Changes to the financial market activity are making some real estate investors concerned about capitalization rates. Recent quarterly data shows a downward trend across markets, including Los Angeles.
Nationally, cap rates in single-tenant net leases decreased across asset classes in Q3 2017 to 6.11 percent, near historic lows of 6.10 set in Q3 2016. Office and industrial net lease cap rates also declined. For office properties, a recent report from JLL found the current cap rate at 4.1%, a 4 basis point change over the last year. REIS found the retail sector rolling average cap rate trending down over a 12-month period ending in Q2 to 7.6 percent.
Twice this year, in March and June, the Federal Reserve raised interest rates. The benchmark rate now stands at 1 to 1.25 percent. These moves are part of the reserve’s aim to reach over 2 percent by the end of 2018. However, inflation is lower than expected and the Fed is not on track to meets its inflation target of 2 percent. Regardless, the impact from the benchmark rate on commercial real estate capitalization rate trends is minimal.
So why are cap rates decreasing? One suggestion is that a decline in deal volume may be the culprit. RCA data reports early Q3 numbers are below 2016 deal activity. With fewer properties exchanging hands, those that do close are commanding higher prices. Therefore, investors are willing to pay prevailing prices for high-quality properties with a strong performance history.
Private investments and 1031 exchanges continue to find net-lease investments appealing. These types of deals account for 70% of single-tenant retail transactions. According to REIS, this pool “accounted for more than 85 percent of the transactions that were priced below a 6 percent cap rate.”
As for what Los Angeles real estate investors can expect, myNOI says the cap rate for multi-family properties in the area averaged 4.84 percent as of September 2017. Cushman & Wakefield reported class A office space cap rates averaging 4.13 percent and class B ranging from 6 to 7.75 percent in its mid-year survey. The same report indicated industrial cap rates ranged from 4 to 6 percent based on class.
Looking forward, commercial real estate investors need to keep an eye on how impending rate hikes, fluctuations in deal volume, and tax cuts are going to influence future cap rate trends.