Media headlines of bank failures, the Federal Reserve’s continued interest rate hikes, a coming wave of distressed real estate, and the threat of an impending recession have caused uncertainty, and the amplification of a doom and gloom market outlook that creates unnecessary anxiety. This anxiety has spilled over to the consumer as 79 percent of the public hold a fair/poor outlook on the current state of the economy in July according to the CNBC All American Economy Survey. That rating is up from 69 percent reported in April.
The overall health of the U.S. economy drives real estate fundamentals. The $20 trillion commercial real estate market is a bellwether for the wider U.S. economy, however, the commercial real estate industry, like many industries, faces a variety of macroeconomic headwinds: tighter lending conditions, interest rate uncertainty, stubbornly high inflation, and recession risk just to name a few. Divergent economic data continues to paint a mixed picture of either continued growth, impending recession, or somewhere in the middle. In our opinion, facts and figures best tell the story:
- Gross domestic product rose by an annualized rate of 2 percent in Q1 and by 2.4 percent in Q2;
- Inflation rose 3.2 percent from a year ago in July – slightly below forecast but 20bhps higher than June;
- June consumer confidence data was the highest it has been in 18 months;
- Both April home prices and May new home sales surprised to the upside;
- New home sales volume in June was 22.5 percent above previous year sales figures;
- Durable goods orders grew in June by 4.7 month-over-month, or the most since July 2020;
- Hiring deaccelerated in May thru July with employers adding 339,000, 185,000 and 187,000 workers, respectively;
- June 2023 retail sales were up 1.6 percent from the same period a year ago; and
- Travel records of passenger traffic were broken over the 4th of July holiday according to the TSA.
The Fed has noted that consumer spending has picked up this year, and some indicators have noted the housing market is turning upward as well. The labor market is tight with slowing payroll gains and corporate profits have increased due to mends in the supply chain. Inflation has moderated somewhat since the middle of last year, but the Fed notes inflationary pressures continue to run high. Therefore, the Fed projections for 2023’s peak funds rate range of 5.5 to 5.75 percent to remain, implying at least one more rate hike before the end of the year.
Some economists think the Fed will hold their monetary policy steady at its September meeting and then hike the rate up again at their meeting in November; others think the Fed is finished raising interest rates. Traders on Wall Street in the derivative markets see almost a 90 percent chance that the Fed holds steady after the next meeting, scheduled for September 19-20. They see chances of another hike this year at about 30 percent.
Higher interest rates, tighter lending conditions, the threat of recession, and banks faced with billions of commercial loan maturities have many taking a wait and see approach. The impact of all this market uncertainty has caused a period of price discovery and disruption to sales volumes. This has investors bracing for asset value write downs and lenders fearing the potential for rising commercial property loan defaults. A number of the $1.5 trillion in commercial real estate loans maturing by yearend 2025 are backed by offices, multifamily, and retail assets.
The good news? A review of the Q2 commercial real estate fundamentals suggest most property types have experienced continued growth. U.S. inflation is dropping and economists’ deep pessimism about the economic outlook is receding, giving way to hope of avoiding a recession. A slowing job market should encourage the Fed to pause its rate hikes. The path ahead over the second half of 2023 will be tricky landscape for Fed policy makers to navigate. As the economy slows and core inflation comes down, market clarity will return. If we are near the end of the Fed’s rate hiking cycle, lending could stabilize, uncertainty will diminish, and price discovery between buyers and sellers will return.