Small-Cap CRE Market Advances at a Slower Pace

While small-cap commercial real estate market conditions improved during the second quarter, evidence suggests the market is nearing a peak, reported Boxwood Means, Stamford, Conn.

Randy Fuchs, Principal with Boxwood Means, said aggregate demand across the office, industrial and retail sectors jumped 32.1 percent during the quarter to more than 21 million square feet after “sluggish” first-quarter tenant activity in sub-50,000-square-foot commercial properties. Office demand rose the most on a percentage basis, up 110 percent, followed by industrial at 31.6 percent and retail with a modest 5.4 percent gain.

“That being said, the improvements in second-quarter occupancies mask evidence of a continuing slowdown at this late stage in the market’s expansion,” Fuchs said. “Aggregate demand declined a whopping 73 percent from second-quarter 2016.”

Fuchs also noted the second quarter’s 38.5 million square foot net occupancy gain was the lowest sum since 2011.

The main reason for low small-cap vacancies is the “subdued” level of commercial construction, Fuchs said. Construction completions averaged 68 million square feet over 12 quarters from 2006 to 2008 during the peak of the last cycle, but quarterly deliveries since the financial crisis averaged less than one-quarter of that–just 16.2 million square feet. This soft trend has persisted as the first-half 2017 total decreased 2.8 percent compared with the same period last year, he said.

Fuchs said small-cap asset price growth is shrinking, commercial leasing demand is lower and–beyond the “choppy” deal volume for smaller multifamily assets–investment activity in the general commercial real estate market is down substantially compared with last year. “These factors impose fundamental concerns, risks and uncertainty about future market performance that will require small balance lenders and investors to increase their due diligence on deals during the second half of the year,” he said.

With cooperative capital market and economic conditions, the small-cap commercial real estate market remains on solid ground, Fuchs said. “But take a step back and second quarter results offer growing evidence that the market is reaching a peak,” he noted.