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Will Nascent Small Business Recovery Finally Start Helping CRE?

Despite Recent Signs of Improvement, Credit Issues and Tough Times Linger for Smaller Retail and Office Tenants
January 15, 2014
A pair of new reports holds hope for accelerated payroll expansion and investment by U.S. small businesses, which play a vital role in fueling broader leasing activity in office and retail markets but have largely held back during the sluggish pace of recovery.

U.S. small business sentiment improved in December, according to the National Federation of Independent Business (NFIB), with a majority of firms more optimistic about future business conditions and future earnings -- and a significant increase in survey respondents reporting capital outlays for purchase, leasing or improvement of buildings, among other forms of expansion.

In addition, private-sector employment increased by 238,000 jobs from November to December, while payroll growth for businesses with 49 or fewer employees accelerated in December, adding 108,000 small business jobs, according to the December ADP National Employment Report released last week - the largest growth for small businesses since the beginning of 2012.

With more than two-thirds of job growth generated by companies of less than 1,000 employees, small business employment trends and financial health are of keen interest to commercial real estate investors, and an important factor in office and retail market fundamentals, particularly occupancies and rental rates in non-investment grade properties.

December employment levels among medium-sized companies with 50-499 employees rose by 59,000 and employment at large companies -- those with 500 or more employees -- increased by 71,000 in December, both relatively unchanged from the previous month.

With the 1.4 point gain in December’s paired with a nearly one point gain in November, the Small Business Optimism Index ended the year at 93.9, well above the January 2013 reading of 88.9.

Missing Small Business Job Growth


Private-sector job creation by smaller employers, which historically has led earlier recoveries, has lagged in the most recent cycle, according to NFIB economist William Dunkelberg, who noted that the index remains well below pre-recession levels, and even missed the highest levels reached during 2013.

"It’s hard to make the case that the small business sector has made significant progress," Dunkelberg said. "Consumers are a bit more optimistic, as are small business owners, but in the context of history, these measures are still weak."

That said, NFIB’s December survey did provide some positive signals, with the best job creation figure since 2007 and a solid late-year surge in the number of businesses reporting actual capital outlays over the past six months.

With the 9-percentage-point December gain, 64% reported capital in recent months, the highest level since early 2005 -- an upswing described by the NFIB as both surprising and remarkable. The percent of owners planning capital projects in the next few months rose two points to 26%.

While 61% said current conditions make it a bad time to expand facilities, the number of respondents characterizing it as a good time to expand rose to 10%, the highest percentage of the year and up from 6% in January and 4% in March and April.

The types and dollar amounts of capital expenditures purchased or leased during the last six months was also cause for optimism among CRE professionals. In December, 8% said they would buy or lease additional buildings or land, up from 6% a year ago and 5% two years ago. Also, 16% said they planned improvements to their existing buildings or land, up from 13% reported both a year ago and two years ago.

The value of the outlays has also risen, with 14% of respondents expecting to spend $100,000 or more, compared to 11% a year ago and 9% two years ago.

Some 26% in December planned to make a cap ex over the next three to six months, up from 21% in January 2013, according to the responses from 635 firms participating in the December survey.

Multiple Factors Holding Back Small Business Job Growth


Economists have attributed the lingering softness in the small business sector to the slower-than-usual housing recovery, sluggish consumer spending and most recently, excess leverage and lack of access to debt capital to help companies stay afloat during tough times.

Neighborhood and strip shopping centers, populated by in-line tenants that include many mom-and-pop run businesses, have been among the last retail sectors to see demand growth. Last year, however, vacancies in both types of centers fell below 11% for the first time since 2009 as the resurging single-family market picked up steam, according to economists from Property and Portfolio Research (PPR), a CoStar company.

The sector is now seeing the fastest vacancy compression among retail properties, and with more than 20 million square feet of absorption in the third quarter, demand momentum has reached its highest level since the recession.

"For recovery in neighborhood centers, you need those in-line tenants to come back. In stronger markets like Boston, we're starting to see mom-and-pop startups opening new storefronts," said Suzanne Mulvee, PPR director of retail research, during the most recent retail review and outlook last fall.

In another promising sign for smaller centers, sales productivity has increased. Retail sales per square foot were up by some 25% last fall from recession levels in neighborhood shopping centers, ranking ahead of the 15% increase by recovering power centers.

Neighborhood centers are still weak, due in part to lingering credit issues among smaller tenants. While stronger credit flow should set the stage for a fairly strong recovery, financing has been an uphill slog for many owners that have exhausted their resources after years of financial struggle.

The continuing sluggish pace of small business lending is reflected in the latest report by the National Association of Development Companies (NADCO), a trade association representing small business lenders, which reported an overall decrease in commercial real estate and equipment finance loan volume to small businesses in January from the previous report in early December.

The monthly loan pool size of businesses funded under the U.S. Small Business Administration Real Estate Advantage, or 504 loan program, was $283.7 million in January, well below the 12-month average for 2013 of $370.2 million -- and a nearly 40% drop from $469.7 million a year ago.

"There is a hesitancy in the market, coupled with the elimination of debt refinancing -- a one-two punch that is hurting small business job creation," said Beth Solomon, NADCO president and CEO. A stimulus program under the federal American Recovery and Reinvestment Act of 2010, which allowed small business borrowers to refinance debt, expired in September 2012.

Soloman said the 10- to 20-year 504 funds are key sources of capital for smaller businesses to buy property, build new facilities or renovate existing facilities. Without legislative initiatives to resurrect debt refinancing, which may come during the current session of Congress, "we will continue to see two very different economies on Main Street versus Wall Street," Solomon added.


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