May 2012

Many observers suggest that commercial real estate is stuck in first gear as mixed economic vital signs confound the 2012 outlook. However, participants focused on headline macro-economic news may be left behind at the starting gate. The fact is that small-cap commercial property sales are rebounding smartly at the outset of the year.

Small-cap CRE sales hit bottom in March 2009 before the Great Recession had run its course. Nearly three years later, sales volume of properties under $5 million has risen by 50%, to $4.0 billion in monthly sales during February according to Boxwood's latest available data.

The sales trend is encouraging and portends greater price transparency, more liquidity and even higher volume in what may emerge as a favorable cycle during the second half of the year. Though February's preliminary estimate declined 5.4% sequentially, investment sales activity has increased 4.9% over three months and 18.6% since February of last year.

It's no surprise that this uptick corresponds with an increase in available financing. The Mortgage Bankers Association reported a 55% spike in mortgage originations in 2011, and recent lender surveys also indicate that bank underwriting standards have loosened a bit of late. Were the conduit lending business to keep percolating this year, that, too, will boost deal-making for a lot of smaller properties.

Sales momentum is also broadening geographically. During February, 84 markets posted year-over-year sales volume gains against 35 that suffered declines, a substantial increase in the advance-decline ratio from the previous month.

The lion's share of advanced sales volume is occurring in the smaller markets, where 70 cities posted positive year-over-year sales growth. The percentage gainers with at least $10 million in monthly sales included San Antonio (505.4%), Central NJ (383.4%), Jersey City (232.2%) and Albany (195.6%).

Amidst these momentum gains, there's the shadow cast by over $300 billion of commercial mortgages scheduled to mature this year. According to Trepp, at current property values the lion's share of the maturing loans would face difficulties refinancing with loan-to-value ratios that exceed 100%. Consequently, the debt overhang will certainly lead to much more product being released onto the market. Whether the prospective rise in property and portfolio sales will be efficiently absorbed by investors or, alternatively, apply the brakes to the recovery depends on numerous factors, e.g., property market fundamentals, investor psychology, financial markets, etc. To date, the small-cap CRE market has proven resilient; this year's unwinding of huge sums of commercial mortgages may present yet another test.

See this page for background information about Boxwood's SCPI measures.