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Realtors expect busy 2019 for small-cap CRE sales

The National Association of Realtors (NAR) surveys commercial Realtors each quarter to get a handle on the health of individual markets around the country for smaller commercial properties valued at less than $2.5 million, where tracking data is not as readily available. NAR’s George Ratiu, managing director of Housing & Commercial Research, spoke with Scotsman Guide News about the prospects for the small-cap market in 2019.  

What is your outlook for the market for smaller commercial properties, the market that Realtors are normally engaged in?

georratiuIt will be tied very much to the [U.S.] economic story in large part, because we expect the economy, broadly speaking, to slow down this year. The Federal Reserve’s moves to tighten its monetary policy are slowing some things down and companies are getting a little bit nervous about the outlook. The IMF (International Monetary Fund) downgraded their view for the global economy earlier this week. So, there are a lot of factors that are clouding the economic outlook. For small-cap commercial markets, this cycle had roughly a three-year lag to it, compared to large cap. Large-cap markets rebounded in 2010. Small-cap markets didn’t see the rebound until 2013, both in terms of sales as well as prices. From that standpoint, I expect the markets to have a little more leeway going forward. So, I think 2019 will still be a good year in the small-cap space.

Is it fair to say the market for smaller properties is more dependent on the local economy as opposed to, for example, an office tower in Manhattan?

Absolutely. Small-cap commercial is much more tied to the health of the local economies. When you look across various metros, there are some that are much better positioned than others. Salt Lake City, for example, is among cities with the fastest growing employment in the U.S. It has one of the lowest unemployment rates. It’s benefiting from state demographics. We are seeing the state’s population rise. It has also had a solid influx of migration from Americans from the rest of the states, but especially California. And a lot of companies are moving into that market because of these reasons, So, demand in Salt Lake City for commercial properties across the board — multifamily, industrial, even office — has been extremely solid. I don’t see that slowing down in 2019. Las Vegas is another market that has seen solid in-migration. So, absolutely, I think the health of local economies will determine the performance of small-cap commercial real estate this year.

In regards to sales volume, do you have any projections for 2019 and how that will compare to 2018?

For the small-cap space, the data that we collect does not allow us to really aggregate a number, much to my chagrin. Based on Realtor experiences, I expect the number to be higher for 2018 [compared to 2017]. Even from our quarterly data, sales were up both in the first, second and third quarter. We are now collecting data for the last quarter. We will have the report on that sometime in February. Anecdotally, talking to Realtors across the country, from Chicago to Salt Lake City to L.A., they have really had a very busy year.   

Is there any one asset type that stands out?

Right now, I think the hottest asset is industrial space. The rise of Amazon — and that shoppers are buying just about everything based on Amazon — has driven extremely strong demand for industrial warehouse spaces. Closely behind that, I see potential in Class B apartments, partly because there is a shortage of workforce housing, or affordable housing across the range. For a lot of investors, the Class B space offers a lot of value-add [opportunities]. You can buy a property, make some improvements and move it up market. So, there is a lot of opportunity in that space.    

What are your thoughts on traditional retail?  

I think the retail apocalypse has been overplayed, frankly. What we have seen is a severe decline in department-store space. Sears has obviously gone through a very well-covered bankruptcy. We have seen Kmart close stores. Part of that is overbuilding. The U.S. built a lot of big-box spaces in the ‘70s and ‘80s, even in the ‘90s. With the increase in e-commerce, naturally there is a decline in that. However, I think the story is more nuanced in the sense that a lot of what are called "lifestyle malls" have been successful in repositioning themselves as experience destinations, whether it is through restaurants, [or] whether it is through building concert venues or a mini urban hub into their footprint.

The other segment, particularly for the small-cap space, are the neighborhood shopping centers. These shopping centers are traditionally anchored by grocery stores. If anything, I think the U.S. is going through a grocery-store renaissance. A lot of the smaller and traditional grocery stores are very much driving solid demand for these neighborhood shopping centers. In tandem, they are bringing into these centers a sort of ecosystem of stores. Those have performed very well and for 2019, I see those driving a lot of growth in the small-cap space.

Is there still a lot of financing available on deals for smaller properties?

Funding has been available from a broad range of sources — both on the equity side, which tends to generally dominate small-cap space, but also on the debt side. Banks are still very much active. They have been very competitive. They have gotten squeezed this last year because of the Fed’s move to increase the rates. Their terms are obviously dependent on the cost of money.  

I see funding as not being an issue in the market both in 2018 and in 2019. On balance, I think there is still a lot of capital chasing limited inventory in the market. To give you a sense of what I mean, I was in Los Angeles a couple of weeks ago and spoke at two different conferences. I got a chance to meet with a lot of Realtors, but also non-Realtor investors. The common thread during the discussion was off-market properties. Right now, basically, all investors are looking for off-market properties. Literally everyone is looking for off-market properties, which tells me there is a significant shortage of inventory still for small-cap space.   

Is there any one part of the economy that worries you, that might severely damage the outlook?

The one thing that honestly concerns me is psychology. The U.S. economy is driven, in large part, by consumer spending. The Fed kept interest rates at roughly zero for eight years. They have been increasing them, and we have seen the markets get a little nervous about it, particularly in this last quarter. As that cost of money is moving up, I think the psychology —  not that by historical standards they [the rates] are any higher than during prior decades — but once people have gotten used to low interest rates, facing all of a sudden higher borrowing costs, higher credit costs, is very likely to lead to a sharper decreasing consumption [rate]. I think the financial markets have already anticipated some of this. So, I would say that is the one thing that concerns me. A sharp downturn in consumer optimism could lead to drops in GDP (gross domestic product), accompanied by declines in demand for commercial real estate, along with other properties. 


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