HFF Research reports on and analyzes the latest commercial real estate data for the second half of 2017 (2Q17) and the first half of 2017 (1H17).
“Investment brokers continue to play a vital role in making the commercial property markets liquid and increasingly efficient. Moreover, their role in the investment markets continues to grow, with brokerage representation of the seller, buyer, or both, accounting for 68 percent of significant income property sales globally in 2016. The top 10 [brokerage] firms collectively accounted for 83 percent of all brokered transactions in 2016, up from 76 percent in 2013. Although relatively small – and declining – in number, these [brokerage] firms are linking capital and property between a growing universe of approximately 200,000 property investors, of which only 20 percent may be active buyers or sellers in any given year.” – Bob White, CEO of Real Capital Analytics (RCA)
As has been widely reported, velocity of investment sales transactions in the first half of 2017 proved challenging for the industry. RCA reports transactions totaling $109.2 billion (-4.8 percent year over year) in 2Q17 and $211.1 billion (-8.5 percent) in 1H17. In previous quarters, indeed in all of 2016, portfolio- and entity-level trades served as culprit to the broader malaise in velocity. Considering end-of-cycle and reinvestment risks, investors were cautious to embed large sums of capital into individual transactions of scale and, alternatively, elected to spread their risk across various geographies, property types, vintages and cost bases.
Source: Real Capital Analytics
To wit, in 2016 the market experienced a -9.2 percent decline overall driven principally by a -29.2 percent decline in portfolio- and entity-level trade segment. Individual transactions, ad interim, were flat. Comparatively, in the second quarter of 2017, individual transactions fell -9.1 percent while portfolio- and entity-level trades climbed 15 percent. Moreover, the number of announced M&A transactions is rising rapidly (*CPPIB>PKY, Allianz+CXP, Greystar>MORE, GOV>FPO, DLR>DFT, SBRA>CCP) with closings still anticipated in the second half of 2017. Large-trade momentum is gaining; not only does this bode well for the drag that has been undermining transaction volumes – particularly in the REIT segment where liquidity of sales has been muted – but, more important, it also signals an increase in confidence within investor segments controlling the largest allocations for real estate: REITs and sovereign wealth funds.
On Friday morning, the Bureau of Economic Analysis printed a 2.6 percent first read on 2Q gross domestic product (annualized). Combined with 1.2 percent 1Q growth, the year-to-date annualized GDP is approximately two percent. This is below our president’s target but is frankly quite good and very accretive to real estate demand. If and when the 2Q figure is affirmed and the preliminary 3Q figure is anywhere near 2.5 percent, the implied economic growth should inspire confidence in the economy; we should therefore see more confidence in the asset class that houses it. As you can see below, the range of zero to two percent GDP growth hasn’t been enough to stimulate palpable growth in transactions. The preliminary 2Q print for sure helps, but we need more.
Source: Bureau of Economic Analysis, Real Capital Analytics
As RCA’s Jim Costello pointed out earlier this year, “the last year and a half are proof commercial property transaction volumes cannot keep climbing at double-digit rates forever. An end in the decline in pace of sales is not the same thing as saying that the market will suffer a rout and that prices will collapse.” Data proves his point. The below graph outlines the investment performance of securities purchased three years prior to the Great Recession through June 30, 2017. Private real estate avoids the volatility of the public equity and REIT shares, enjoys higher capital appreciation than the corporate bond index and ultimately grows to a worth of 2.36 times 11 years on. This metric is well in excess of the other indices whose methodology assumes dividend reinvestment, from which the NCREIF index does not benefit. Lastly, while asset valuations show slower growth in value late in the hold period they do not appear to be directly undermined by sluggish transaction volumes in the underlying market place.
Source: National Council of Real Estate Investment Fiduciaries, Standard & Poors, Barclays, National Association of Real Estate Investment Trusts, CoStar
The resiliency real estate valuations are experiencing is supported by two primary factors, the first being debt markets, which are very accommodating to landlords seeking new capital. As transaction velocity declined consecutively for several quarters, landlords wishing to avoid a transaction were successfully able to achieve recapitalization through refinance and potentially on a tax-free basis while maintaining an equity stake for future upside. The trend has carried forward in the first half of 2017, with originations climbing +14.7 percent. Most lender types are experiencing expansion in production, but not all:
Free flow of debt capital underpins valuations in an environment of sluggish equity trades.
Source: Mortgage Bankers Association
Income return is a very high and consistent component of total return, further supporting real estate valuations among slower transaction volumes. The below image demonstrates average annual income/cash and capital appreciation returns since 1980. Investors deeply desire a balanced combination of these two metrics without volatility; real estate delivers.
Source: Standard & Poors, National Council of Real Estate Investment Fiduciaries, U.S. Treasury, Federal Reserve, CoStar
Analyzing 15 years of history (a period more relevant to investors participating in the “modern” commercial real estate industry), we see that private real estate provides one of the highest average annual returns among competitive asset classes, experiences lower volatility and thus provides investors with very favorable risk-adjusted returns. Reviewing Sharpe ratios for each asset class (CAGR less 4.1 percent from Treasuries, divided by standard deviation), we see private real estate enjoys the highest/most favorable scores for risk-adjusted returns. Over 15 years, this consistent and favorable performance creates significant wealth and draws significant capital commitments from investors.
Source: Dow Jones, Standard & Poors, Bloomberg, U.S. Treasury, National Council of Real Estate Investment Fiduciaries,
National Association of Real Estate Investment Trusts, HFF Research
The largest investors across the world are governed by investment policy, with target allocations based on the investment office’s desired distribution of risk across asset classes. Each of the investor types listed in the below graph demonstrates significantly underfunded real estate portfolios relative to target, including sovereign wealth funds and insurance companies, which together control trillions of AUM. The CPPIB>PKY transaction, announced in 2Q17 and anticipated to close in the second half of the year, is exemplary of institutional capital’s ability to alter strategy to directly invest in real estate through transactions of scale. Within the closed-end fund space, dry powder (capital committed but yet to be funded) seeking U.S. real estate assets currently exceeds $140 billion, representing an all-time high. Protracted levels of capital seeking to enter the real estate space will provide a cushion for valuations amidst lower transaction volumes.
Source: Preqin, Morgan Stanley Research
With the health of valuations, capital formation and investment returns well-covered, we shift our focus to HFF’s performance in the marketplace.
The role of HFF as an intermediary has strengthened. In the last week of March, Real Capital Analytics' CEO Bob White wrote this article's introductory quotation on his company’s “RCA Insights” blog espousing the very same maxim the HFF Leadership Team has for many years; in a challenging environment of transactions, HFF can outperform due to the heightened need for our capital markets services.
Such was the case in the first half of 2017. As the table below testifies, HFF’s investment sales volumes outperformed the broader industry in 1H17. HFF’s overall performance reflected market share gains. Additionally, HFF’s debt originations soared; across every major lender type, HFF significantly increased its market share in the first six months of 2017. As announced on our second quarter 2017 earnings call, HFF’s overall performance outperformed industry benchmarks in the first half of 2017, reflecting market share gains.
Sources: HFF Research, National Council of Real Estate Investment Fiduciaries, Real Capital Analytics, U.S. Treasury, CoStar, Oxford Economics, Bureau of Economic Analysis, Federal Reserve, Barclays, Morgan Stanley Research, Preqin, Mortgage Bankers Association
*Canada Pension Plan Investment Board’s acquisition of Parkway (NYSE: PKY), Allianz’s joint venture with Columbia Property Trust (NYSE: CXP), Monogram Residential Trust’s (NYSE: MORE) takeover by a fund led by Greystar, Government Property Income Trust’s (NASDAQ: GOV) acquisition of First Potomac Realty Trust (NYSE: FPO), Digital Realty’s (NYSE: DLR) merger with DuPont Fabros (NYSE: DFT) and Sabra Health Care’s (NASDAQ: SBRA) merger with Care Capital Properties (NYSE: CCP)