Small-Cap CRE Market Poised For Late-Stage Course Adjustment
The small-cap commercial real estate space market and investment trends have flattened out and appear vulnerable, said Boxwood Means, Stamford, Conn.
“Space demand [for commercial properties under 50,000 square feet] rebounded modestly during the second quarter, but it was insufficient to offset the sustained slowing trend,” said Boxwood Means Principal Randy Fuchs. “The most favorable reading of second quarter results was that market stability prevailed.”
Aggregate small-cap CRE net absorption across office, industrial and retail sectors equaled 9.8 million square feet in the second quarter, up from 4.9 million square feet early in the year but down 66.4 percent year-over-year.
“Industrial demand barely reversed the negative net absorption of the previous quarter–the first of its kind in 34 consecutive quarters,” Fuchs said. He noted the first quarter “served as a wake-up call to small-cap investors and lenders about this sector’s seeming invincibility.”
Demand for small-cap office space grew significantly to 3.8 million square feet in the second quarter after a “meager” 1.7 million square feet during the first three months of the year, Fuchs said. But he noted leasing velocity has slowed considerably: total net absorption equaled 5.5 million square feet through June, down nearly 60 percent compared with the same period last year. Similarly, retail demand softened with a 59.7 percent decline over the first six months year-over-year with total net absorption equaling only 10.2 million square feet.
“It would be a miscalculation to think the weakening leasing trends have come about only because of slowing global demand, trade tensions and tariffs, a stronger dollar and overall softer domestic business spending,” Fuchs said. “Beyond these legitimate concerns, we continue to assert that structural factors are a root cause for the decline in small business demand for space, especially in the industrial and office sectors.”
Fuchs said assessing downside risk to a mature market like this one is challenging when the conventional markers of a late cycle such as oversupply, mounting vacancies and growing cap rates are missing. “Yet, the escalation in trade tensions and tariffs that has already taken a bite out of U.S. GDP, compounded by the profound small-cap CRE space and job scarcity have shaken business confidence and limited expansion and investment plans,” he said. “At minimum, it appears we’re poised for a late-stage course adjustment. At the worst, continued economic turmoil will tip the scales downward for an already tenuous small-cap CRE market.”
