Small Loan Briefing by Randy Fuchs

Rents on Main Street Persevere

Deteriorating U.S. economic conditions have slowly but surely dented the performance of small commercial properties. We know that small-cap property values peaked in the summer of 2006 and have since been falling back to earth. What about small-cap rents? On a national scale, Main Street rents are holding their own for small investors. Yet, strengths and weaknesses have emerged in different parts of the country.  

Across the roughly 100 commercial real estate markets for which Boxwood tracks small-cap performance on a monthly basis via LoopNet space listings data, national asking rents for office, industrial and retail properties have declined consistently for months, albeit at a modest pace. As of September, retail rents have dipped for 14 consecutive months to $18.67/sq.ft. on average, but this weakness translates into only a 2.8% drop from the peak rent level reached in July, 2007. The Southwest region suffered a sizable 0.9% loss in September rents, contributing to a 7.3% year-over-year decline that is the largest among the six regions. By contrast, rents in the Northeast have remained buoyant, up slightly in the latest month and 4.8% since last September. So it appears that fundamentally our neighborhood-based strip centers, small shopping centers and street retail shops have so far endured, despite negative factors for this sector such as  the ongoing housing correction, growing job losses, elevated gasoline prices and unfavorable consumer sentiment. 

By comparison, national industrial rents have been weaker. At  $8.39/sq.ft. on average, rents were down 0.7% in September and 3.5% since their peak level in December of last year. This comes as no surprise as demand for small warehouses and flex space has fallen off in lockstep with the contraction in manufacturing output, transportation and shipments. Industrial rents in the Southeast and Midwest have suffered the most as a result, with the biggest one-year rent losses at 6.9% and 4.7%, respectively. On the other hand, with its regional focus on healthy energy and export industries the Southwest has posted the best gains, up 4.7% since this time last year.

To date, office rents have proved to be the most resilient. After all, office employment changes tend to lag those in retail and industrial sectors, which typically respond more quickly to economic downturns.  Hence, September rents, at $17.27/sq.ft., have slipped only 0.75% since their peak in February of this year, led by modest gains in the Northeast and Mid-Atlantic regions. That said, national rents have edged downward for seven consecutive months, and we might anticipate further fall out in the months ahead if small businesses reduce the number office workers. Small-cap office rents in the Southeast have already been adversely affected, down 4.3% from September of last year.

Prolonged economic woes or deep recession will certainly apply further downward pressure on small commercial property markets and investors. So far, though, the damage appears to be contained.