By the Numbers

Overall credit in CRE improves although the riskiest tail gets longer

Mary Beth Fisher, PhD | September 10, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Sales volume, prices, days on the market, distressed sales as a share of the total. These and other benchmarks keep pointing to a robust market in commercial real estate. Weak spots remain in hospitality and office properties, where shifts in demand due to pandemic are exacerbating longer-term trends of slower price appreciation. The overall credit of outstanding commercial real estate is improving, although the riskiest tail is getting longer.

The highlights:

Commercial real estate sales volume has fully recovered to pre-pandemic levels. There were 1,591 commercial real estate repeat sales transactions that closed in July 2021, down modestly from the 2,097 sales in June 2021. Sales in July were on pace with trailing 12-month average of 1,605 repeat sales a month, which is in-line with the average level of monthly transactions recorded prior to the pandemic (Exhibit 1).

Exhibit 1: US CRE transactions (repeat sales, pair count)

Note: The CoStar indices are constructed using a repeat sales methodology. The methodology measures the movement in the prices of commercial properties by collecting data on actual transaction prices. When a property is sold more than once, a sales pair is created. The prices from the first and second sales are then used to calculate price movement for the property. The aggregated price changes from all of the sales pairs are used to create a price index. Investment grade properties are larger-sized, typically 4-star and 5-star quality properties that match the type most often purchased by institutional investors. Any property not meeting the investment grade criteria belongs to the general commercial category.
Source: CoStar

Liquidity in the CRE market has deepened in the wake of the pandemic and continues to favor sellers. Buyers are paying over 94% of asking prices, a record high. The average number of days a property spends on the market has been flat at 222, slightly above the all-time lows of 2018 and 2019 of 195 days (Exhibit 2). The ratio of listings that are withdrawn from the market by the seller during a given month fell to 23.0% in July from 28.7% a year before.

Exhibit 2: Market liquidity indicators

Source: CoStar

Distressed sales as a proportion of total sales have so far not increased as a result of the pandemic. CRE sales categorized as distressed have hovered around 2% to 3% of monthly sales volume since late 2017 (Exhibit 3). In July there were 1,591 sales pairs, 276 of those were investment grade properties and 1,315 were general commercial properties. Of those transactions, 6 of the investment grade properties (0.38%) were distressed sales, and 24 of the general commercial property sales (1.51%) were distressed.

Exhibit 3: US CRE distressed sales pairs (% of total sales)

Note: CoStar defines a property sale as being distressed if the most recent sale transaction is an auction, a deed in lieu of foreclosure, a distress sale, a foreclosure, an REO sale or a short sale.
Source: CoStar

Land and multifamily sectors lead property prices higher, while hospitality appears to have come off the bottom. CoStar’s composite commercial property price index has risen by 14.7% year-over-year as of July, led by land (15.5%) and multifamily (12.4%) (Exhibit 4). The hospitality sector has notched three straight quarters of property price declines, but after falling -11.7% in the first quarter of 2021, the sector clawed its way back to only being down -4.2% year-over-year by the end of the second quarter of 2021. That possibly indicates that hospitality property prices hit a trough, but the latest renewed weakness in hotel data due to the spread of the Delta variant could keep pressure on the sector for several more months.

Exhibit 4: Primary property type indices (equal-weighted, quarterly)

Note: In the equal-weighted index every transaction is weighted equally, regardless of the value of the transaction. An equal-weighted index is heavily influenced by low-value deals where transaction volume is highest, and is considered more relevant for measuring broad market performance of average properties. A value-weighted index is most sensitive to price variations of high value properties and is often used for analyzing capital flows. Both types of indices are constructed by CoStar and complete details and data are available here.
Source: CoStar

Multifamily property price gains have mimicked home price appreciation in single-family residential. Single-family home prices increased 18.0% year-over-year in July 2021, and were up 1.8% month-over-month, according to CoreLogic HPI and the CoreLogic Case-Shiller Index (Exhibit 5). HPI gains are expected to moderate over the next year, with forecasts of a 2.7% increase from July 2021 to July 2022.

Exhibit 5: Home Price Index and Case-Shiller Trends and Forecast

Source: CoreLogic

Single-family rent growth has spiked higher, though it has not quite kept pace with HPI. Median rents for single-family detached properties rose by 10.5% year-over-year in June (Exhibit 6), compared to a 4.6% rise for attached homes. This should keep upward pressure on single-family rents. The public SFR operators have already reported much higher rent increases for a new lease as opposed to a renewal, though both have risen sharply.

Exhibit 6: Single-family attached vs detached rental price growth

Source: CoreLogic

The issuance pipeline in CMBS, CRE CLOs and SFR deals has built up and the spigot is opening. Deal flow should be robust through the fall. A 25 bp back-up in rates would really help optics for total return investors, but it will probably take two strong employment reports to produce that move. And by then it’s November. Real estate price growth will almost certainly begin moderating, but the overall context of the market remains very strong.

Mary Beth Fisher, PhD
marybeth.fisher@santander.us
1 (646) 776-7872

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