Sales and Leasing Trends, Falling Levels of Distress Reflect Improving Financial Picture for Smaller Tenants
In a trend that may bode well for a broadening recovery in CRE markets, small business owners are feeling more optimistic -- or at least less pessimistic -- about sales, hiring and expansion prospects over the next three to six months, according to the latest national index by the National Federation of Independent Business (NFIB).
The NFIB Optimism Index rose 1.8% in November, with small business owners anticipating improved sales, hiring and capital spending amid a 'less negative' outlook for business conditions over the next three to six months.
Eight of the 10 index components improved or remained unchanged in this month’s report, based on the responses of 781 randomly sampled small businesses in NFIB’s membership surveyed throughout November.
While encouraged by the results, the advocacy group was careful not to portray the report as unrealistically sunny during a time of continued difficulty for many small businesses struggling in the tepid recovery.
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"The numbers have been depressing for so long, any little progress looks good," said NFIB Chief Economist William Dunkelberg, who co-authored the monthly Small Business Economic Trends report with policy analyst Holly Wade. Dunkelberg noted that the November reading is still "eight huge points" below its pre-2008 average and 14 points below the comparable recovery period in 2001.
A seasonally adjusted 7% of owners are planning to add jobs over the next three months -- a four-point improvement over the previous month and the strongest reading in 38 months -- although the number should be at double-digit levels in a solid economic recovery.
"Optimism appears to have climbed because fewer owners expect business conditions or sales to be worse in six months, indicating some hope on the horizon," the NFIB said. "Improvement, although small, was widespread, with the forward-looking components indicating positive trends for the first time in many months.
"Still, our current reality is still very much the ongoing economic winter."
The sentiment of small business owners contains much significance for
commercial real estate and its investors, as more than 70% of job growth is generated by companies of less than 1,000 employees. The health of smaller businesses is an important factor in office and retail market fundamentals, particularly occupancies and rental rates in non-investment grade properties.
Those non-investment grade properties are starting to stabilize as their tenant base begins to gradually recover from the recession. The CoStar General Commercial Index, derived from repeat sales of non-investment quality properties, increased by 1.4% in October -- the sixth straight month of rising prices since the general property index reversed 32 months of price declines dating back to September 2008, according to the latest CoStar Commercial Repeat Sale Index (CCRSI).
Accordingly, with smaller tenants and mom-and-pop retailers finally seeing light at the end of the tunnel, the level of distress sales as a percentage of total general commercial property sales has fallen from a high of 33% in March 2011 to 24% in October 2011.
In the office market, leasing trends also reflect the improved financial position of those tenants, many of which delayed or canceled business expansions or lease extensions. CoStar data shows that smaller tenants have returned to the marketplace over the last year. As of the third quarter, more than half of all new leases signed during the previous 12 months involved smaller tenants, while large office tenants occupying over 25,000 square held steady at 6% of new office leases.
Smaller businesses have been slower to recover in part due to excessive leverage and lack of access to capital. Smaller businesses have had more difficulty securing credit, unlike large corporations and REITs, which have very good access to capital. Nearly half of small business owners own their business premises and 39% own investment real estate, increasing their debt levels and hampering their ability to invest directly in their business.
The percentage of owners planning capital outlays in the next three to six months rose 3 points to 24% in November, according to the NFIB, the highest reading in 40 months. But it's still 5 to 10 points below expected levels in a growing economy. Despite improving conditions, just 8% described the current period as a good time to expand facilities -- still very low, but only a point below the best reading over the past 38 months.
Access to credit markets did not appear to be a concern among the NFIB respondents, with just 3% reporting financing as their top business problem -- far below weak sales, and excessive taxes and regulation -- and 93% reporting that they either have adequate credit or don’t need to borrow.
However, traces of concern about creditworthiness are embedded in the survey findings. One-quarter of the owners reported that weak sales ruled out investment in new equipment or new workers because they're not likely to generate enough additional earnings to repay loans required to finance the expansion. The average reported interest rate on short-term loan maturities of 12 months or less was 6.3%, basically unchanged since 2008 in spite of the Federal Reserve’s efforts to lower lending rates for small firms.
"The weak recovery provides little incentive to borrow to support expansion or buy new equipment, even if interest rates are low," NFIB said.