Signal strength emanating from small commercial property markets in July was more positive and consistent. Rents are stabilizing, leasing activity is improving and for-sale property prices are firming up. While fundamentals are far from healthy, the market's compass is clearly pointing northward. See the National and Regional Trends Update report for July.

Of course, the trajectory of property fundamentals remain vulnerable because of a weakness in aggregate economic demand: it limits the small business formation and jobs growth that spurs more office and industrial usage by tenants; and it dampens consumer expenditures that fuel retail shop expansions. Small-cap CRE markets will likely bounce along the bottom with soft rents, elevated vacancies and brittle property values until such time that the economy cranks up further.

As an indication of the vulnerability of space fundamentals, small commercial property vacancies increased 38 basis points to 11.2% in the second quarter. Only 9 of the 98 metro areas tracked by Boxwood Means posted vacancy declines over the past 12 months.

As shown in the graph, there is substantial movement and variability in vacancy conditions at the metro level (click on the image to enlarge it.) In the upper right quadrant of the graph, several California markets such as Riverside-San Bernardino, Stockton and Bakersfield are trailing the rest of the metros while others including Ft. Pierce, Greenville and Tulsa are recovering faster (lower left quadrant) based on recent vacancy movements. The scatter diagram, which portrays average U.S. vacancy rate changes over two time periods as the intersection of the thin horizontal and vertical blue lines, suggests that metros with below-average vacancy changes over the past year continue to out-perform. On other hand, markets with above-average vacancy changes over the longer term are still lagging.

The positive association between past and present vacancy movements illustrated here offers lenders and investors some insight for collateral risk management as well as targeting loan origination markets.