Small-Balance Fundamentals Lift Investments

Tucker, Michael

August 15, 2016

The small-balance sector bounced back in the second quarter after a recent pullback in investment sales and prices for properties under $5 million, reported Boxwood Means, Stamford, Conn.

"Impressive second-quarter fundamentals reassured small-balance lenders and investors that there's plenty of gas left in the tank," said Boxwood Means Principal Randy Fuchs.

Fuchs said small-cap commercial real estate fundamentals strengthened significantly during the second quarter. "Demand soared to a post-recession high," he said, noting a "whopping" 76.1 million square feet of net absorption across the office, industrial and retail sectors--the second-highest total since fourth-quarter 2007's 104.4 million square feet absorbed. 

"Also, remarkably, the aggregate demand through the first half of the year exceeded the net absorption total for the first six months of last year by 62 percent and represents the highest mid-year total since at least 2006," Fuchs said.

All sectors felt the effects, Fuchs said. Office net absorption jumped 119 percent year-over-year to 21 million square feet, the highest quarterly demand figure since at least 2006. At mid-year, office demand was 86 percent ahead of the same six months during 2015.

Similarly, retail sector quarterly and year-over-year demand climbed 156 percent and 105 percent, respectively, with a mid-year total that surpassed last year's first six months by 68 percent.

"Industrial demand, which has been robust for three year's running, also turned in a stellar quarter," Fuchs said. Demand rose 54 percent year from a year ago to 23.3 million square feet and mid-year net occupancy levels exceeded last year's pace by 42 percent. 

"The small-cap commercial real estate demand and vacancy trends offer convincing evidence that the Main Street USA economy is healthy and expanding," Fuchs said. "Small office-using firms are hiring; the utility of smaller warehouse/distribution and flex buildings is largely undiminished by big supply chain and logistic facilities. Similarly, despite formidable online sales, neighborhood shopping and strip centers still satisfy important needs for everyday items like groceries and personal care products and services."

Fuchs said fears about the U.S. economy and the extended length of the current real estate cycle weigh heavily on many investors, especially institutional buyers confronted with peak pricing for major-market assets. "Many have pulled chips off the table because of increasing perceptions of economic and market risks that, in the event of a downturn, may adversely affect property values," he said. "Out of similar concerns, lenders are underwriting loans more conservatively, which produces more challenges for borrowers." 

But the discipline generally exhibited by the space markets coupled with still-favorable cap rate spreads and returns compared to alternative investments reassures CRE lenders and investors, Fuchs said: "In the absence of any further shocks to the financial markets, we expect both small- and large-cap investment sales to further pick up the pace."

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