How CRE Investors Can Prepare for a Recession in 2023

It isn’t exactly breaking news that commercial real estate investors are worried about a recession. Widespread concerns over economic turbulence have been looming all year, driven by rising inflation, increasing interest rates, and, perhaps most importantly, two consecutive quarters of negative GDP growth, the standard threshold of a recession. However, the National Bureau of Economic Research hasn’t declared one. Healthy job growth, solid employment numbers,  and a relatively nominal decline in GDP have kept the economy out of a formal recession.

Next year, that could change. 

More than two-thirds of economists expect a downturn in 2023, and 98% of US CEOs are preparing for a market contraction in the next 12 to 18 months. Some, like JP Morgan Chase’s Jamie Dimon, believe that a recession is only nine months away. While experts predict a shallow and brief downcycle, the event will come with job loss and expectations that unemployment will reach 4% to 5%. 

While economic fundamentals are shifting, commercial real estate fundamentals remain steadfast. Accordingly, developers and stakeholders should prepare for a challenging year, understanding that the industry has a bright long-term outlook.  

Measured Optimism for 2023

Although the risk of a recession is increasing, there is some good news; the commercial real estate industry is poised to withstand a downturn. When looking at sector-specific metrics, the market has a lot of positives: availability of capital, attractive vacancy rates, healthy leasing activity, rising rents, and strong transaction activity. These benefits will attract investment and support healthy returns, even if the economy declines. According to Deloitte's 2023 Commercial Real Estate Outlook, 66% of respondents expect property revenues to increase in 2023 due to its strong fundamentals. 

In a way, early 2022 was a sneak preview of next year’s marketplace.

GDP growth declined in the year's first half, down 1.6% in the first quarter and 0.9% in the second quarter. Yet CBRE research shows commercial real estate investment increased 10% year-over-year. In addition, it found that portfolio transaction volume increased 31%, and trailing four-quarter sales volume totaled $881 billion, a record high. The firm’s data illustrates continued investment appetite through intensifying recessionary pressures. 

That said, there were some notable setbacks in transaction activity this year. 

Due to the higher cost of capital via interest rate increases, entry-level volume declined by 17%, and private investors, REITs, and cross-border investors were net sellers. However, private investors accounted for 61% of all transaction volume in the year's first half, and institutional investors remained net buyers. The NCREIF Property Index expects institutional returns to stabilize around 8% next year, closer to yields from 2017 to 2019. 

A recession will definitely put downward pressure on the real estate market. But the sector’s strong fundamentals will continue to drive activity and returns despite economic turbulence.

Benefits of a Recession

It would be nice to live in an endless bull market, but recessions play an important role in the business cycle. Jeff Klotz, CEO of the Klotz Group of Companies, called economic ebbs and flows “healthy,” explaining that they ease challenges created during a bull market. Price growth tops that list. In 2021 alone, commercial real estate prices increased by 19.5%. Moreover, Real Capital Analytics’ CPPI national all-property index was up 17.4% at the beginning of 2022. Rapid price growth is great news for owners, but buyers - and traditionally, investors are net buyers - have strained to keep up with rising prices. 

A recession would help to temper this trend. The ULI 2023 commercial real estate investment report predicts price growth will slow to 6%. That’s a far cry from the nearly 20% appreciation in 2021 but still above the long-term average of 5.2%. 

An ebb in pricing trends will have multiple benefits across the market. Investors and developers with an appetite to absorb the risk can purchase assets at a discount and benefit from improved values as the economy recovers. A price correction will also lower the barrier to entry into real estate or highly sought-after assets. Another benefit is that developers will see decreased competition for materials and labor, helping to improve construction pricing. 

Recessions bring instability, uncertainty, and some loss, but it is also a moment to rebalance market needs and cool down overzealous investment that can build during a bull run. 

Managing an Economic Shift

It’s clear that an incoming recession, should one happen, is not dire news for the commercial real estate industry. Sustained demand and strong fundamentals will help prop-up investment activity; however, savvy stakeholders will make strategic adjustments to hedge against the downside. 

According to Nikita Zhitov of CityPlat in an article for Forbes, investors should start by shoring up the balance sheet by keeping healthy levels of liquidity, reducing debt to at least 50% or, ideally, as low as 30%. Zhitov also recommends refinancing any maturing debt that has balloon payments in the next five years. These steps will ensure investors can weather the downturn. 

Many of these suggestions can be augmented or supported by technology. Commercial real estate companies should utilize workflow optimization software and AR management tools to improve financial monitoring. Embracing big data analysis solutions that can provide better insight into shifting market patterns is also a good idea. 

Intelligent platforms with predictive analytics features can support commercial real estate professionals through challenging market conditions. The software solutions use artificial intelligence to identify potential budget overruns, provide strategic insights, and foster more predictable outcomes. Advanced technology has become increasingly important to help firms remain competitive, an essential advantage in good times and bad. 

The road ahead is likely to be bumpy. But commercial real estate players with an understanding of the market’s fundamentals, sensible risk tolerance, and prepared to handle a cycle change will manage it just fine. Want more insights on how to navigate the marketplace during an economic downturn? Download our 4 Recession-Proof Asset Classes whitepaper to gain insight into navigating a volatile landscape.