As 2022 ended, it proved to be another quarter of economic uncertainty, and there is no shortage of opinions on the state of the US economy and where it is headed.
As of the date of writing this, there seems to be growing sentiment that a recession is highly possible. For example, the Conference Board’s Leading Economic Index declined for the 10th consecutive month, falling in December by 1% (according to a report released in January). As noted in the report, the index typically peaks about a year ahead of a recession and the index last peaked in February 2022. Add to this, about 52% of economists surveyed by the National Association for Business Economics believe there is a more than 50% chance the US will enter a recession in 2023. Further, a Bloomberg survey of 73 economists point to a moderate GDP outlook for the 2nd and 3rd quarters of this year citing slower consumer spending, lessened business investment, and weaker industrial production. In this same study, these respondents pegged the probability of recession over the next year to be 65%.
But the expectations of a slowdown may be exactly what is needed (or intended), given the Fed’s recent and aggressive interest rate policy (in fact, we write this post with a Fed announcement just hours away, which may change our outlook even further). While surveys regarding a recession are mixed, there is strong consensus that after the stimulus and investment programs of previous quarters, inflation needed to be addressed. And there are some signs of progress on that front – CPI has declined each month since June. And while CPI and wholesale price growth was down once again in December, it has not come down to the Fed’s target levels, so there is more work ahead – especially if the Fed wants to achieve the “soft landing” it prescribes.
And yet, with all the potential headwinds, the employment market remains tight – as indicated by the BLS 14 January report which pointed to a healthy drop in first-time claims for unemployment insurance. This total was reported to be the lowest in 15 weeks and well below economists’ expectations. The much-reported wave of tech layoffs, while making headlines, has not yet shown signs of spreading into large-scale layoffs across all sectors in the economy. That said, with a recession comes expected pressure on employment, so a cautious outlook is necessary.
Economic uncertainty has not yet halted foreign investment – quite the contrary in some markets. Take for example that foreign buyers picked up $6.8 billion of South Florida residential real estate between August 2021 and July 2022 (a 34% increase on the prior year), according to a report from the Miami Association of Realtors (as reported by Axios). Nationally, the dollar volume of foreign buyer purchases increased 8.5% between August 2021 and July 2022. Institutional buyers are also quite active on the commercial side, nationally. Middle East-based GFH Financial Group announced it purchased a majority stake in Big Sky Asset Management, a $2 billion real estate asset manager. In 2022, GFH also acquired SQ Asset Management, a student housing lender. Singapore-based GIC partnered with Oak Street to acquire STORE Capital for $14 billion and is also part of a group that bought a majority interest in a 41-property office portfolio valued at $1.1 billion. Tishman Speyer and Japan-based Mitsui Fudosan announced a JV to develop logistics properties throughout the US. And lastly, in the student housing space, Landmark and Abu Dhabi Investment Authority announced a $2 billion development JV. In total, trailing 12-month cross-border investment in US real estate totaled $63.4 billion. So, given the general stability of US real estate, it seems like foreign investors will remain aggressive in 2023, albeit perhaps at more moderate levels.
Our snapshot view in early 2023 leaves us with the following few themes, currently:
- Rent growth will remain positive in some sectors, in particular multifamily and student housing, but not at the historically high levels of previous quarters.
- We expect tightened underwriting standards both on the lending and acquisition side.
- If there is an economic slowdown and as new supply under construction is delivered in the multifamily and student housing sectors, vacancy rates may increase (or absorption rates will flatten) in the short term, as the supply is digested.
- Higher borrowing costs (and tightened lending standards) will slow development starts and transactional volume in some markets.
- The office market still lags when it comes to absorption, which can be directly linked to the persistence of the hybrid work models and now, the pending economic uncertainty.
- Similar to the previous quarter, the current economic landscape requires patience and agility, but now with an increased focus on economic indicators; the health of target regional economies, and Fed monetary policy. In fact, the writing of this post is just shortly before the next Fed meeting!)
- As the economy continues to digest stimulus; interest rate increases flatten inflation growth; businesses evaluate their operational and talent strategies; and onshoring gains momentum, their collective impact on the real estate and capital markets sectors will unfold over the next two to three quarters – through changes in borrowing costs, rental rate growth, construction starts, institutional demand, and tightening of lending standards in the asset class.
- Given the current outlook, we anticipate a slowdown in development (although not in some regions that continue to show signs of growth); some downward pressure on multi-family/student housing pricing, rental rate growth, and transaction volume in the near-term; and stubborn vacancy and absorption rates for the office sector.
- Changes in lending rates and underwriting standards could present some interesting opportunities in the debt or preferred equity space over the next 24 months.
- Given the spike of deliveries in the luxury multifamily and student housing sectors, there may be some interesting opportunities in the more affordable, value-add Class B projects in certain markets.
- A patient and agile approach means continuing to work with our operating partners under ever-changing market conditions and pursuing agile strategies that are reflective of current realities.
- Economic uncertainty still requires disciplined underwriting assumptions, critical assessment of risk, and an enhanced focus on the stability of an asset’s potential for cash flow, and its competitive position.