By the Numbers

Higher rates hit commercial real estate pricing

| June 10, 2022

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.

Commercial real estate prices fell in May for the first time in two years, according to the broad index tracked by Green Street, declining 1.2%. But CoStar had already shown a softening commercial real estate market in the first quarter of the year. Stagnant or declining prices hit all property sectors. The likely suspects: higher interest rates and higher cap rates, too.

The Green Street Commercial Property Price index is down 1.0% so far for the year although still up 13.2% compared to pre-pandemic levels (Exhibit 1).  Since Green Street’s pricing approach is somewhat forward-looking, other commercial real estate price indices are likely to weaken in coming months.

Exhibit 1: Commercial real estate prices are down 1% so far this year

Source: Green Street

CoStar’s indices had already shown commercial real estate prices declining in the first quarter of this 2022, but the indices are constructed differently. Green Street focuses exclusively on high quality, institutional grade properties owned by REITs. Green Steet models property values based on commercial real estate transactions that are being negotiated or under contract. CoStar uses a repeat sales methodology based on closed transactions. CoStar’s universe of properties is also much broader, as they track commercial real estate properties down to $2.5 million in value.

Price stagnation and declines are broad-based, impacting almost all property sectors (Exhibit 1):

  • Best performers are Lodging (up 3%) and Health Care (up 1%), both of which have struggled to regain traction since the pandemic
  • Worst performers were Malls (down 5%); with Apartments, Office, Net Lease and Self-Storage all down 2% on the month

Exhibit 2: Lodging and healthcare lead, malls lag

Source: Green Street

The broad-based but modest weakening is consistent with the slowdown being caused by higher interest rates driving up borrowing costs. Capitalization rates tend to be correlated to the level of interest rates (Exhibit 3). As rates declined for years, cap rates compressed. As rates rise and borrowing costs increase, property values should stagnate or decline somewhat for a while and allow cap rates to increase.

Exhibit 3: CMBS and ACLI cap rates and CMBS spreads

Sources: KBRA, Trepp, ACLI Commercial Mortgage Commitment Database, Federal Reserve

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

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