Historically, Property Values Don’t Increase Until Two Years After Sales Activity Rebounds
By Chad Littell
CoStar Analytics
November 27, 2023 | 12:56 P.M.
Since the Federal Reserve began raising its benchmark interest rate in March 2022, the U.S. commercial real estate market has seen declining sales. A wait-and-see approach permeates today’s market as investors digest potential future effects of higher borrowing costs.
As commercial property owners generally take a cautious stance by remaining on the sidelines, the price discovery process has yet to fully take hold. Therefore, an uptick in sales activity should carry with it the possibility that this increase in deal flow could pressure asset prices as the revelation of long and variable economic lags unfolds.
Taking a cue from the previous commercial real estate downturn, the next few quarters could very well be the low point in commercial real estate sales activity, as sidelined capital returns to scoop up discounted assets. Value-add and opportunistic capital comprise the lion’s share of the amount of committed but unallocated investment capital a firm has on hand, and its influence on asset prices has generally lowered the market’s center of gravity. Seven quarters have passed since transaction volumes began falling in 2022, and history suggests a bottom in sales velocity may be in store next year.
By way of illustration, in the first quarter of 2007, office deal volume peaked at 4,232 sale transactions before stubbing its toe with just 1,656 sales in the first quarter of 2009. It took two full years for office transaction counts to find a floor. In the following two-year period through 2011, transaction volumes rose 63% off their lows, yet the median office price per square foot continued to fall, dropping an additional 22% between the first quarter of 2009 and the first quarter of 2011. After a multiyear period of searching for price with little proof, hitting the gas on transaction flows exacerbated price declines as each new price point reinforced this downward trend.
Similarly, the industrial and retail sectors experienced a related pattern where two years of falling transaction totals were shadowed by two years of price discovery. From the second quarter of 2007 to the first quarter of 2009, the industrial market saw its deal flow shrink by 61%. Once the deal velocity returned to the market, increasing 74% in two years, industrial gave back another 16% of overall value before finding its footing and recovering in the first quarter of 2011.
Despite seeing transaction counts for retail properties recover in the first quarter of 2009 after 15 months of declines, it took nine quarters for retail prices to bottom out after sale transactions rebounded by 119%. The median retail price per square foot established a new cycle low in the second quarter of 2011 after giving up an additional 18% of value as lower sale comparables reinforced the pricing trend.
However, the multifamily sector stands apart from other major asset types in bucking this trend. Due in part to its 12-month lease structures, rental apartments are the most sensitive to swift economic changes as it was the first-in and first-out of the last downturn. The process of two years of slowing transaction volume and two years of price declines also held true for multifamily, but the unique aspect of this sector is that these two-year periods overlapped — they happened simultaneously.
Pricing in the multifamily sector bottomed after just two years of declines coming out of the Great Recession. This short but pronounced period may provide leading price indications for the entirety of commercial real estate. Even though prices for multifamily sales stopped falling in late 2008 through early 2009 and shuffled sideways for the better part of a year, it was the first of the four major asset types to find price stability and did so a full two years ahead of the pack.