CRE N Illinois

For the first half of 2019, cap rates remained stable

For the first half of 2019, cap rates remained stable,ph1

Thanks to moderate growth, low inflation and falling long-term interest rates, cap rates for commercial real estate assets held steady in the first half of 2019. In Chicago, two sectors have a favorable outlook as they came in below the national average.

According to the CBRE North America Cap Rate Survey, multifamily and industrial cap rates tightened the most in H1 2019, with office, retail and hotel cap rates exhibiting modest movement. Though there was mixed sentiment for the hospitality sector, the report’s authors expect cap rates to generally remain stable for the rest of 2019.

“While the fortunes of the global economy should be watched closely due to increased tensions over trade with China, Persian Gulf hostilities and the prospect of a hard Brexit, there seems to be sufficient economic momentum and monetary policy flexibility in the U.S. to sustain real estate prices,” said Richard Barkham, global chief economist, CBRE.

Despite the heightened tensions brought on by geopolitical factors, Barkham hasn’t seen evidence that investors are overly concerned. Instead of hitting the pause button, they have instead shown a strong appetite for real estate from debt and equity capital.

During the Chicago market’s first half of 2019, cap rates remained broadly stable. Class A industrial and neighborhood retail, however, signaled strong investor sentiment as cap rates in those sectors posted below the national average.

Industrial

Class A industrial and logistics cap rates declined 5 bps in H1 2019 to 5 percent, the lowest level since CBRE’s Cap Rate Survey began in 2009. The average rate for acquisitions of all tiers and classes of stabilized assets for fell to 6.27 percent as cap rates and returns on cost for the sector remained at historically low levels.

In Chicago, Class A cap rates fell as low as 4.5 percent. Although cap rate decreases by class were modest on average, they confirm investor preferences for Class B assets in Tier II and Tier III markets where the largest cap rate compression occurred.

“Industrial activity in Chicago remains strong and investors recognize it as a very strong market,” said Ryan Bain, senior vice president of capital markets with CBRE in Chicago. “Infill properties still remain the most popular options for investors and we continue to see local, national and international investors making moves in the Chicago region.”

Retail

As investors continued to display interest in stabilized grocery-anchored neighborhood/community centers, cap rates for these properties remained stable at 7.48 percent. High-street cap rates were relatively stable and remained the lowest of all retail property categories at 4.76 percent. On the other hand, big-box and other retailer closures continued to influence the perceived risk profile for power centers, with average cap rates increasing by 6 bps to 8.45 percent.

In Chicago and beyond, demand for high-quality retail assets was strong. Throughout the North American survey, Class A retail product ranged from 4.76 percent to 7.16 percent. Chicago recorded Class A rates at 5.5 percent, below the national average of 6 percent. Over the next six months, retail cap rates are expected to see relatively uniform movement across all segments.

“Urban retail continues to be popular with investors, particularly in emerging neighborhoods where owners and developers can repurpose older facilities to cater to new residential and office growth,” said Keely Polczynski, senior vice president of capital markets with CBRE in Chicago. “Myriad omnichannel retailers have rapidly expanded in these new markets and food and beverage users continue to report robust sales, giving investors a lot of confidence.”

Office

Stabilized downtown office property cap rates decreased slightly to 6.67 percent. In the suburbs, stabilized office cap rates remained at 7.91 percent, supported by improving market fundamentals. Spreads to CBD cap rates are near their highest levels this cycle, however.

“Office cap rates should remain stable for both CBD and suburban properties over the next six months, supported by strong tenant demand for space, favorable investment sentiment and expectations for stable or decreasing interest rates,” said Chris Ludeman, CBRE’s global president of capital markets.

Many investors have exhibited a shift toward high-quality properties in secondary markets. Class AA properties in Tier II markets registered the largest decrease in H1 2019, down 12 bps.

Multifamily

According to the CBRE survey, multifamily cap rates and expected returns on cost maintained record lows. Cap rates for urban infill stabilized assets averaged 5.20 percent in H1 2019 and expected returns on cost for infill value-add acquisitions averaged 5.95 percent. Suburban stabilized assets priced at 5.49 percent on average, while expected returns on costs averaged 6.23 percent.

“Multifamily cap rates are at historically low levels, confirming positive pricing trends and sustained investor interest in the sector, and a willingness to acquire assets at low cap rates,” said Brian McAuliffe, leader of CBRE’s multifamily capital markets business for the Americas.

Cap rate spreads between Class A and Class B, and between Tier I and Tier II markets remained tight. This suggests that some investors are trading class for value, finding better opportunities in lower-quality assets as well as in secondary and tertiary markets.

Hospitality

Hotel cap rates remained stable in H1 2019 at 8.28 percent, with the most dramatic increases occurring among full-service and economy segments in Tier I cities. Cap rates in Tier I suburban locations for full-service hotels increased by 20 bps to 8.02 percent. Every market segment in Tier III cities recorded declines in hotel cap rates, led by a 10 bps drop in the economy segment.

This late in the cycle, operating fundamentals are creating downward pressure on investment activity which is down almost 50 percent from 2018. The cap rate volatility between markets isn’t necessarily driven by changes in sales composition, however, but rather actual movements in capitalization rates.