Mixed Conditions in Small-Cap CRE

Small-cap commercial real estate conditions were “mixed” during the first quarter, reported Boxwood Means, Stamford, Conn.

Fundamentals for commercial real estate properties under $5 million posted another generally positive quarter to start out the year, but mixed space market conditions and sluggish price growth together serve notice, said Boxwood Means Principal Randy Fuchs.

zFuchs noted leasing activity across the small cap office, industrial and retail sectors slowed significantly from last year’s “breakneck” pace. He said aggregate net absorption across the three property types totaled just 10.8 million square feet during the quarter, down 65 percent year-over-year and the lowest quarterly demand increase in more than four years.

To illustrate the pullback’s severity, Fuchs said small-cap office demand plunged 74 percent year-over-year to 1.6 million square feet during the first quarter. Similarly, small-cap industrial demand plummeted 72 percent to 3.2 million square feet while retail demand dropped 55 percent to 6.0 million square feet absorbed.

Fuchs noted the pullback in overall occupancy growth came after a “mammoth” year in 2016 that saw 224.1 million square feet of aggregate net absorption, surpassing the previous high-water mark set in 2014 by 16.2 percent.

“Vacancy rates remain in uncharted low territory, but have flattened out as tenant demand wavered,” Fuchs said. He called the 7 percent small-cap office vacancy rate extremely tight by historical norms, hovering 120 basis points beneath the previous 2006 low point. “However, office vacancies were unchanged for two consecutive quarters for the first time since the second quarter of 2012 and narrowed by only 20 basis points over the last three periods,” he said.

Likewise, the national small cap industrial vacancy rate remained flat at a record-low 3.6 percent–250 basis points below its previous low point–while retail vacancies held steady at 4.6 percent for the third quarter in a row.

“With some weakening in sales transactions, the likelihood of further interest rate hikes and some relatively new risks to the U.S. economic engine, it’s still encouraging that small cap commercial and multifamily prices are holding up in this period of flux,” Fuchs said. “Some continued price fluctuations may be expected as buyers adjust expectations for their income streams and sellers come to terms with less fervent deal activity.”

Fuchs said small cap commercial prices may continue to edge higher with the return of solid job and GDP growth, “but the era of double-digit price increases for a multitude of multifamily markets is likely behind us.”

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