Underlying Solid Fundamentals Position Small-Cap CRE Sectors to Lead an Economic Recovery.
Despite concerns about commercial property distress and plunging valuations in the broader CRE market, small-cap CRE remains relatively strong and durable, according to an analysis of CoStar occupancy data by Boxwood Means.
Small-Cap Retail CRE Resurgence
Strong retail sales growth in Q3 of 2023 led to an 8.4 million square foot increase in the demand for small-cap CRE retail properties, marking 12 consecutive quarters of positive net absorption. Together, resilient shoppers, driven by a strong labor market and personal earnings growth, have kept the U.S. economy humming, particularly in the small-cap retail sector. As a result, vacancies dropped ten bps to 3.4% while asking rents rose by 3.9% year-over-year.
Small-Cap Office Beats Large-Cap General Office Market
During the same period, small-cap CRE office properties with smaller footprints, shorter lease terms, and suburban locations maintained a lower vacancy rate of 6.5% compared to the general office market, which struggled with nearly 60 million square feet of occupancy losses in the national market and a record 13.4% vacancy rate. Since tenants executed more than half of the leases for large-cap office space before the pandemic, which have yet to expire, vacancies are likely to increase.
Small-Cap Industrial Faces Strong Headwinds
Although the small-cap CRE retail and office sectors showed positive trends in contrast to their large-cap counterparts, the small-cap industrial sector is grappling with substantial challenges. Weak manufacturing fundamentals, such as reduced customer inventories and factory order backlogs, have significantly reduced manufacturers' industrial space requirements. Nevertheless, occupancy rates for the small-cap industrial sector remain comfortably below their long-term averages, reassuring investors that a more profound disruption in the small-cap industrial market is unlikely.
Small-Cap CRE Opportunities for Mortgage Brokers
The Boxwood Means analysis concludes that small-cap CRE is uniquely positioned to ride out any impending market upheaval since the sector’s underlying operating fundamentals are relatively strong and durable and will likely continue to support stable property-level net operating income and asset valuations. Because of this, mortgage brokers who diversify their businesses to serve the needs of small-CRE investors are likely to outpace performance in the consumer real estate market.
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