Commercial real estate prices are back to pre-crash highs but transactions are falling

Commercial real estate transactions took a huge hit in August.

That month’s data, compiled by Real Capital Analytics, show transactions on income-producing properties dropped to $30.5 billion, a fall of 23%. Transactions consisting of multiple property portfolios fell 46%, while single asset deals declined 19% year-over-year.

This is happening while the sources of financing have been shifting. For the first half of 2016, regional and local banks were the biggest lenders for income-producing properties in the United States.

From January to June, $183 billion were borrowed to finance commercial properties valued above $2.5 million. One out of every five dollars in those mortgages came from smaller banks, with New York Community Bank and Signature Bank lending a combined $5 billion, putting those two at the top of the list of smaller lenders.

Those smaller banks are taking a bigger slice of a shrinking pie at the expense of commercial mortgage backed securities (CMBS). Just 9% of mortgages were made through CMBS in the first half of this year. Two years ago, CMBS loans dominated the market at 28% of commercial mortgages.

Some borrowers used the CMBS market to finance larger deals involving multiple properties. But there are now fewer of those types of deals. According to Jim Costello, vice president at Real Capital Analytics, that may have led to a downturn in commercial property transactions.

“You can’t go to your local bank down on the corner and get a $10 billion loan,” said Costello. The CMBS market, he said, “was very efficient in terms of getting a number of investors to kind of spread the risk around.”

The state of the commercial real estate market has some people concerned, particularly Boston Federal Reserve president Eric Rosengren. Although he is thought of as a more dovish member of the Federal Open Market Committee, he was one of three to dissent at the Fed’s most recent meeting at which the central bank voted to keep rates steady. Rosengren has made clear his worries about commercial real estate’s rising prices.

“You should be concerned about what the banks are doing and look at that cautiously and just make sure that they’re not getting too far ahead of their skis,” Costello said.

US commercial real estate’s average cap rate—which is equal to a property’s net income divided by its value—is back down to 6.5%, where it was in early 2007. During the financial crisis, cap rates soared above 8%. Cap rates fall as property values rise.

Nonetheless, Costello won’t call the current market a bubble, especially given the near-record low interest rates found in today’s mortgage market.

“‘Bubble’ is fighting words,” he said. “A bubble is about poorly formed expectations… [In the previous boom] people were buying on expectations of tremendous income growth moving forward. [Now] they’re buying and paying very high prices just for the current yield. And really what is a high price today, it’s not about this crazy expectation of mania, of trying to get a property and ride that appreciation wave. It’s really just a capital preservation move. With the yield curve so low and with rates so low, capital is moving in just as a way for preservation because there’s some sort of ongoing yield.”