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Rise In Small-Business Loans May Aid Real Estate Demand

Recent reports indicating that small businesses are tapping more debt to fund expansions have fueled optimism that mom-and-pops and other small companies may finally be participating in the economic recovery.

It's a welcome bit of news for commercial real estate landlords, who for the last several quarters wondered when — and if — small business would begin to drive meaningful leasing demand for small buildings and spaces, which make up a significant portion of the property market in the U.S.

"We're hearing of customers that want to expand who are finding multiple bankers willing to fund or contribute to their expansion," said Larry Callahan, CEO of Stone Mountain, Ga.-based Pattillo Industrial Real Estate, which owns 20 million square feet primarily in Georgia, South Carolina and Florida. "That's noteworthy because that wasn't the case even six months ago.

Lending Looks Up Bank loans outstanding to small businesses totaled $586 billion at the end of the fourth quarter last year, an increase of $2 billion from the end of the third quarter, according to the Small Business Administration's March lending bulletin, which culls data from the Federal Deposit Insurance Corp. The 0.4% uptick represented the first time in 10 quarters that small-business lending grew, the SBA said.

Similarly, the percentage of small-business loan approvals continues to rise, according to Biz2Credit, a New York-based online platform that connects entrepreneurs looking for loans with lenders.

Large banks with more than $10 billion in deposits approved an average of 15.9% of small-business loan applications in February, up from 11.7% a year earlier, Biz2Credit said last month. It noted that even very large banks such as TD Bank (TD) and Bank of America (BAC) increased approvals for some loans. Small banks OK'd half of small-business loan requests on average, a year-over-year hike of about 300 basis points.

Buildings totaling 50,000 square feet or less — generally referred to as "small-cap" properties — stand to be among those benefiting from the lending upturn. Small-cap industrial, office and retail real estate accounts for one-third to more than 50% of all commercial square footage in the U.S., according to Stamford, Conn.-based Boxwood Means, a research firm specializing in the small-cap property space.

Overall, the small-cap segment generally enjoyed a healthy occupancy surge in 2012: Industrial tenants absorbed 29 million square feet, a year-over-year increase of 150%, while office users absorbed 5.5 million square feet last year, a 52% increase over 2011, said Randy Fuchs, a founder of the firm. Retailers soaked up 13.7 million square feet in 2012, a 2% drop from 2011.

Mom-And-Pops Prognosis Fuchs foresees another year of fundamental improvement in the small-cap arena and says that improved small-business lending would only bolster the gains.

"I'm bullish on the small-cap market because demand has been improving, vacancy rates are below the highs of the recession and new construction is clearly under control," Fuchs said.

To varying degrees, owners of large multitenant buildings are seeing similar trends. During earnings calls with analysts earlier this year, executives with DCT Industrial Trust (DCT) and Prologis (PLD) noted that the housing recovery was fueling demand for industrial space by small suppliers of carpet, tile, appliances and other housing-related goods in some of their U.S. markets. Skepticism Lingers Housing-related small businesses that were decimated in the downturn have not returned to the Southeast, however, and leasing activity among small tenants in general is far from "robust," Callahan cautions. What's more, William Dunkelberg, chief economist for the National Federation of Independent Business, questions whether enough small businesses have the confidence to significantly influence the real estate market.

A monthly small business survey by the group in February found that some 75% of respondents thought the economy would be in the same condition or worse in six months. Additionally, upwards of 64% of small businesses were uninterested in taking out a loan to expand. Based on the March survey, due out Monday, sentiment hasn't changed much, he says.

"If you're going to borrow money, you've got to be able to put it to work with enough confidence that you're going to be able to at least pay the loan back," he said. "I think there is plenty of money available, but I think that the businesses banks would like to lend to are sitting on the sidelines.

In some cases, landlords have pared the number of small local tenants in their properties. During an earnings call early this year, executives with shopping center REIT Weingarten Realty Investors (WRI) said that national and regional tenants comprised about 80% of its roster, up from 69% in 2009.

Company executives explained that a lack of mom-and-pop business formation and a strategy to buy better properties contributed to the greater focus on national and regional tenants.

Sales Bonanza Still, in addition to fueling expansions, the increase in small-business lending, coupled with the low interest rate environment, is driving small-cap property investment sales. According to Boxwood Means, U.S. property sales of $5 million or less totaled $10.3 billion in December, the highest one-month sum since the firm started tracking the data in 2005.

While Fuchs acknowledged that concerns about higher capital gains taxes kicking in this year drove some of the end-of-the-year activity in 2012, he noted that preliminary small-cap sales data of $2.7 billion in January represented a year-over-year increase of 6.5%.

"Clearly there is growing investor confidence in these assets," Fuchs said.

Investors aren't the only buyers. Pattillo Industrial recently sold buildings to existing tenants facing renewal or looking to expand as well as to small businesses that were initially interested in leasing, Callahan says. "Small businesses are realizing that they have a growth opportunity," he said, "and are deciding they want to own."