willingness of buyers and sellers to reach agreement on price, the report says that sales are likely to increase markedly over 2009 levels.

The report showed optimism about the lending climate as well. Banks appear more willing to lend, although underwriting remains very conservative and more equity is needed to secure debt, the report says.

But there is plenty of pent-up demand, and some investors are flush with money for acquisitions. “There is a tremendous amount of capital seeking real estate opportunities, and now is still a great time to buy,” said Smith.

In a number of markets, good deals can be found, including distressed assets. “Many investors in our survey still anticipate incurable deleveraging issues on the part of both lenders and owners to provide opportunities to acquire quality assets at below-peak pricing, and there’s strong competition among buyers for such deals,” said Smith.

Looming debt maturities are expected to pose major problems for owners and lenders, pressuring owners to sell at distressed prices. Although lending institutions and special servicers of commercial mortgage-backed securities are likely to provide some of the forced sales, other sources will also fuel the transactions, said Smith.

“More distressed selling will likely come from borrowers, who are more comfortable with where the market is now and will accept a loss in order to move on,” she said.