How Will The Recession Impact Commercial Real Estate?

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High interest rates and a potential recession will make this year a challenging one for commercial real estate, an industry pundit said.

Richard Barkham, global chief economist for CBRE, predicts a recession for next year that will only exacerbate economic challenges.

“High interest rates and a recession will make 2023 a challenging year for commercial real estate,” Barkham said. “Though inflation eased in late 2022, it was still running at more than 7%. The Fed will continue raising rates until it sees a marked reduction in inflation nearer to its 2% target. Weakening fundamentals and higher cost of capital will generally lower asset values.”

Still, he doesn’t predict a deep recession for this year.

“The recession will not be particularly deep, Barkham said. “Corporate finances are in good shape and employers will shun excessive layoffs to avoid losing employees in a tight market for skilled labor. While consumer confidence is highly subdued, average household debt is low compared with the onset of previous recessions. These factors suggest a moderate downturn, with unemployment unlikely to breach the 6% level. Inflation will be significantly lower by the second half of 2023, setting the stage for falling interest rates and the beginning of a new cycle that will last to the 2030s.”

Pace Of Change Won’t Ease

“Despite economic headwinds, the pace of change will not ease,” Barkham said. “ESG environmental, social, and corporate governance] considerations and the growth of the digital economy will continue to affect real estate demand. Hybrid working offers many benefits for businesses and employees, but companies and the office sector will have to evolve. Cities too will need to adjust to new commuting patterns and reduced office demand.”

“The resurgent retail sector is just now reaping the benefits of a long period of change, which is attracting keen investor interest. Data centers and industrial real estate will probably be the most resilient sectors and the housing shortage will benefit the multifamily sector. The hotel sector’s recovery from pandemic restrictions will continue, but life sciences activity, which was turbocharged by COVID, will ease for a while as venture capital becomes scarcer. All sectors in all places will be required by governments, occupiers and investors to make significant decarbonization efforts.”

Optimism Remains Despite Likely Recession

“Sharply higher interest rates will weigh on the US economy in 2023,” Barkham said. “House prices and retail sales will decline, and unemployment will rise. The US dollar’s continued strength against other global currencies will further squeeze corporate earnings and export sales, limiting business investment. As a result, CBRE expects a recession in 2023, resulting in less real estate investment and leasing activity. Adding to the contractionary effects of tighter monetary policy is a weaker global economy. Elevated energy prices, the war in Ukraine and weaker housing demand will inhibit growth in 2023.”

“Although we expect a recession, we are not overly pessimistic. The US consumer has low leverage and a relatively strong balance sheet. The digital economy and the reshoring of manufacturing—particularly semiconductor production—are two significant growth drivers.”

Slowdown In Consumer Demand Seen

“Declining inflation in 2023 will provide a tailwind for the economy toward the end of the year,” Barkham said. “While the drop will be gradual and bumpy, CBRE forecasts that a slowdown in consumer demand, the easing of global supply chain bottlenecks and a weaker housing market will push inflation down to around 3% by year’s end. We expect that the Federal Reserve will scale back its rate hikes after interest rates peak at 5.2%. The economy should stabilize by the start of 2024 but the downturn’s impact on real estate will linger until employment growth resumes.”

“For the first time in a decade, there is a chance of a buyer’s market in real estate. Declining inflation in 2023 will provide a tailwind for the economy toward the end of the year. While the drop will be gradual and bumpy, CBRE forecasts that a slowdown in consumer demand, the easing of global supply chain bottlenecks and a weaker housing market will push inflation down to around 3% by year’s end. We expect that the Federal Reserve will scale back its rate hikes after interest rates peak at 5.2%. The economy should stabilize by the start of 2024 but the downturn’s impact on real estate will linger until employment growth resumes. For the first time in a decade, there is a chance of a buyer’s market in real estate.”

Geopolitical Improvements Could Ease Recession’s Impact

“Assuming the Ukraine-Russia war ends next year, as many expect, commodity and food prices should come down,” Barkham said. “Energy prices will fall, though will not return to pre-war levels as countries continue to seek alternatives to Russian energy sources. China will continue to grapple with COVID, weakness in its housing market and structural shifts in its economy. However, it does not have to deal with high inflation and its current round of stimulus will boost growth in the Asia-Pacific region.”

Risks And Opportunities From Recession

“The precise fallout from rapidly rising interest rates is hard to predict, which in turn creates risk,” Barkham continued. “Risky financial positions established amid the past decade’s ultra-low-interest-rate environment may be unsustainable, creating conditions for a financial shock that could lead to a credit crunch. This most likely will occur in highly indebted emerging markets, particularly in Latin America. On the upside, inflation in the US could fall more quickly than expected as supply constraints ease and retailers move into deep discount mode.”

 

Source: MPA

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