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Demand for small commercial properties cools

Has the market for small commercial properties peaked? A significant downshift in leasing demand could foreshadow a decline in transaction volume, sales prices and future rental growth, according to analysts who watch small-cap real estate trends.

The tracking company Boxwood Means has already deemed the market for smaller properties close to the peak, indicating that it may already be on the verge of decline.

smallbuildings The biggest warning sign is a sharp drop in the demand for space in buildings under 50,000 square feet over the first two quarters of 2017, compared to an especially strong 2016 level. 

The net aggregate absorption in smaller retail, industrial and office buildings totaled 38.5 million square feet in the first half of 2017, down 66 percent compared to the same period in 2016, Boxwood Means reported. This was the weakest demand since 2011. 

"It's tough to sugar-coat that reversal," said Boxwood Means Principal Randy Fuchs. Fuchs said investors also have reason to be nervous about trends in rental growth and vacancies, which on the surface remain rock solid. 

The aggregate vacancy rate of commercial properties is near a record low of 4.6 percent. That rate, however, has not moved down over the last several quarters. Construction activity also has picked up in the office and industrial sectors, which could begin to push up the vacancy rates in these sectors. 

Fuchs also noted recent rental spikes in the office, retail and industrial sectors, which have risen in the range of 4 percent to 8 percent over the past two quarters. This is the strongest growth in rents since 2008 and "classic late-stage advances," he said.

Fuchs acknowledged, however, that there could be some time left in the cycle.

"At the end of the day, it’s a fool’s errand to try and predict an inflection point in commercial real estate," Fuchs told Scotsman Guide News. "If this CRE [commercial real estate] market expansion has proven anything, it’s that moderate U.S. economic growth and attractive capital-market conditions sustained over a long period of time can defer CRE’s cyclical maturity date longer than historical trends might suggest." 

Still going strong?

Other analysts said it's yet unclear if the market for small-cap properties has topped out. The National Association of Realtors (NAR) is in the midst of gathering its second-quarter data from Realtors, said George Ratiu, an NAR analyst. Most surveyed Realtors broker deals involving properties priced under $1 million, but the survey includes a full range of asset sizes up to over $100 million. 

"Anecdotally, they (Realtors) are still quite busy," Ratiu said during a telephone interview. "A lot of deals are happening in their markets." 

Ratiu said that the small-cap market is highly fractured and dependent on the local economy. In Plano, Texas, for example, small commercial real estate has been boosted by the new Toyota North American headquarters that opened this year, as associated industries have moved into the north Texas region.

 Ratiu said lenders have generally tightened their standards this year, and some markets have few available buildings for sale, Ratiu said.

"Owners are probably trying to time the market a bit," Ratiu said. "They have been watching prices go up and up, at least with the small-cap space. They are probably trying to squeeze the gain. As a result, they are probably waiting to put properties on the market."


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