Small-Cap CRE Leasing Velocity Slows

Small-cap commercial real estate leasing velocity slowed “considerably” during the third quarter as rent growth accelerated, reported Boxwood Means, Stamford, Conn.

Randy Fuchs, Principal with Boxwood Means, said tenant leasing activity in sub-50,000-square-foot-properties plummeted more than 64 percent quarter-to-quarter across the office, industrial and retail sectors. Demand fell a “whopping” 86.5 percent year-over-year to just 7.8 million square feet. “This was the lowest quarterly advance in five years and supports the narrative that the commercial real estate market may be reaching its limit after a bull run lasting eight years,” he said.

As further evidence, Fuchs said the combined 46.1 million square feet of space absorbed during the first three quarters equals only one-third of demand for 2016’s corresponding nine months.

“All three sectors suffered a pullback,” Fuchs said. He noted small-cap office demand declined by 84.8 percent during the quarter and 93.8 percent year-over-year to just 952,000 square feet. Net industrial sector absorption–1.9 million square feet–dropped by 66.2 percent and 89.4 percent for the quarter and year-over-year, respectively–the lowest quarterly volume since the same period in 2012.

Similarly, retail net absorption decreased by 50 percent quarter-over-quarter and nearly 80 percent year-over-year to 4.9 million square feet. “Though by historical norms retail’s 2017 occupancy gains have also been modest, it’s important to note that small retail tenants–many located in convenient strip centers serving neighborhood residents–and catering to consumers’ everyday needs such as food liquor stores, nail salons, cleaners, etc. have proven to be resistant to the fallout from online sales relative to many big-box retailers and department stores,” Fuchs said.

Small-cap rents have increased across all sectors, Fuchs said. Industrial rents rose a “hefty” 2.2 percent during the quarter to an $8.95 per square foot average after an unprecedented 2.4 percent gain in the previous period. “With small industrial space in high demand from various light manufacturing, warehousing and urban in-fill uses, rents surged over the last 12 months–the highest annualized rent growth in at least 11 years,” he said.

Office rents are nominally 1.6 percent above their former peak level at $20.46 per square feet after a 1.1 percent quarterly increase, Boxwood Means reported. “Small-cap retail continues to be resilient in the face of e-commerce threats as rents rose 1.2 percent quarter-over-quarter and an exceptional 5.7 percent year-over-year,” Fuchs said, calling it the highest annualized rent growth since 2007.

Average small-cap retail rents were effectively flat–growing just 0.1 percent during the quarter, Fuchs said.

“But there are no stop signs for multifamily,” Fuchs said. “The chronic undersupply of affordable rental housing combined with a demographic tidal wave of renter households assures small-balance lenders and investors of favorable prospects for current and future investment in the sector.” He noted 9 million new renter households joined the marketplace over the last decade, the biggest 10-year boost on record.