CoStar Commercial Repeat-Sale Indices: A Tale of Two Investment Worlds Merging Into One

CoStar Commercial Repeat-Sale Indices: A Tale of Two Investment Worlds Merging
Into One

CoStar's July 2010 Commercial Repeat-Sale Indices Indicates a Pause and
Softening in Institutional Grade Investing
By Mark Heschmeyer
August 4, 2010

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Commercial real estate pricing has been a tale of two worlds, with the largest
metropolitan markets attracting significant institutional capital and forcing
prices upward over the first two quarters of 2010, while the broader market has
continued to soften, according to the first monthly CoStar Commercial
Repeat-Sale Indices (CCRSI), produced by CoStar Group, Inc.

This divergence may soon change, however, with the indices, compiled over the
last 10 months, now indicating a pause and softening in overall investor
activity, even within the primary markets for investment- or institutional-grade
property.

Over the past 10 months, the overall composite CCRSI oscillated from positive to
negative and back again, with preliminary July figures very likely to be down
for investment-grade property markets. From May to June, the composite CCRSI was
down 7.78%, with the investment grade property declining by 4.83%, reversing
previous positive gains.

The pause in some of the positive price trends corresponds to renewed
uncertainty in the U.S. economy, persistent weakness in the housing market and
concerns surrounding the European economy. In addition, financial reform has
slowed commercial mortgage markets as lenders are now in the process of
analyzing and interpreting capital requirements and "skin-in-the-game"
provisions.

Many of the opportunity funds continue to seek out distressed properties, which
are affecting the prices shown in the index. But the expectation of a "tsunami
of opportunities" has not materialized and overall transaction volumes remain
below normal, according to the CoStar indices.

Distressed sales as a percent of transaction volume are highest for hospitality
at 35%, followed by multifamily at 28%, office at 22%, retail at just under 20%
and industrial at about 17%. These volumes appear to be stabilizing and the
"extend and pretend" behavior of some lenders is likely to continue for the next
several months, according to index findings.

CoStar Group launched the Commercial Repeat-Sale Indices as a measure intended
to provide consistent and timely information to help answer some of the
fundamental economic questions regarding the commercial real estate industry,
including, 'Are prices climbing or falling?' and 'On a month-to-month basis are
property values going up or down?'

"Currently, there are no effective, non-biased indices to measure commercial
real estate price movements, and even less comparative information by property
type or geographies," said CoStar Group Chief Executive Officer Andrew Florance.
"In response to this void, we've developed the CCRSI to provide a comprehensive
set of benchmarks that investors and other market participants can use to better
understand and predict CRE price movements."

CoStar has identified more than 85,000 repeat sale pairs in its U.S. database,
which it believes is the largest and most comprehensive comparable sales
database in the U.S. commercial real estate industry.

"An accurate measure of real estate price changes is a critical component to
understanding investment or market performance. With commonly used average,
median price and price per square foot indices, there are no controls for the
ever-changing mix of properties sold during different time periods," added
Florance. "Therefore, we do not believe average or median price indices per
square foot are useful for rigorous analysis of market cycles. Appraisal-based
indices are ineffective because they introduce lag and bias and minimum price
cut indices are a circular reference in that they use price to define price."

"By covering all levels and all types of CRE transactions, and by using
well-tested available methodologies, we believe that CoStar's indices will
provide one of the most comprehensive benchmarks for tracking and analyzing CRE
price movements to date."
Editor's Note: For more information about CCRSI Indices, please visit
www.costar.com/ccrsi/.

The development and release of the CCRSI is important for two significant
reasons, Florance said.

"First, this will come out a month earlier than any other index out there, so
when the market is in flux like right now or is going to turn, this information
provides a leading indicator of how the other larger property indices will be
turning," Florance said.

"Second, this is the only set of indices really reflective of the broader
market. In terms of sales volume, the existing indices ignore 70% to 80% of the
property transactions. So this really is more indicative of what the typical
real estate owner is experiencing, and a better index for this broader market."

In addition to the overall CCRSI, CoStar has constructed more than two dozen sub
indices using the unique breadth of CoStar's property and comparable sales data.

SUB-INDICES SHOW BROAD SOFTENING
When all commercial real estate transactions are considered, every major
property type appeared to soften in terms of prices in the last three months.
However, the top-10 largest office markets posted a positive 6.2% price change
as did the top-10 industrial markets which rose 2%.

Retail prices suffered the most in the second quarter of 2010 with a drop of
12%, in part because the top 10 retail markets had a -17% loss in prices.

By region, Northeast and West suffered more of a pullback than the South and
Midwest, although both are coming off much higher peaks than South and Midwest.

The only positive price trends out of 16 regional indices provided below were
Midwest office at 5.7%, Northeast apartments at 3.5%, West industrial at 1.8%
and South apartments at 1%.

SALES PAIRS TREND UPWARD
The CCRSI July report is based on data through the end of June. In June, 665
sales pairs were recorded, up significantly from May, during which 506
transactions occurred. Overall, there has been an upward trend in pair volume
going back to 2009. February 2009 appears to have been the low point in the
downturn in terms of pair volume, when 374 transactions were recorded. Since
then, pair volume has increased overall, and beginning in November 2009,
year-over-year changes in pair volume have been positive every month.

In terms of the mix of pairs that have sold, June saw an increase in the
proportion of repeat investment grade properties trading hands. Investment grade
sales amounted to 31% of the total number of sales in June, the highest level it
has been going back to January 2008. This indicates an increased mix of larger
properties changing hands, which had been at decreased levels since the
beginning of the recession.

Prior to June, 24% of sales pairs in 2010 were considered investment grade. This
compares to an average of 33% of sales pairs being investment grade in 2006 and
2007, before the start of the downturn.

Distress is also a factor in the mix of properties being traded. Since 2007, the
ratio of distressed sales to overall sales has gone from around 1% to above 23%
currently. Hospitality properties are seeing the highest ratio, with 35% of all
sales occurring being distressed. Multifamily properties are seeing the next
highest level of distress at 28%, followed by office properties at 21%, retail
properties at 18%, and industrial properties at 17%.

CoStar Group said it plans to provide CCRSI updates on the first Wednesday of
each month to serve as timely indicators of the overall health of the commercial
real estate industry.

H. Austin Esfandiary
Direct: 202 591-9032