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Improving Fundamentals Driving Up Property Profits and Values
CoStar Group By Mark Heschmeyer May 27, 2015
Commercial real estate owners posted strong net operating income (NOI) growth last year. For the properties reporting year-end 2014 financials, NOI grew by 2.8% on average, compared to growth of 2.64% in 2013, according to Wells Fargo Securities.
Wells Fargo based its analysis on NOIs reported by properties collateralizing loans in conduit CMBS transactions. More than half of those properties have now reported full-year 2014 financials.
If the growth rate holds among the remaining properties yet to report, it would mark the second highest level of NOI growth since the financial crisis, only falling short of the 3.43% NOI increase seen in 2012.
As Wells Fargo notes, the continued growth in property NOI is further improving collateral performance in the CMBS arena. Term defaults and maturity defaults declined considerably in 2014 and remain low to-date in 2015.
Examining the NOI data by property type, Wells Fargo found that hotel properties are showing the highest year-over-year growth at 11.93% in 2014, up from 7.67% in 2013 and 9.12% in 2012.
Hotel property prices bounced back in 2014, according to year-end analysis in the CoStar Commercial Repeat Sale Indices (CCRSI). CoStar’s Hospitality Index surged upward by 17.7% in 2014 after relatively flat growth of just 0.6% in 2013. National hotel occupancies have reached their highest level since the mid-1990s, fueling room rate and RevPAR growth as well as investor demand.
Thus far, office properties are reporting the lowest NOI growth for 2014 among the property types at 1.12%.That is up about one-tenth of a percentage point from the previous two years.
CoStar’s CCRSI also shows improving fundamentals supporting the price growth of its office indices. Pricing in the Office Index increased 9.5% in 2014 and the Prime Office Metros Index advanced by a similar 9.2% rate over the same period as investor interest continued across both core and non-primary markets.
Overall office market fundamentals improved significantly in 2014 as office vacancy decreased to 11.3%, from 11.9% in 2013. Despite a moderate pickup in development, net absorption grew even more strongly, up 40% from 2013 levels, suggesting diminishing headwinds from both shadow supply from the last recession and the trend among employers to reduce office space per employee.
NOI growth rate among multifamily properties continues to increase but at a more moderate rate, up 4.29% in 2014, from 4.97% in 2013 and 5.82% in 2012, according to Wells Fargo.
Last year, multifamily values exceeded their previous peak, according to CoStar. Multifamily pricing continued to expand, growing 11.7% in 2014. The Multifamily Index was the first property segment to enter a recovery phase, driven by a greater availability of debt financing and investor demand for well-leased assets in core coastal markets. However, most apartment markets are now in the expansionary phase of the cycle, where elevated construction levels are beginning to exert pressure on occupancies and rent growth.
Industrial property NOIs appear to have bounced up from 2013 to a 2.4% increase vs. 2.2% a year earlier but down from 2.9% in 2012. Notably, though, self-storage properties are posting the second-highest NOI growth rate at 7.2%.
Industrial property prices advanced by a solid 11.9% in 2014, according to the CoStar CCRSI. Industrial vacancy fell to 6.8% in 2014, 80 basis points below the 2007 cyclical low of 7.6%, and construction added only 106 million square feet in 2014, well below the 159 million square feet of net absorption. Because of the segment’s low vacancy level and relative lack of supply, industrial rent growth, usually unremarkable, remained the strongest of the four main property types throughout 2014, posting a 4.3% increase for the year.
Thus far, the NOI growth rate for retail properties in 2014 at 1.82% is slightly lower than 2013’s at 1.94%, according to Wells Fargo.
As for property pricing though, CoStar’s Retail Index posted the largest gains in 2014. The overall Retail Index posted a 13.9% increase in 2014, the most impressive gain among the four major property types, as pricing ramped up in response to improving market fundamentals. Pricing gains aggregated in the core coastal markets over the last year. With development largely quiet, retail demand outpaced supply by a two-to-one margin in 2014. This dropped vacancies 20 basis points to 6.3% in the fourth quarter of 2014, the lowest rate in more than six years, while annual rent growth remained steady at nearly 3%.
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