Demand for Small-Cap Space Declines

Low demand overshadowed an otherwise solid first quarter for small-cap commercial real estate properties, reported Boxwood Means, Stamford, Conn.

Aggregate small-cap CRE demand across the office, industrial and retail sectors “plummeted” to just 1.9 million square feet during the quarter, a nearly 90 percent drop from the previous quarter as well as a year ago, said Boxwood Means Principal Randy Fuchs. He noted early 2019 represented the lowest combined net absorption for sub-50,000-square-foot space in the last 34 quarters. He called the drop in industrial demand “particularly striking.” Net negative absorption in that sector equaled 3.3 million square feet, translating to a 144 percent net occupancy loss year-over-year, the first negative turn since 2010.

“Industrial’s occupancy slide is a direct result of supply scarcity,” Fuchs said, citing an absence of adequate leasing options for users of small warehouses, light industrial and flex facilities.

Fuchs said demand dropped in the small-cap office and retail sectors, too. The office sector finished the quarter with a net occupancy gain of 1.3 million square feet, but demand dropped more than 70 percent year-over-year. Retail fared only slightly better with a nearly 70 percent decline in positive net absorption year-over-year.

But weak deliveries are keeping a lid on vacancies, Boxwood Means reported. “Developers remain sidelined by the few and costly small-building construction opportunities in many metro areas,” the firm’s Small Balance Advocate report said, noting aggregate deliveries across the three property types fell 5.4 percent quarter-over-quarter to 19.2 million square feet.

The national vacancy rate for small-cap properties edged up 10 basis points across the board in early 2019. Though a minor increase, the directional change marks the first quarterly reversal in sector vacancy rates in more than eight years, the report said.

“While slowing asset sales and prices and the supply-demand gap that has notably curbed net absorption during the first quarter may not pose major threats or disruption to the market’s present stability, the weight of these factors is real and will likely create more friction over time,” Fuchs said. “Small-balance lenders and investors that temper economic bullishness with a dose of vigilance about these market trends will be prepared to make the most sensible and secure deals.”