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Cap Rates Decline Amid Slow Commercial Real Estate Recovery

06/24/2013 | By Carisa Chappell

Cap Rates Decline Amid Slow Commercial Real Estate Recovery

High demand from investors and low interest rates continue to push down capitalization (cap) rates in the commercial real estate market, according to an analysis from consulting firm PwC.

The report noted that in the second quarter of 2013, the combined overall cap rate fell to 6.91 percent across the 34 United States markets included in the survey conducted by PwC. It marked the 12th consecutive quarter that cap rates have fallen and represented the largest quarterly decline since the end of 2010. The average cap rate during the first quarter of 2013 was 7.08 percent.

Susan Smith of PwC’s real estate advisory practice said the trend is surprising, given the slow recoveries in both the commercial real estate market and broader economy.

“Overall cap rates remaining low is a mystery to some of the real estate investors,” she said.

“Surprisingly enough, they continue to decline, even though the recovery of commercial real estate is described as uneven. One of the terms used this quarter by an investor was, ‘lopsided.’”

Smith said demand from both domestic and international investors is helping to drive cap rates down. She added that low interest rates are playing a large role in falling cap rates. Many buyers are taking advantage of favorable debt terms and are willing to accept lower initial returns with the expectation that they will increase over time, according to Smith.

Smith added that low cap rates currently have some investors questioning if property markets might be “overpriced.” She said those concerns are especially high in some of the top-tier geographic markets. These include New York, San Francisco and portions of Los Angeles.

The overall cap rate shifts show some of the steepest declines within the office sector, especially the high-tech office market, according to the report. The average cap rate was 6.63 percent in central business district office markets in the second quarter, the lowest average reported for that market segment since 1994.

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