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Larger “trophy” properties in big cities have certainly benefited from the recent strong real estate market, but recently the bigger story has been about places like San Antonio, Charlotte, and Nashville and smaller commercial properties — a perfect area of focus for entrepreneurs.

The secret behind the popularity of some secondary markets lies in the fact that those cities can offer many of the same perks as larger cities like New York or L.A. – but without the higher price tag. Cities with plentiful entertainment options and that facilitate people being able to walk or bike to businesses and parks areas are collectively bringing in new renters and buyers in both residential and commercial markets. Cap rates (income-price multipliers) in these cities have also remained on a relatively even keel, so that opportunities for investors are still available.

The Smaller City, Small-Balance Difference
The small-balance commercial real estate market behaves a bit differently than that for larger Class A properties. Global investors don’t seem to chase the small-balance market, for one thing. Another differentiator is that the small-balance commercial market tends to move more in tandem with the residential housing space, which has also ticked up as of late.

The sector is clearly more amenable to smaller real estate entrepreneurs. It’s more accessible, as the dollar requirements are smaller. But it’s also more interesting (more profit potential), since the big players often overlook the small-balance space. It’s a sector ripe for small businesses looking to make a mark. (Feb 19, 2016)

While individual properties can sometimes be riskier if they are based on only a few tenants, in other respects the small-balance market seems to exhibit some degree of stability. “The prices in the small-cap CRE (commercial real estate) domain don’t have the same peaks and valleys as the large CRE market,” said Randy Fuchs, principal at Boxwood Means, a research group that surveys trends in smaller commercial properties.

Record-low vacancies and recurring gains in leasing demand would seem to assure another solid year for the small-balance space, according to a recent Small Balance Advocate report. Rents for small cap warehouse and flex buildings are doing particularly well, with office and retail rents also on the rise, albeit at a more modest pace.

Entrepreneurs are Also Creating the Financing
Small-balance commercial real estate is an increasingly fragmented market. The top 15 small-balance lenders took over 20 percent of sub-originations, for example, but those same banks seem to be shedding small-balance real estate loans. “Despite their dominance in the small-balance commercial space, commercial banks face increasing competition for smaller loans, especially from the growing herd of alternative and non-bank lenders,” said Fuchs. “The trend of small business real estate loans within bank portfolios is declining — and seemingly irreversibly so.”

Real estate crowdfunding has stepped into the void. Firms like RealtyShares have enabled smaller investors to participate more broadly in specific real estate investments. Through online platforms, people can now review real estate investment projects at their convenience – say, sitting with their laptop or tablet at the kitchen table at 10pm, after the kids have been put to bed. Previously, introductions to these opportunities might have required specially arranged meetings with attorneys, bankers or financial advisers – that is, if the person had such connections at all.

These opportunities were not only more difficult to access — they were also often still limited to institutions or persons of very substantial wealth. A project syndicator seeking $2 million in equity wouldn’t typically concern himself with contributions of $10,000 or $20,000; rather, he would search for investors able to contribute ten times those amounts, in order to simplify his task of managing investor updates and distributions during the life of the project. Technology, however, has enabled large numbers of unrelated investors to pool their contributions and make a significant investment through a single legal entity – keeping things easy for syndicators while broadening the source of potential investors.

Lands of Opportunity
California and Florida seem to be leading the small-balance comeback at the moment – with annual returns for selected Florida cities are among the best in the country, including Sarasota and Fort Lauderdale. To some extent these latter regions are “playing from behind,” since they had precipitous losses during the recession. As a result, however, lenders and investors may still find attractively priced assets in some of these markets.

Small-cap commercial real estate operators – and investors – are presented with good opportunities and risks in local markets and with smaller properties – and the lower prices at which many of these assets still trade may offset the risk of any overly ambitious capital growth expectations.

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