DALLAS – Commercial real estate industry leaders are preparing for tougher times – tighter lending, higher interest rates and likely a recession.
There’s disagreement about how big a slowdown is coming.
“Inflation is at decades high and the Fed is very aggressive,” said Tim Wang, managing director of research for Clarion Partners, a major property owner in North Texas and nationwide. “It’s reasonable to assume we will have a recession.
“The question is on timing, severity and recovery,” he said. “Winter is coming.”
Wang – who talked with members of the Urban Land Institute who are meeting in Dallas this week – said even with negative economic signs, the country still faces a labor shortage.
ULI members who were recently polled said they expect unemployment to remain below 5% for the next two years – recession or no.
William Pattison, head of real estate research and strategy for MetLife Investment Management said he doesn’t expect a big jump in unemployment even if the economy goes into recession.
“If a mild or even severe recession is in the cards next year, we are probably not going to the 9% or 10% unemployment we saw in the past,” Pattison said at the real estate trade group’s annual meeting. “And if a recession occurs and unemployment only goes up to 4% or 5.5% - which I think could be reasonable - the Fed is probably not going to be overly motivated to be quickly cutting rates.”
The Federal Reserve – which has been cranking up borrowing costs this year to fight inflation – may decide to ease up, said Arthur Margon, partner with Rosen Consulting Group.
“If they really want to get inflation back to 2% they are going to have to wring the inflation out of the economy like a wet towel,” Margon said. “We think that when the Fed sees inflation coming down, they’ll stop talking about 2% and say we can all live with 4%.
“If they do that then you will wind up with a mild recession.”
Dallas-Fort Worth is one of the country’s top markets for both commercial property building and real estate sales. Billions to dollars in new developments are in the works here.
Higher interest rates have already hammered the country’s real estate industry, which shrugged off the COVID-19 pandemic and has been on a hot streak.
ULI’s new forecast calls for commercial property transaction volumes to fall from about $855 billion last year to $600 billion this year and again in 2023.
“The construction pipeline we have certainly seen slow down even before capital market conditions started slipping,” Pattison said.
He said builders are being cut off from construction loans.
“The largest banks stopped or significantly slowed lending back in June and the smaller banks have pulled back pretty significantly,” Pattison said. “That’s also affecting things in addition to the higher rate environment.”
Unlike in previous cycles, there’s no big overhang of empty real estate in most U.S. metro areas, Margon said.
“Right now, nationally supply and demand for most property types are in good balance,” he said. “We would expect when you have strong inflation real estate generally would be a good hedge.”
But values of commercial properties are taking a hit due to the higher interest rates and expectations of an economic slowdown.
“It’s really unclear exactly what the values are,” Margon said. “Everybody in this room who is not kidding themselves knows they are lower.
“The only question is how much lower?”
With fewer properties changing hands, that’s hard to gauge, he said.
“There are not enough transactions to be statistically significant yet to show that there has been a break in pricing,” Margon said. “Certainly, there has been in single-family housing.
“You don’t have to be a genius to figure at 7% mortgages people aren’t going to pay as much as they did at 2% to buy a house.”
Real estate returns for forecast to decline by almost 50% this year, according to ULI’s most recent survey.
Some real estate types will do better than others.
During the last few years warehouses have been strongest development sector. Real estate execs expect that to continue.
While the growth of e-commerce has fueled an industrial building boom, supply chain shifts have also driven demand said Pattison.
“Probably a more important reason for that has actually been not just sales volume but e-commerce delivery speeds,” he said. “They need something like three to four times the footprint in all the major markets in the U.S.
“That trend still has a couple years to run – maybe even five or six years to run - before we reach an equilibrium.”
Companies that got caught short on inventory during the pandemic are also scrambling to add warehouse space.
“We seem to be leaving the era of just-in-time logistics to a just-in-case,” Margon said. “It’s going to really fuel demand for logistics space all around the country and in places that have not been touched by e- commerce.”
Economists are less sanguine about the prospects for the office market.
While many workers are returning to the office after saying home during the pandemic, most are not there five days a week.
“If we wind up having as the norm for office workers Tuesday, Wednesday, Thursday then what does a company do when their leases roll over in two years or five years to right size their space for this kind for use?,” Margon asked.
Pattison predicts about 5.5% of office workers around the country will stay at home and work full time.
“If that number turns out to be 7% or 8% then offices have a very rough road ahead of them,” he said.
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