Editorial|&utm_term=|Website-Editorial-NAT(Website)|"> Auction.com's chief economist Peter Muoio tells GlobeSt.com. The firm recently released its latest Commercial Real Estate Nowcast, which revealed that commercial valuations in November increased 46 basis points from October. We spoke exclusively with Muoio about valuations and where they are headed in the new year.
GlobeSt.com: Where do you see commercial valuations headed in 2016?

Muoio: We expect commercial real estate valuations to generally continue to increase in 2016 but at a slower pace than in the past few years. 

GlobeSt.com: What factors are you watching most closely?

Muoio: With the Fed finally having raised rates, the pace and frequency of monetary tightening in 2016 and the potential impact on cap rates is a key issue to watch. In our view, the Fed's overall tightening cycle will be shallow and measured, with maybe just one or two additional increases in 2016. For real estate, higher interest rates have a dual variate effect. Interest rates are a component of cap rates, and their rising could place upward pressure on cap rates, reducing real estate valuations. Additionally, higher interest rates will very modestly raise debt-funding costs. However, the beginning of a tightening cycle also signals increased confidence in the economy, which portends stronger NOI growth in the coming years. This could reduce spreads on cap rates, which in some property markets and segments remain fairly wide.

GlobeSt.com: What hidden dangers are lurking on the horizon?

Muoio: Our outlook for valuations is predicated on the economy gaining momentum, boosting commercial absorption, lowering vacancies and increasing rent gains—all driving NOI increases that help lift valuations. A disruption to economic growth would short-circuit this. The other risk is that the Fed is more aggressive in pushing rates higher, which would also represent risk to the magnitude of commercial valuation gains. 

GlobeSt.com: Are there any particular markets or sectors that the industry should keep an eye on?

Muoio: While commercial valuations look to increase in general in 2016, the apartment market may not participate in the gains. National apartment vacancies rates are very low, but have stabilized around the 4% level and look to remain near the same range in coming years since supply and demand are fairly equally balanced. While rent growth will continue to drive NOI gains, the lack of occupancy improvement will limit those gains. Apartment segment cap spreads are also relatively tight compared to other property segments, so upward pressure on caps from rising interest rates could be felt more in this segment. 

From a market perspective, our best guess is that trophy markets—which saw large drops in cap rates as they acted as a flight to safety during the hunt for yield—will see cap rates rise as more liquid bond products once again become viable alternatives. These markets have seen the strongest valuation gains and therefore would be at more risk to the constraining impact of rising rates on values. However, secondary markets, which did not see this effect, will be less affected by the rise and may even see spreads fall on the improved growth outlook, though there would likely be a "benchmarking" impact on smaller markets if major market caps start to increase. Additionally, the New York City apartment market faces an onslaught of supply, and even modeling for record absorption levels shows vacancies rising to their highest level in decades.