Small-Cap CRE Demand Slows as Rents Soar

Michael Tucker mtucker@mba.org

May 10, 2018


Demand for small-cap commercial real estate slowed "considerably" during the first quarter, but tepid new supply kept vacant space in check and rents soaring, reported Boxwood Means, Stamford, Conn.

Randy Fuchs, Principal with Boxwood Means, said net absorption across the office, industrial and retail sectors totaled just 16.2 million square feet during the first quarter, down 27 percent year-over-year.  Absorption slowed to the lowest quarterly volume in more than five years, Fuchs said.

"Certainly the slowdown in net absorption stirs up fresh concerns about the future of the market's eight-year expansion," Fuchs said. "But if there's one hallmark of this bull market's health and durability, it's the temperament of small-cap CRE vacancy rates--seemingly suspended in time at record-low levels."

Fuchs noted the aggregate national vacancy rate remained below 5 percent for the seventh consecutive quarter and currently rests 190 basis points below the pre-recession low at 4.4 percent.

All three sectors have achieved record lows, Fuchs said. Industrial vacancies averaged 3.4 percent, 260 basis points below the previous cyclical low, and the national office vacancy rate averaged 6.7 percent, 140 basis points beneath its previous low before the Great Recession. But the small-cap retail sector may be the most interesting story. Despite brick-and-mortar retail's well-documented travails, the average vacancy rate for small-cap retail centers fell 10 basis points year-over-year to 4.3 percent, "comfortably" 150 basis points below the previous low point in 2006.

Fuchs credited the continued viability of small grocery-anchored community and local strip centers that serve everyday consumer needs, making them more resistant to e-commerce challenges than larger retail centers.

Small-cap rents reached new highs in the first quarter. "Extremely low space availabilities continue to drive rents higher to the delight of small-time investors," Fuchs said, calling the level of rent inflation "unprecedented for our time." For example, since 2006, average annual increase in industrial rents equaled 1.5 percent. Yet small-cap industrial rents consistently exceeded 2 percent rent growth for the last five quarters and reached an "extraordinary" 2.9 percent between January and March, he said.

Small-balance loan originations totaled a "robust" $228.8 billion last year, down slightly compared with 2016 but still the third-highest total on record, Fuchs said. "Vast and diverse sources of interim and longer-term credit continued to flow into the space for loans under $5 million as real estate debt looks increasingly more attractive than bonds for investors."

Fuchs noted commercial banks' dominion over the small-balance loan space continues to erode. The top 15 lenders commanded a collective market share of 19 percent, down from the mid-20 percent range several years ago, he said. In addition, two non-bank lenders, CBRE Capital Markets and Greystone, joined the ranks of small-balance lenders.

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