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Cap rates compress as investors become Increasingly active, performance durability and post-COVID recovery prospects favored health and economic outlooks improving.

Multiple factors point to an economy that is firmly in recovery as vaccinations continue. A number of stimulus checks and new support programs such as federal unemployment insurance have helped to lessen the financial burdens of those most impaired by the health crisis. For those who were able to keep working, stimulus measures and fewer consumption options have bolstered personal savings. The total value in savings deposits and money market funds has increased an estimated $4.3 trillion since February 2020. These pent-up savings are giving way to heightened retail spending as more venues reopen. Core retail sales have grown 13 percent from the February 2020 pre-pandemic benchmark. Reviving air travel suggests that both business and leisure travelers are also back on the move.

Varying performance restrains overall marketable inventory. Strengthening economic tailwinds should boost commercial real estate fundamentals this year, inciting recovery speculation among investors and spurring buyer activity. At the same time, the recovery has thus far been uneven, with some cities, states and property types jumping ahead of others, generating a broad range of valuation variance. Many owners remain in a holding pattern, awaiting additional clarity before they sell, which is restraining the flow of marketable inventory. This demand-supply unbalance has exacerbated the expectation gap between buyers and sellers in many markets, slowing deal flow for underperforming assets.

Competitive bidding spurs cap rate compression. Buyers have most aggressively focused on assets that weathered the pandemic best, including many industrial, multifamily and self-storage properties. Investors have also targeted property types expected to make a quick post-crisis recovery, such as hotels as well as certain types of retail and seniors housing. While some discounting has occurred in unique situations, valuations of most asset types have largely held steady or surpassed pre-health crisis levels as strong buyer interest has aligned with limited for-sale inventory. This dynamic has also led to cap rate compression among sought after assets.

Commercial property yields offer compelling margins. A limited number of marketed assets is supporting price appreciation and cap rate compression in regions with a positive growth outlook. Despite these contracting yields, the margin remains wide relative to alternative low risk investment vehicles. Interest rates are still historically low, with the 10-year Treasury rate trailing the average commercial property cap rate by over 400 basis points. As the economy reopens, investment demand profiles are strengthening, and that anticipated momentum will carry over into markets and property types that have faced more recent hurdles.

Sources: Marcus & Millichap Research Services; CoStar Group, Inc.; Federal Reserve; MNet; NICMap; Office of Financial Research; Real Capital Analytics; RealPage, Inc.

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