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Market for smaller commercial assets is still booming


The high prices commanded for trophy office and multifamily properties in Manhattan and a few other big cities have caused some to speculate that we are at the top of the market and that the clock is now running out on the strong commercial real estate market. This cycle is often defined by what is happening with these multi-million dollar properties.  

Most commercial lenders and Realtors, however, operate in the market for smaller-sized properties in midsized cities like Nashville, Tennessee, and St. Louis, and here the story is much different. Smaller properties also are in the midst of a market boom, analysts told Scotsman Guide News, but the gains have been slower to come and the market itself is more stable.

smallcapcommercial“We don’t see any evidence that the small-cap CRE [commercial real estate] market is getting long in the tooth so to speak,” said Randy Fuchs, a principal with Boxwood Means, which tracks trends in smaller commercial real estate assets.  

“The warnings and the fears may be out there about being in the ninth inning have to be taken in the context of which marketplace you are really talking about,” Fuchs said.

One contrast is that sales prices for properties valued under $5 million have increased modesty. Boxwood’s index that charts the aggregate price of properties in 120 markets was up around 3 percent year over year toward the end of last year, Fuchs said. The index also remains about 6.2 percent lower than its previous peak in late 2007. This is not the case with major indices that chart the prices of high-value properties, which were running well ahead of the last price peak of a decade ago in most of the asset classes.   

A slow, strong recovery 

Rents and vacancy rates for retail, office and industrial properties also were extraordinarily strong last year, according to Boxwood Means data, with vacancy rates at the lowest level in more than a decade. Fuchs said the small-cap commercial market, with the exception of apartments, hasn’t seen much new supply.  

As a result, companies have been moving into the space in existing buildings at a pace not seen since 2006, just before the last market peak. Last year, companies absorbed 220 million square feet in smaller buildings, and just 74 million square feet was added to the inventory, Fuchs said.

“Supply has been uniquely constrained during this post-financial crisis period,” Fuchs said. “A lot of that has to do with the trajectory of the U.S. economic growth. It has been very moderate since 2010, and that has also been somewhat unique. There hasn’t been the crazy supply from market exuberance.”

In a forecast released this week, the National Association of Realtors (NAR) said the commercial real estate market would remain “stable” for the near future. The  majority of NAR’s commercial Realtors are involved in deals involving properties priced under $2.5 million. This is a roughly $100 billion a year market about one quarter the size of the large-cap market. Institutional investors, like hedge fund managers and foreign pension funds, have tended not to be active here. NAR’s surveys, however, indicate that institutional investors are taking more of an interest in properties outside the major cities.

“Investors are always attracted to the large market because of cash flow, but we had tightness of inventory going on for about 2 1/2 years,” said George Ratiu, a commercial analyst with NAR. “Obviously, that has dried up a lot of available spaces in gateway cities. Investors have moved on to places like Nashville; Louisville, (Kentucky); Indianapolis; St. Louis; Kansas City, (Missouri), places where the economies are fairly balanced.”

Ratiu noted, however, that smaller banks are still financing roughly half of the deals in the small-cap market, and investment by large global players is still fairly limited.

“A lot of investors are making what tends to be termed value-add investments, namely, they are buying these properties, they are renovating them, they are getting some cash flow, and possibly down the road selling them,” Ratiu said. 


 

Questions? Contact at (425) 984-6017 or victorw@scotsmanguide.com.

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