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Why a small business hiring boom is good for office REITs

The National Federation of Independent Business Optimism Survey is a finger on the pulse of small business

The National Federation of Independent Business is a monthly report that contains a wealth of information regarding trends for small businesses. It examines labor markets, plans for capital expenditures, credit availability, inventory and sales data, inflation, earnings, and economic outlook. The survey goes back to 1986, so it’s useful to compare current conditions versus prior peaks and valleys.

NFIB Small Business OptimismEnlarge Graph

Small business accounts for roughly half of U.S. GDP and jobs. While the financial press tends to focus on the large-cap stock market indices as a barometer of the economy, small business tends not to get as much focus. Large capitalization stocks generally have a large international focus, which means their earnings and sentiment don’t necessarily represent the economy as a whole. When forecasting the Fed’s next move, it pays to focus on small business earnings as much as or more than the earnings of, say, Apple.

The Optimism Index dips slightly from its 12-month high, but internals are turning around

The Optimism Index ticked up to 93.9 from 92.5 the previous month. “Normalcy” is an index reading of around 100, so we’re well below the trend. The employment index increased 2 points in December, while the expectations of earnings trends ticked down 1 point. Expectations about the economy increased 9 points. Small businesses increased payroll by 0.24 workers on average—the highest level since early 2006.

More firms are reporting sales declines rather than sales increases. Of all small business owners, 14% cited poor sales as their greatest problem. Regulation and red tape came in second, with 20% of all respondents citing them as their biggest concern. The first place went to taxes, which were cited by 23% of the surveyed firms as their biggest concern. The lowest concern? Credit availability, although half the respondents said they weren’t interested in borrowing. This dovetails with the low capital expenditures level, where only 26% of all respondents intend to make capital outlays in the next three to six months. This is a recessionary reading, but it has been par for the course since the recession began.

While optimism is holding in there, the drop in sales is particularly worrisome and signals a potential slowdown.

Implications for office REITs

Office REITs like Boston Properties (BXP), Vornado (VNO), S.L. Green (SLG), Kilroy (KRC), and Brookfield Office Properties (BPO) will rely on small business formation and expansion to lower vacancy rates, which are still elevated for this part of the recovery. The fact that small business is hiring at the fastest pace in eight years is a good sign for further office demand going forward.

To learn more about how office REITs are faring, see this Market Realist series.