Small-Cap Rents Rise at Fastest Pace in Years

Tucker, Michael

June 16, 2016

Small-cap rents surged during the first quarter as small property landlords benefited from extremely tight markets, reported Boxwood Means, Stamford, Conn.

Boxwood Means Principal Randy Fuchs said small-cap industrial properties saw the highest growth as rents jumped 1.6 percent during the first quarter and 6.4 percent year over year. "That's the highest growth rates for these respective periods since at least 2007," he said. At a national average of $7.69 per square foot, nominal industrial rents now stand just 2.7 percent below their pre-recession pea.

Fuchs noted that Boxwood Means defines small-cap properties as those under $5 million and drew supply and rent data from CoStar, Washington, D.C.

Office rents rose 0.9 percent during the quarter and 2.3 percent year over year as the office sector responded to increasing office-producing jobs, Fuchs said. He called the recent movement noteworthy: "over the past 41 quarters, there have been only three other periods that posted similar increases."

Retail rents also performed well, Boxwood reported. They increased by 0.7 percent during the quarter--among the highest quarterly growth rates over the past 10 years--and 2.3 percent over the last year to $16.76 per square foot.

Though small-cap annualized retail rents increased at 2 percent or more for the last three quarters, they remain 8.1 percent below their pre-recession high, Fuchs said. By contrast, general retail properties saw national rents increase 3.5 percent over the past 12 months.

"It's notable that small-cap rent growth lags the level of rent appreciation in the general commercial real estate market, and moreover, that small commercial rents have yet to fully recover or exceed pre-recession rent levels as have the larger property markets," Fuchs said. "Of course, leases in smaller properties (generally under 50,000 square feet) typically have a shorter duration than lease terms in bigger properties and, hence, are marked to market relatively more often with smaller rent increases."

Fuchs said during an upcycle, lease renewals in bigger institutional investor-owned properties are subject to heftier rent bumps after their typical five- to 10-year terms expire. "As a result, it's predictable that larger rent increases prevail in today's vigorous general CRE marketplace," he said. "But on the flip side we'll also see bigger rent discounts in this domain after the market reverses course."

Fuchs noted that recent rent increases in the general CRE market triggered a "sizable" increase in new construction activity, which could slow general rent increases for new and renewal leases as the market expansion matures. "But supply pressure is quite modest in the small-cap arena and, with persistently strong positive net absorption, vacancies are tighter than at any time over the last decade," he said. "Combined with recent favorable reports on consumer spending, salary and payroll growth and housing sales, we can expect small-cap space fundamentals to remain quite strong even as supply continues to modestly expand."

The Mortgage Bankers Association will host a Small Balance Lending Summit June 22 and 23 in Chicago to examine the sector in detail.

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