A common tool in evaluating commercial real estate is pointing toward a less risky environment for investors in the Albuquerque metro area market, according to a survey of mostly local industry insiders by the New Mexico chapter of the Urban Land Institute.
Cap rates, a formula-based measure of market fundamentals, have continued a three-year trend of declines in all commercial property types – office, industrial, apartments and retail. That is an early indication of a slow shift away from a market in distress.
The average blended cap rate, short for “capitalization rate,” was 8.1 percent at midyear across all property types, the lowest it’s been in five years, the institute’s survey found.
The drop from the most recent high of 9.5 percent in 2010 would appear to signal real-estate values are starting to solidify.
“Cap rates in general for Albuquerque have descended down to where we were when the downturn started (8 percent in 2008),” said Todd Clarke, CEO of Cantera Consultants & Advisors, who conducted the study for the Urban Land Institute.
‘The tipping point’
As in 2008, there’s still a lot of uncertainty in commercial real estate, he noted, adding, “I think we’ve crossed the tipping point.”
Based on a simple equation using a property’s net operating income and price, cap rates are considered a valuable tool to reflect real estate values. A rule of thumb is that a change of 1 percent in the cap rate, up or down, translates to a change in a property’s value by a factor of about 12 percent.
Cap rates are also an indicator of the rate of return on a commercial property. They often are used to compare commercial real estate to other types of investments like stocks and bonds.
A building that’s close to fully leased to high-credit tenants will have a lower cap rate than a building that has a lot of vacancy or tenants with lower credit ratings. The reason is that the building with a lot of vacancy or low-credit tenants is considered higher risk as an investment.
The high average blended cap rates during the harshest years of the economic downturn – 8.9 percent in 2009, 9.5 percent in 2010 and 9.2 percent in 2011, according to the survey – reflect the crash in real-estate values as space went empty due to business closures and downsizings.
The average blended cap rate during the 2005-07 boom years was 7.5 percent, a still relatively high rate that reflects the inherent risk of investing in most commercial property types in a smaller, third-tier metro such as Albuquerque.
‘One benchmark’
Although popularly quoted, cap rates are just one tool to evaluate commercial real estate, said John Ransom, managing director of Colliers International’s Albuquerque office.
“It’s one benchmark we look at, a snapshot,” he said. “We look at so many other things as well.”
The common measures of the performance of a commercial real-estate market – vacancy rates, average asking lease rates and new construction – portray a local commercial real-estate market where the office and industrial property types are still in a down cycle.
Both apartment and retail properties in general have bounced back. Although it did hit a lull in 2008-09, the local apartment market has held up well during the downturn. At 7 percent, it has the lowest average cap rate among all commercial property types in the metro.
The retail market had the second-lowest average cap rate at 7.7 percent, according to the institute’s survey. From a real-estate perspective, the toughest years for retail were 2009-10.
“Retail falls into two categories,” Clarke said. “There’s the newer, nicer stuff – Paseo del Norte corridor, the Cottonwood area, Uptown – and then there’s everything else. I think the cap rate reflects the newer, nicer stuff.”
Three measures
The gradual improvement in the commercial real-estate market is reflected by most of the answers given by the roughly 100 owners, investors and brokers surveyed by the institute on three basic measures of the market’s health:
- Property values : 32 percent said values had increased, compared with 13 percent in 2010; 27 percent said values decreased, compared with 74 percent in 2010; and 41 percent said values had remained the same, compared with 14 percent in 2010.
- Vacancy rates : 24 percent said vacancies had risen, compared with 78 percent in 2010; 37 percent said vacancies had dropped, compared with 9 percent in 2010; and 39 percent said they had remained the same, compared with 14 percent in 2010.
- Rental rates : 21 percent said rates had increased, compared with 11 percent in 2010; 26 percent said rates had decreased, compared with 69 percent in 2010; and 53 percent said they had remained the same, compared with 20 percent in 2010.
The survey also asked respondents to prioritize a list of concerns and issues. Not surprisingly, the top concern was job growth, followed by favorable tax policies and low interest rates, which are top concerns of Albuquerque’s business community in general.
What was surprising were a couple of the items at the bottom of the prioritized list, including “interest in building green” and “optimism about N.M. business,” Clarke pointed out.
“I expected more people to be talking about building green,” he said. “I think the lack of optimism about the New Mexico economy was a surprise. It’s not real tangible. Collectively, it feels like a hopelessness about encouraging the government to get out and do something to encourage job growth.”
By Richard Metcalf (Albuquerque Journal)
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