Commercial real estate leaders are bracing for tougher times, with tighter lending, rising interest rates and a possible recession.
There is disagreement as to how much of a slowdown will come.
“Inflation is at a multi-decade high and the Fed is very aggressive,” said Tim Wang, managing director of research at Clarion Partners, a leading North Texas and national property owner. “It is reasonable to assume that a recession will occur.
“The issues are timing, severity and recovery,” he said. “Winter is coming.”
Wang told members of the Urban Land Institute, who are meeting in Dallas this week, that the country still faces a labor shortage despite signs of a downturn in the economy.
ULI members recently polled said they expect the unemployment rate to remain below 5% over the next two years, recession or not.
William Pattison, head of real estate research and strategy at MetLife Investment Management, said he doesn’t expect the unemployment rate to rise significantly even if the economy hits a recession.
“If we expect a mild or severe recession next year, we probably won’t see the 9% or 10% unemployment rate we’ve seen in the past,” Pattison said at the annual meeting of the real estate trade association. If it does occur and the unemployment rate only rises to 4% or 5.5%, this would be considered reasonable, but the Fed probably wouldn’t be overly motivated to rush to cut rates.”
The Federal Reserve has been raising borrowing costs this year to combat inflation and may decide to ease, said Arthur Murgon, a partner at Rosen Consulting Group. .
“If we want inflation to go back to 2%, we have to drag inflation out of the economy like a towel,” Murgon said. “If the Federal Reserve sees inflation fall, they will stop talking about 2% and say he can live on 4%.
“If they do, you’ll be in a mild recession.”
Rising interest rates have already taken a toll on the booming real estate industry that fended off the COVID-19 pandemic.
New ULI projections call for commercial real estate transaction volume to fall again to $600 billion this year and 2023, down from about $855 billion last year.
“The construction pipeline is certainly slowing even before capital market conditions start to deteriorate,” Pattison said.
He said the builder has been cut off from construction loans.
“The big banks stopped or drastically reduced lending in June, and the smaller banks cut back quite significantly,” Pattison said. “It’s also impacting things in addition to the higher rate environment.”
Unlike previous cycles, most U.S. metropolitan areas don’t have large overhangs of vacant lots, according to Murgon.
“Right now, national demand and supply for most property types are in balance,” he said. “If there is strong inflation, we expect real estate to generally be a good hedge.”
However, rising interest rates and expectations of a slowing economy are hurting commercial real estate values.
“It’s really unclear what exactly the value is,” Murgon said. “No kidding. Everyone in this room knows they’re low. The only question is how low they are.”
He said it’s hard to judge because few properties change owners.
“There are not enough statistically significant trades yet to show that there has been a change in price,” Murgon said. “Certainly, it was in a detached house.
“You don’t have to be a genius to calculate a 7% mortgage. You don’t pay more to buy a house than a 2% mortgage.”
According to ULI’s latest research, real estate revenues are expected to drop by almost 50% this year.
Some types of real estate work better than others.
Over the past few years, warehouses have been the strongest development sector. Real estate executives expect it to continue.
While the growth of e-commerce is fueling a boom in industrial buildings, changes in the supply chain are also driving demand, Pattison said.
“Perhaps the more important reason is really not just sales volume, but e-commerce delivery speed,” he said. “They need a footprint that is three to four times larger than he is in every major market in the US.
“This trend will continue for a few more years, maybe five or six years, until equilibrium is reached.”
Businesses that have run out of inventory during the pandemic are also rushing to add warehouse space.
“We seem to be leaving the just-in-time logistics era to just-in-case,” Murgon said. It will really stimulate demand in
Economists are not optimistic about the outlook for the office market.
While many employees are returning to the office after staying home during the pandemic, most are not working five days a week.
“If office workers were to use Tuesdays, Wednesdays, and Thursdays as the norm, and if the lease was rolled over for two or five years, it would take a lot of time to properly size the space for this kind of use. What will companies do?” asked Murgon.
Pattison estimates that about 5.5% of office workers nationwide will stay home and work full-time.
“If that figure turns out to be 7% or 8%, the office is in a very bleak future,” he said.