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CRE Prices in an Irregular World of Capital Supply We're often asked how it could be that small cap CRE prices trail by so much the robust appreciation of institutional assets over the last couple of years. We suggest that the answer lies generally with a disparate supply of capital, but we can also say that some small cap CRE markets have nevertheless performed quite well, thank you. Institutional prices, here defined by the RCA CPPI - Core Commercial Index that tracks principal commercial (non-multifamily) transactions above $2.5 million, have increased a heady 29.2% over the last three years and, as of April data, hover 11.9% above the previous 2007 peak level. By contrast, Boxwood's national Small Commercial Price Index (SCPI) for transactions under $5 million rose by only 13.4%, or less than half the rate of the large-cap CRE domain during the same three years, and remains 5.2% below the previous apex. We think this disparity chiefly lies with the wave of global equity capital that washed ashore seeking not only safe harbor from more volatile foreign markets but also the opportunity for strong capital appreciation. As prices for trophy properties slowly began to percolate in 2010 and eventually reached a boil with double-digit annualized gains for 30 consecutive months during 2013-2015, this stellar price appreciation attracted even more capital in perhaps a classic example of the price elasticity of supply. That price-supply dynamic isn't anywhere near as powerful in the small cap CRE world where assets primarily trade hands among local and regional players whose money pockets also aren't as deep. But that doesn't mean that selected metro areas within the smaller domain are immune to price inflation. Indeed, some are standouts. As shown in the nearby graph, peak-to-current prices in a number of oil and gas-related markets (Houston, Tulsa, Scranton, Greeley), among others, have ballooned into positive territory while property values in other markets (West Palm Beach, Fort Wayne and San Francisco) have also soared though still below previous peak levels. The simple fact is that the underlying growth of these local economies is the primary driver behind the ramp up in small commercial property prices. And because of that, the varying asset price trajectories across and within large and small cap CRE domains underscore how important it is for lenders and investors to use suitable tools of the trade to underwrite and monitor collateral values during all phases of the real estate cycle.

Small Balance Players Can Take Heart in Housing Trends Widespread references to baseball inning analogies underscore the pre-occupation these days among industry players with how much more time is on clock (ugh!) before CRE market fundamentals and sales prices begin to falter. Seven years into the market's expansion, an absence of clear directional signals only heightens the unease and perceived investment risk for lenders and buyers. Yet small balance market participants may draw some inferences about the future outlook from residential housing market trends. As we have cited in times past, small cap CRE prices tend to move more closely with residential housing prices than they do with values of institutional assets. Our newest study reinforces those relationships, and offers some insight into the durability of the small-cap market expansion. As shown in the nearby graph, the linkage between small cap CRE and residential housing prices (as indicated by the S&P Corelogic Case-Shiller National Index) has been modestly strong with a correlation coefficient averaging .51 over the past 10 years. The strength of the relationship was at its height during the previous peak era of 2007-2008, and a similar positive relationship has re-emerged over the last couple of years as the market has matured. You might note that any specific point in time on the graph shows the lagged effect of 36 previous months of correlations, so that, e.g., SCPI's lowest correlations with residential housing occurred during the three years climaxing in 2012 when both indices bottomed out after the Great Recession. This makes a lot of sense since we know from previous Boxwood research that small cap CRE prices lag residential prices on the way down but are more closely aligned on the way back up. By contrast, SCPI's correlation with institutionally-oriented asset prices (as indicated by the Core Commercial sub-index component of Moody's/RCA CPPI that excludes multifamily) has been consistently weak, with an overall coefficient of just .13. Indeed, prices were negatively correlated during the downturn and only slightly positive during the initial years of recovery. Later, including nearly 30 consecutive months between 2013-2015 as institutional asset prices jumped by double-digit percentages, that relationship tapered even further since small cap CRE prices advanced at only a very modest pace. So, to the extent that past is prologue, the takeaway for small balance lenders and investors is to follow local residential housing market trends closely because as goes housing, so goes small cap CRE. The fact that the S&P Corelogic Case-Shiller National Index rose 5.8% in the 12 months ending in March - the highest pace in nearly three years - along with increasing home sales and housing starts in many areas of the country pose a strong, parallel argument for a sustained and robust small commercial property market.

Boxwood's Randy Fuchs to Join Important MBA Panel Session We're proud to have Randy Fuchs speak again at this year at MBA's upcoming Small Balance and Portfolio Lending Summit. The small commercial property and loan markets - like the CRE market at large - have been consistently strong over the course of this lengthy market expansion. However, winds of change may be afoot as space market fundamentals have recently stalled and property sales have declined. Join Randy and other panelists for a session that includes Boxwood's latest research and the go-forward market opportunity for small balance lenders on June 29 in Dallas. We will also have an exhibit table, so please stop by and say hello. See you there!

CRE Prices and Alternative Facts Popular wisdom is that national commercial real estate prices have reached new heights in the post-financial crisis era. This view was recently boosted by the Federal Reserve Chairman, Janet Yellen, who signaled that CRE prices were "high," while other Fed officials expressed similar concerns about over-heated markets. To combat the potential for asset price bubbles, Federal officials say they are leaning towards enhanced financial supervision of commercial banks and thrifts. That's all well and good. But if the Fed believes the magnitude or breadth of CRE asset inflation is accelerating, it's conceivable that monetary policy will be further tightened leading to a faster pace of interest rate increases that would likely be damaging. Given the potential risks at stake here, it behooves Federal officials and industry pundits to pick their measurement tools wisely. The single best gauge of CRE investment conditions is surely not the number of construction cranes on the skyline of gateway cities like Los Angeles, New York or Seattle. Equally nonsensical is it to rely entirely on metrics that capture the price performance of just one investment class, such as property trades solely of large institutional properties. But it wouldn't be the first time that has happened. Ten years ago we argued that the 40% drop in CRE prices during the financial crisis, as consensus opinion had it, was only partially true because that assessment was heavily influenced by the popular and well-respected Moody's/RCA CPPI focused on institutionally-oriented asset sales principally above $2.5 million. (Full disclosure: we are big fans of RCA and, as illustrated here, often employ the CPPI metrics for comparison purposes.) As counterpoint, Boxwood's market research indicated that within the more extensive small cap CRE domain involving assets under $5 million in value the peak to trough price decline was much less steep, at 29%. This 1,100 basis-point gap underscored the sizable difference in asset price volatility between the two domains which, at the time, went largely un-noticed by bank regulators and market analysts alike. As a result, commercial properties of all sizes - but especially those on Main Street America - were unnecessarily held hostage to the austere mortgage lending regime that ensued. Today we can agree on the following: that institutional prices are generally elevated; there are bubble-like conditions in a handful of cities; and apartment prices are generally frothy. But we disagree that these conditions are necessarily concerning and, more importantly, that they fairly represent investment conditions broadly - nor specifically in the small cap CRE arena. Let's initially look at some institutional price trends. As of December, Moody's/RCA CPPI Core Commercial Index had gained a hearty 8.2% year over year catapulting asset values by 14.1% above the former peak level achieved during the fall of 2007. Core Commercial prices cumulatively have increased by a whopping 67.6% over the last five years. Note, however, that there was a distinct slowing in the rate of appreciation during 2016 compared with the previous 12 months when double-digit annualized price gains were the norm. RCA attributes the price deceleration to the credit issues at the beginning of last year, challenges in the CMBS market and a slowdown in the number of megadeals. This easing of price growth was also evident in cities often synonymous with bubble territory. While Core Commercial prices soared over the last three years in San Francisco (52.4%), Seattle (41.9%), Manhattan (31.7%) and Boston (27.8%), with the exception of San Francisco annual returns last year slowed to a crawl. So a commercial bubble in prominent metros appears to be contained at the moment. That being said, certain segments of Core Commercial like CBD Office and Industrial showed renewed strength during the fourth quarter and may bear watching. And, of course, the institutional Apartment sector has been on an extended tear with cumulative price appreciation of 91.4% over five years. Furthermore, a robust 11.4% annual return in December also highlights that favorable apartment demand trends continue to outstrip supply and are sustaining strong flows of both domestic and foreign capital into this property type. Outside of the Apartment sector though, market risks in the large cap arena seem manageable, and cautionary flag waving by Federal officials seems unwarranted at this time. It is even more premature when we consider price trends within the broader category of small commercial real estate. Indeed, Boxwood's national Small Commercial Price Index (SCPI) that tracks sales of commercial properties under $5 million in value across 120 markets tell a very different story: Prices rose by only 3.3% year over year (through November) and remain 6.2% below the previous cyclical peak in late 2007 (see the nearby graph). The fact is that these smaller assets, typically represented by Class B- and C-grade quality buildings a sizable portion of which are owner-occupied, are not touched or galvanized by global capital. Instead, local capital tends to drive these trades, especially in secondary and tertiary markets. Also, over 100 of these smaller markets are covered by Boxwood's national Index which helps explain the subdued but more inclusive U.S. price performance. This is not to say that small cap CRE prices uniformly lack luster. In total, 104 of the 120 markets posted positive annualized returns during November including 37 that exceeded yearly gains of 5% or more, led by Vallejo (11.7%) and followed by Sarasota (11.6%), Fort Myers and Fort Lauderdale (9.7%), and Miami and Las Vegas (9.6%). Yet commercial prices in only 19 cities (led by Greeley, Tulsa, Scranton and Houston) have recovered more than 100% of their respective losses from the financial crisis. Which means that prices in 100 markets are still below their former peak and arguably pose little threat to overall market stability. The same might not be said for small cap apartment prices (see the nearby graph). Boxwood's Small Multifamily Price Index of 40 markets surged 10.1% year over year in November and topped its previous peak by 28.1%, precipitated by high levels of tenant demand for affordable rental housing as well as a funding bonanza for small-balance multifamily borrowers sponsored by Freddie Mac and Fannie Mae. Notwithstanding high prices in both institutional and non-institutional apartment sectors, the point is that Main Street America's real estate prices remain safely below former peak levels, and Federal officials and market analysts that continue to portray the CRE marketplace as homogenous and elevated do so at the peril of all participants, particularly small business real estate owners whose continued access to reasonable financing is key to their business investment and expansion.

High Altitude for Small Cap Multifamily Prices Even after a five-year run, multifamily assets remain the hottest commodity among all primary property types. With a 1% gain preliminarily in August, small multifamily asset prices have returned 7.9% year to date and a sizable 10.1% compared with 12 months earlier according to our latest research. Such properties, defined by transactions with a value under $5 million, largely represent the affordable rental housing stock for lower-income households. The rising price trend for smaller multifamily assets reflects strong tenant demand that comes from different directions. Low inventories of for-sale homes have driven single-family housing prices beyond the means of many first-time buyers. Also, many millennials simply prefer rental apartment living and have thus postponed single-family home purchases. Small multifamily prices have also been bolstered by wildly successful small balance lending programs sponsored by Freddie Mac and Fannie Mae whose attractive financing has whetted investor appetite for small apartment buildings. With these unusual forces at play, Boxwood's national Small Multifamily Price Index (SMPI) has soared relative to the Small Commercial Price Index (SCPI) comprising small office, industrial and retail properties (see the nearby graph). SCPI rose 0.6% in August on a preliminary basis but is up only 3.7% year over year. And while SCPI has slowly retraced its losses to within 6.6% of its peak level during the previous cycle, SMPI on the other hand is 26.5% above its previous apex. This multifamily price surge has to a great extent banked on the success of a number of supply-constrained or tech-oriented markets with recoveries that have surpassed former peak levels by wide margins such as New York (by 71.5%), San Jose (66.1%), Portland (64.2%) and Seattle (61.5%). Frankly, though, prices for the vast majority of U.S. metros show ample positive momentum into the fall highlighted by robust 2% growth or more over the last three months for nearly 50% of the cities that we track.

Bull Market Remains Undeterred Small cap CRE space market results for third quarter dispelled any rumors about the bull market's demise, as the latest wave of tenant demand propelled vacancies into unprecedented, low territory. Aggregate net absorption of 68.1 million sq. ft. across office, industrial and retail sectors ranked as the second largest quarterly total in over nine years (after second quarter's record total). This year's massive leasing velocity dismisses outright any concerns about the sustainability of the small cap CRE market expansion with occupancy growth of 53.4% through three quarters that simply overwhelmed the levels of net absorption for the same time frame last year. (Small cap CRE markets are restricted here to properties under 50,000 sq. ft.) With little friction from added supply, vacancy rates slipped to new depths. The national office vacancy rate dropped 40 basis points (bps) in the quarter and 120 bps YOY to 7.3% according to CoStar data. At this level, average office vacancies are 100 bps lower than the rock-bottom rate attained during 2006. Similarly, vacancy rates for small shopping centers and general retail stores narrowed by 30 bps in the quarter and 90 bps YOY to 4.7%. Retail's national average vacancy rate is now 120 bps beneath the pre-recession nadir. The vacancy rate for small warehouse, flex and light industrial properties dipped 20 bps and, at a national average of 3.8%, has penetrated way below the previous floor of 6.1% reached a decade ago. See the nearby vacancy trends graph. A restrained construction pipeline augurs stable and tight space market conditions going forward. As shown in the nearby graph, aggregate projects under construction (UC) totaling 53.1 million sq. ft. are just a fraction of the previous peak amount. That is, while the pipeline today has expanded nearly 50% since the 2011 trough, UC projects are still only 25% of the total in 2006. The lag in new projects can be partially explained by agency regulations that impose higher capital reserves on bank construction loans qualifying under the high volatility commercial real estate (HVCRE) rule. So, too, the U.S. economy's uneven and moderate growth trend plays a role. Finally, we suggest that a lack of transparency generally for the small cap CRE market and, more specifically, inadequate distinction between market trends in the smaller and larger CRE domains-also has a diminishing effect on small balance lending for new construction projects (and even some stabilized properties). But the bottom line is there's ample momentum behind the bull market as we approach year end.

A Picture Worth a Thousand Words [or Less] The classic supply-demand graph nearby is common fodder for industry professionals who know that times are good when the national vacancy rate drops to new lows following leasing demand that convincingly exceeds supply. We can end the story there by subscribing to the idiom above, but to do so comes with the risk of overlooking the latest, impressive chapter. The fact is that small cap CRE fundamentals are at a momentous point in the current cycle because of favorable, if not restrained U.S. economic growth over a long period of time. The economy added over 2.5 million jobs last year, the second best year for job gains since 1999, and June's surge in job growth dispelled most fears that the economy was stalling seven years into the recovery. Also, wages are modestly increasing, job openings are at a record-high and consumer spending is robust. These are primary factors stoking a small cap CRE expansion that is underscored by some breathtaking numbers that may escape the casual glance at a graph. For example, second quarter marked 23 consecutive quarters of positive demand topped off by a whopping 76.1 million sq. ft. of net absorption - a gain of nearly 90% YOY and the second highest total since the 104.4 million sq. ft. during fourth quarter, 2007 according to our analysis of CoStar data covering office, industrial and retail inventory solely under 50,000 sq. ft. Moreover, the demand was well distributed: net absorption for office and retail grew by more 100% apiece YOY; and industrial demand increased by more than 50% over the same quarter last year. These demand trends demonstrate that the Main Street USA economy is expanding: i.e., that small office-using firms are hiring; that the utility of smaller warehouse/distribution and flex buildings is largely undiminished by big supply chain and logistic facilities; and, similarly, despite formidable online sale trends, neighborhood shopping and strip centers still fulfill important needs for everyday items like groceries and personal care products and services. Meanwhile, even though deliveries of new construction projects have jumped in selected metro areas in response to the elevated demand, overall supply remains subdued. Over the past three years ending this June, deliveries of small cap buildings averaged only 15.5 million sq. ft. per quarter across the three major property types. By contrast, new construction put in place averaged 67.4 million sq. ft. per quarter at the height of the market between 2006 and 2008, or more than four times the recent rate of deliveries. As a result, the overall (combined) vacancy rate of 5.3% has tapered to its lowest level in at least 11 years, comfortably seated 120 basis points below the prerecession low of 6.5%. All three sectors have plumbed new depths with vacancy rates for industrial (-190 bps), retail (-90 bps) and office (-50 bps) all beneath their respective nadir in the previous upcycle. Given the above, rents are advancing at a fast clip and are within a stone's throw of peak levels attained in 2008. The takeaway here (with far less than 1,000 words) is that within a historical context these are stunning second quarter results that provide fresh affirmation for small balance lenders and investors that core market fundamentals are not only sound and supportive of current levels of transaction activity but also show plenty of momentum entering the second half of the year.

MBA's 'Coming Out' Party for SBL Appreciate the opportunity to speak at the MBA's inaugural Small Balance Lending conference in Chicago last week as part of a great panel session on market trends. I [Randy Fuchs] likened the event to a 'coming out' party for the small balance market and its participants after years in relative obscurity, and I'm grateful that MBA stepped up to the plate and made it happen. We foresee another banner year for small balance lending; first quarter commercial/multifamily loan originations were $40 billion according to Boxwood's preliminary estimate, on par with Q1 2015 which turned out to be a record year with loan volume totaling $181 billion. Sam Chandan of Chandan Economics reported that first quarter small multifamily loan originations were up 15% YOY as Agency lending in particular continued apace. Jim Going, CEO of ReadyCap Commercial, suggested that the competition for loans was as fierce as ever, but that the overall size of the market - as well as its fragmentation - continue to be irresistible opportunities for lenders of different stripes. The primary reason for our own favorable outlook on lending is that core fundamentals remain very strong: at the national level 20 consecutive quarters of positive net absorption; small-cap vacancies at record lows; little supply pressure (in contrast with the large cap CRE market); and escalating rents (e.g., industrial rents were up an unprecedented 6% YOY during Q1). As a result, small cap property sales are again on a record pace this year, and positive sales price momentum persists. Also, it doesn't hurt that the GSAs have created a remarkable marketplace for small balance multifamily loans, and their seller servicers like Arbor, Hunt, Sabal and others are making it easier than ever to originate loans online. My presentation slides can be viewed here; the MBA will be posting presentations from all panelists on the MBA website.

Siren Call of Small Balance Lending The Sirens were simultaneously beautiful and treacherous creatures of Greek mythology whose enchanting voices and music tempted mariners to draw near, only to shipwreck on the rocky shores of their island. Though their fate is far less cataclysmic, several de novo lenders - some with bucket loads of venture capital for online marketplaces - were beckoned by the siren call of the small balance lending (SBL) market and now face a stark reality: the ostensibly highly-fragmented and boundless opportunities of the space aren't exactly what they were cracked up to be. Clearly, the overall size of the SBL market is inviting. Total origination volume during 2015 reached a new peak of $181.3 billion, the highest total since at least 2006 and encompassing over 200,000 individual purchase and refinance transactions according to Boxwood's research. Perhaps even more seductive is the fragmentation of the SBL market at the national level. For example, our research indicates that last year the top 15 lenders accounted for only 23.4% of the total market for SBL loans under $5 million, up 1.3% from 2014 but oscillating within a narrow range for years. Moreover, the next 50 top-ranking producers commanded only 12.9% of the market, underscoring the sizable fragmentation for the remaining 60% of the origination market at the national level. But this welcoming aerial picture can often distort what may be a more hazardous, ground-level reality. Accordingly, if we sharpen our vision from the national to state level, the degree of market fragmentation changes dramatically. In other words, the level of competition for loans grows more intense. The nearby bubble graph shows the market size and level of lender concentration for a variety of states using last year's data. The bigger the bubble, the greater the loan volume, with states to the upper right with higher degrees of lender concentration, and states in the lower quadrant showing less concentration. California and New York pop out as the biggest markets with annual loan volume of $32.7 billion and $21.7 billion, respectively, but also stiff competition that pose some barriers to successful entry: e.g., California's No. 1 lender seized a sizable 18% market share and the top 15 accounted for an imposing 45% of total state volume; similarly, New York's No. 1 lender commanded 10% of the market and the leading 15 firms a collective 49% share. Other states offer relatively better opportunity. Take Texas for example: third greatest annual loan volume at $17.5 billion with the leading 15 lenders grabbing only 23% of the total market; or Florida with $10.7 billion and a slightly higher capture rate of 31% for the top 15. Obviously, some of the states represented by smaller bubbles mid-graph suggest a less attractive risk-return profile. Of course, this competitive landscape can be reshaped or disrupted over time as borrowers seek better financing solutions to meet their needs. Then again, the state lender concentration figures above have proven to move, albeit slowly, towards greater concentration over time, not less. We can already see the impact of this intense competition on naive lending strategies by mid-course changes in direction by a couple of national SBL platforms, e.g., to different types of borrowers as well as towards other asset classes. The SBL market is indeed enormous and promises bountiful opportunities. However, as Boxwood's research shows de novo national lenders in particular need to be mindful of the perilous Sirens lurking in the space.

CRE Prices Turn Lower on Market Sentiment The window looks to have closed on the double-digit annual price gains of the last couple of years. Our reading of the Core Commercial (CC) component of Moody's/RCA CPPI (that excludes multifamily and tracks sales transactions of investment-grade properties principally above $2.5 million) suggests a turn in market sentiment, as large cap CRE prices slipped for a third month in a row, off 0.6% in February and 1.8% since December. The last time the CC Index posted three consecutive months of negative returns was way back in January, 2010 just before the recovery got underway. We can point to the tumult in the debt markets in the months bracketing the New Year as a primary driver behind the setback in prices. But it's also conceivable that selected sectors of the investment market are correcting given astronomical prices for trophy assets and rock-bottom cap rates. Take, for instance, CBD Office, the perennial darling of institutional investors that outperformed all other commercial property types with a cumulative 95.8% gain over five years according to Moody's. It appears the tables have now turned for this sector, where prices notably declined by 1.7% in February and 5.2% over three months. A similar pattern has emerged for Industrial: i.e., a 48.8% cumulative return over five years, but losses of 0.9% and 2.7% for the most recent one- and three-month periods, respectively. Overall, the CC Index increased 7.3% over 12 months - not too shabby by most measures - but down precipitously from annualized price appreciation in the mid-teens as late as last summer. The nearby graph illustrates the strong pullback in price growth for large caps. The graph also shows how price gains in small cap CRE, evidenced by Boxwood's Small Commercial Price Index (SCPI), significantly trail the performance of larger assets. SCPI price growth slowed to just 0.4% over three months and just 3.6% year over year in February - the lowest annualized gain since January, 2013. It's fairly safe to say that we've crossed a threshold into a period, temporary or otherwise, of normalizing property prices. It was ushered in by volatility and fear in the financial markets several months ago as crude oil dropped below $30 per barrel, high-yield bond markets deteriorated and the stock market swooned by 10%. Financial investors grew concerned about a stock market downturn or even recession and, seemingly on cue, many real estate investors headed for the sidelines. These are some of the proximate causes for the slowdown in CRE investment sales activity and prices. Yet psychology may be playing a role here, too. Many investors, particularly in the institutional domain, were wondering out loud for months about the sustainability of the CRE market's surge and whether prices had topped out after the extended, multi-year run. Those cautious views permeated the industry, and we might argue that those general sentiments or expectations became a self-fulfilling prophecy by dampening buyer zeal and ultimately bringing about the softer prices that investors were concerned about in the first place.

Heated Small Cap Multifamily Prices Cool Off The big run-up in small cap multifamily prices has abated. Boxwood's Small Multifamily Price Index for assets under $5 million rose to a new high in January, but the slim 0.2% gain was the lowest monthly increase in four years following a similar increase in December. And though these assets generated a healthy 7.5% annual return in January, it prolongs a downward trend of single-digit, annualized price advances that began last August. The pull-back mirrors somewhat softer multifamily space markets, where the national vacancy rate rose for the third quarter in a row according to Reis, Inc. as supply of new apartments has continued to exceed demand. As the nearby graph illustrates, surging investor demand for small multifamily assets produced several years of double-digit price growth that has elevated Boxwood's Index of 48 primary and secondary multifamily markets 16.8% above the previous peak set in 2006. By contrast, Boxwood's commercial price index for the same markets increased by only 3.9% year over year and remains 8.4% below its pre-recession peak. While outsized national price increases for small multifamily assets may be behind us now, we will see some metro areas continue to outperform this year. Portland (15.8%), Dallas (15.4%), San Antonio (14.8%) and West Palm Beach (14.0%) are a few of the cities that produced robust annual returns through January along with evidence of vigorous forward price momentum. Also, let's not forget that generally speaking the demand drivers behind core multifamily market fundamentals are still relatively healthy, and borrowers and investors can still find very favorable small balance financing terms from agency lenders to refinance or acquire these smaller assets. For the latest small cap CRE price trends and more research on this domain, see next month's Small Balance Advocate report on this page.

As Housing Goes, So Go Small Caps We often talk about the important relationship between small cap CRE and residential housing. Years ago our research showed that small commercial property prices were more highly correlated with home prices than with prices for institutional CRE assets which tend to be more influenced by the ebb and flow of global investment capital. So it's no surprise that we continue to keep a pulse on home prices and their impact on small cap CRE. Of late, home prices have flattened out. While the 20-City Composite of the S&P/Case-Shiller U.S. Home Price Index rose to a 5.7% annual rate of growth - highest in 19 months - it's clear the trend is now more subdued. Home prices were unchanged during January as well as the latest three-month period. And eight of the Index's 20 metros lost ground during January after 10 posted losses in the previous month. Small cap CRE prices have only modestly out-performed according to Boxwood's Small Commercial Price Index for the same 20 markets (SCPI-20). Prices increased by 0.4% in January and just 1.2% over three months. And the 7.0% annualized return, albeit encouraging, is behind last year's pace. The graph nearby shows the recent leveling off in month-over-month prices for both indices. It also illustrates two more trends: one is that the amplitude of seasonal home price swings has strikingly diminished over the past two years; and the other relates to small cap CRE prices. That is, small cap CRE prices historically lagged changes in home prices by roughly six months. As the graph shows, that gap has largely disappeared, and housing and small commercial prices are moving together on a near simultaneous basis. Some housing analysts indicate that pent-up demand and low housing inventories are likely to produce a robust home buying season this spring. If past is prelude, that event will likely have an immediate and positive impact on small cap CRE markets.

Private Lenders Upped Market Share in 2015 Scrappy private lenders increased market share last year as small balance commercial originations volume soared to $180 billion. In this increasingly competitive marketplace, private lenders and individuals grabbed a 1.4% share of the dollar volume for commercial and multifamily loans under $5 million - doubling their stake from 2014 - and elevating the group to fourth from 11th place among the top 20 SBC lenders. See the nearby league table. JP Morgan Chase Bank, ranked #1, was the only other entity to post a material improvement with a year-over-year gain of 74 basis points for a 5.8% share. Overall, the top 20 lenders increased their collective share by 132 basis points last year to 23.4%. In so doing, these leaders, nearly all of which are national and regional banks, exercised collective muscle to win modest-sized new deals with competitive rates and terms, and retained others via depository relationships. Nevertheless, the rise in private lending underscores the challenges that small balance borrowers face in certain parts of the country where asset values have not sufficiently rebounded despite the general CRE recovery, or otherwise the sponsor's credit is impaired and/or the properties are in a transitional stage. As a result, many small balance borrowers have pursued alternative debt sources such as bridge financing. Regarding the asset valuation gap, Boxwood's Small Commercial Price Index (SCPI) indicated that, as of December, national small cap CRE prices had recovered 60.2% since the end of the financial crisis but remained 8.9% below the previous 2007 peak level with still sizable losses in many markets hit especially hard by the recession.

Raise a Glass to a Very Good Year Before the noticeable successes of 2015 disappear from the rearview mirror, it's worth highlighting two dimensions of last year's outperformance in the small commercial property and loan space. First, Boxwood tracked a massive $180 billion of small balance commercial (SBC) loan originations under $5 million in value. This was the highest volume on record, advancing 9% year over year and eclipsing the previous peak of $176 billion posted in 2013. How big a market is this really? Well, the SBC loan volume encompassed a whopping 205,000 new loans split roughly one-third purchase/acquisition loans and two-thirds refinance loans. Need some additional, external validation of the market's tremendous size? - Consider this: The SBC market is approaching the same size as annual sales for our domestic beer market! The second highlight of 2015 was the record $93 billion in small cap CRE sales transactions. Asset sales rose 14% year over year to a new high for the second year in a row against a backdrop of solid core fundamentals, cheap debt and a stable, if not improving U.S. economy. Transaction growth wasn't ubiquitous, but still, 93 of the 122 markets within Boxwood's national coverage turned in positive sales volume gains. See the nearby graph showing the symmetry between national property sales and loan volume growth. So raise a glass of your favorite beer and toast all the thousands of small private investors, small business real estate owners and capital providers for making 2015 a stellar year.

A Mixed Bag for Oil Patch Markets Market perceptions are that CRE conditions have deteriorated in metro areas with a sizable economic dependence on the slumping energy industry. However, Boxwood's Small Commercial Price Index (SCPI) has yet to reveal any substantial across-the-board fallout for CRE in selected oil patch metros. While a couple of the smaller energy-dependent cities have shown a bit of weakness, generally speaking small commercial property prices in these markets proved to be buoyant during 2015. Oil prices have fallen from roughly $100/barrel to $33/barrel in the past 12 months. In previous oil slumps the drop in prices was devastating for the economies of many metro areas heavily concentrated in the energy sector. Along with that, property values were crushed. Lately, discussions have touted the benefits of growing economic diversification for some oil patch metros. Yet the magnitude of the recent decline in energy prices has been simply enormous and, regardless of the diversification achieved, we might still expect plunging oil prices to exact its own 'price' on the real estate markets. As you can see from the nearby graph, so far it's been a mixed bag of outcomes for small cap CRE prices as oil prices (West Texas Intermediate crude) cratered over the 18-month period. (Note in the graph that scales for the two vertical axes show very different ranges of value. Property prices moved in a fairly narrow band over the period while oil prices dropped precipitously.) Small cap CRE prices in three of the seven metros declined slightly during 2015 including Mobile (-2.3%), New Orleans (-1.4%) and Galveston (-0.2%). These are all relatively smaller populated cities. Annual returns for the remaining and mostly bigger cities have all been positive and led by Houston (6.7%), Baton Rouge (5.7%), Oklahoma City (5.3%) and Tulsa (2.6%). There is corroborating evidence for this apparent market stability. CRE space market fundamentals were steady during 2015 in the face of energy market deterioration. Despite a modest uptick in general office vacancies in some of the metros such as Houston, Tulsa and Baton Rouge - increases largely resulting from an upturn in office building deliveries - office net absorption and rents remained in positive territory according to CoStar's fourth quarter data. Moreover, the industrial sector in nearly all of these oil patch markets ended the year on a strong note. In addition, residential housing prices through October of last year (the latest data period available) exhibited no signs of softening, ranging from 2.0% annual home price growth in Mobile to 7.4% in Houston according to U.S. Federal Housing Finance Agency data. Boxwood's small cap CRE price trends in these oil patch markets seem to contrast with general perceptions about where these markets stood at year's end. Granted, property prices in three smaller markets dipped and office fundamentals in a couple have softened up. In the coming months our research and other real estate-related data may unanimously confirm sinking expectations for the group, but as of fourth quarter real estate market conditions have offered up few clues.

Tale of Two Domains Double-digit 12-month returns for large cap CRE prices over 30+ consecutive months have raised some concerns over the sustainability of this rising price trend. For some perspective, the graph nearby plots the spread between Boxwood's SCPI-117 national composite index of small cap CRE prices and large cap prices represented by the Moody's/RCA Core Commercial Index (excluding multifamily). As shown, prices for significant assets were 29.3% higher than small commercial asset values (under $5 million) as of November - the widest spread in at least eight years and pre-dating the last market's peak. Though average prices for assets in the small cap CRE domain typically recover at a relatively modest pace, this benchmark indicates that prices for institutionally-oriented properties have become untethered to, and a bit bubbly compared with price levels for smaller assets during this time horizon. It also suggests that in a relative sense the smaller CRE domain may offer investors potentially greater upside at this point in the cycle.

Originations Dip among Valuation Uses Recent property valuations by Boxwood's clients hint towards a possible slowing in small balance loan originations at year end. Originations accounted for 30% of the valuation uses for FieldSmart reports ordered by clients during fourth quarter, down nearly four percentage points from third quarter. Loan renewals rose with a plurality of 33% of all valuation uses. Though representing a small overall percentage, portfolio monitoring also increased as concerns over market risk and values heightened. FieldSmart commercial evaluations are tapped by 100+ lenders on as a cost-effective alternative to appraisals on small balance loan collateral.

Third Quarter SBC Originations Increase Small balance commercial (SBC) loan originations topped $46 billion during third quarter representing a 5.0% increase for the period and a healthy 8.7% gain year over year according to Boxwood's latest market research. The strong year-to-date volume of $129 billion, sustained by rock-solid space market fundamentals and ample, low-cost debt, is on pace to challenge the record total of $176 billion posted in 2013. See Boxwood's upcoming Small Balance Advocate monthly report for more details and our latest insights regarding the small commercial property and loan markets.

Musings on CRE Prices and Differing Market States Construction cranes, trophy deals and soaring asset values in some big cities can hoodwink us about the overall circumstances of CRE prices. Read the full article here.


SmallBalance Advocate Report Third Quarter 2017
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