Metropolitan Philadelphia Sales Transactions of Commercial Real Estate by Type

"As long as the music is playing, you've got to get up and dance."

- Charles "Chuck" Prince, CEO, Citigroup, 2007

During the past three years (2014-2016), $21.5 billion of commercial real estate has been sold in the Philadelphia metropolitan area, exceeding the previous cycle's figure of $20.0 billion during its boom years (2005-2007).

And though it appears sales activity may have peaked in 2015, several indicators suggest "the music" will continue "playing." Unlike 2007, the economy shows little signs of faltering and the specter of a financial crisis is small. In fact, jobs continue to grow at an impressive pace and commercial real estate market fundamentals remain sound.

What Investors Want:

"In the Americas, which property sector do you believe to be the most attractive for investment purchase?"

Helping underpin our belief that sales transaction activity will continue, we refer to CBRE's recently released Americas Investor Intentions Survey 2017, which reveals the sentiment of nearly 1,000 investors across the Americas. Among other interesting insights, the report shows that 83% of investors intend to maintain or increase their purchasing activity from 2016.

The demand for industrial (mainly warehouse distribution) buildings is impressive (as seen in the figure above), but so is the sentiment for multifamily buildings, despite fears of overbuilding in some submarkets.

Locally, our professionals characterize the investment sales market as one that remains strong and active as well, supported by a diversified economy, good market fundamentals, and attractive yields compared to gateway markets.

What is it about commercial real estate that investors continue to clamor for?

Traditionally, the reasons have ranged from CRE's ability to act as a hedge against inflation to its attractive yield versus other investments, among others. Interestingly, the Americas Investors Intention Survey reveals that respondents' main motivation for investing in CRE was the generous spread between its yield and that of the U.S. 10-year Treasury.

This yield spread offers investors a "cushion" against rising interest rates, in addition to purportedly showing how much risk investors are pricing into CRE. After the 2001 recession, this yield spread reached nearly 500 basis points (bps), and then fell to a precariously low level of only 144 bps in Q2 2007. During the Great Financial Crisis in 2008, this spread surged back up to 475 bps and has stayed at an historically high level since.

Our view on the trajectory of cap rates assumes this yield spread "cushion" will decline as interest rates rise and investors find comfort in continued strong market fundamentals, allowing cap rates to remain steady. The one wild card involved is how much investors have accounted for artificially low interest rates in this historically high yield spread "cushion."