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Sales of smaller commercial properties soar

It has been widely reported that large institutional investors have been pouring money into trophy commercial properties in America’s biggest cities. Over the past year, however, investors of a different stripe have been buying up smaller commercial properties at a record pace. 

Assets priced under $5 million have been bought and sold at record levels during the first half of the year as investors have rushed to capitalize on a market that still favors buyers in many cities. Vacancies have dropped, prices have stayed reasonable in many markets and new construction has floundered, a new Boxwood Means study says. The company tracks smaller assets across all major commercial sectors.

Sales volumes of small-cap assets — which are up 14.4 percent through the first half of the year compared to 2014 — are moving at the fastest clip since at least 2005, Boxwood Means said. The company said that this year’s sales volume is on track to exceed last year’s record level of $81.1 billion.

“We are talking about very local demand by small investors, and business real estate owners,” said Randy Fuchs, principal at Boxwood Means. “It has been compelling for several years because of improving commercial real estate markets as well as the slow, but increasing health of the general economy. The record pace that we are seeing here is an acknowledgment by participants that these assets, these smaller assets,  are just basically good places to put in money at this point in the economic cycle.”

Small-cap assets are under 50,000 square feet, and often depend on a single tenant. They are, therefore, more volatile and riskier than trophy, investment-grade properties, said George Ratiu, a commercial analyst with the National Association of Realtors. NAR regularly surveys its commercial members, and most work deals for smaller-asset properties. 

The investor who buys a small-cap property is a different breed from the Real Estate Investment Trusts and pension funds that have been buying up large assets in San Francisco and Manhattan, Ratiu said. The investor in smaller assets often needs to take out commercial bank loans to purchase a restaurant, a strip mall or warehouse building. On a national basis, the market for larger commercial properties recovered more quickly, he said, but deals for smaller assets are now increasing.

“We are actually seeing the same pickup in investment transactions from our own members,” Ratiu said. “It seems like the trend is very much there.”  

Construction remains down

The heavy interest in small assets has been driven by higher demand for leases, falling vacancies and a curious lack of new construction projects, Fuchs said. Nationwide companies absorbed a net 36 million square feet of space in this small-asset class in the second quarter, which exceeded the quarterly average by 80 percent.

The construction of buildings under 50,000 square feet, however, has generally fallen across sectors, except in central business districts. A combined 63.3 million square feet was under construction through June, down 20 percent compared to the first half of 2014. The second-quarter pace of construction was at just 40 percent of the long-term quarterly average pace, the Boxwood Means study said.

"It is a bit of a head-scratcher that developers of smaller buildings have not responded to the very tight vacancies that exist in the small-cap domain," Fuchs said. He said vacancies are at record lows for industrial and have been falling in retail and office. 

Fuchs noted, however, that prices haven't risen that steeply — just 5 percent — on a national basis over the past year. He also said that rents, while improving, still remain below the peak levels, and some markets are doing much better than others.

“Lenders may be somewhat adverse to giving developers money for smaller properties unless they have tenants in tow already preleased,” Fuchs said. “That may not seem necessary in a low-vacancy environment, but that could be a factor as well."


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