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Predicting the economic future is a real estate developer’s favorite pastime. The job inherently requires that developers assess future risk and predict with great accuracy the economic environment into which they’ll deliver a property. The practice, of course, isn’t foolproof. Developers breaking ground in 2018, for example, could never have imagined completing the project in the middle of a global pandemic. Still, it’s essential to understand the trajectory of the market and create informed and data-backed economic forecasts as part of the standard underwriting process.
In the last year, however, that game has become increasingly challenging. Economic leaders predicted a recession in 2023, with nearly two-thirds of economists expecting a downturn by July—and yet, one never came. In fact, growth in the first half of the year has wildly outpaced expectations, with GDP growing 2% in Q1 and 2.4% in Q2. Now, new mid-year economic reports are delivering different and more optimistic forecasts.
Let’s take a look at the data and see what the future holds.
Inside the Mid-Year Reports
At the beginning of the year, experts were sure the US would enter a recession at the midyear. In an AP survey, more than half of economists predicted a recession in the second or third quarter, and a survey from The World Economic Forum found two-thirds of economists predicted a recession sometime in 2023. By April, those forecasts began to temper. PwC’s Q1 report estimated that the US would narrowly avoid a recession in 2023, with GDP growing .2%, and JPMorgan elevated its forecast in July, estimating economic growth between 1.5% and 2% for the year.
The most compelling update, however, came from The Federal Reserve following its July meeting. Federal Reserve Chair Jerome Powell said that the Fed no longer predicts a US recession, saying, “So the staff now has a noticeable slowdown in growth starting later this year in the forecast, but given the resilience of the economy recently, they are no longer forecasting a recession.” He added that there was an increased likelihood of what he has called a “soft landing,” where the Fed can control inflation without widespread job loss or an economic contraction. The comments were a welcome sign of optimism from the Fed, which predicted a mild recession in 2023 as recently as March.
While economic forecasts have improved, the renewed sense of confidence isn’t ubiquitous. HSBC’s mid-year report continues to forecast a mild recession in the fourth quarter, saying “the warnings were flashing red.” Although JPMorgan upgraded its 2023 growth expectations, it said a recession was still likely at the end of the year or in 2024, and a survey published by Bankrate showed that 59% of economists are predicting a recession in July 2024. So, for many, the expectation of an economic downturn has merely been delayed to next year.
Investors have been deliberating about the likelihood of a recession for a year-and-a-half, and the predictions are becoming tiresome to follow. To push predictions into July 2024 will be to extend the conversation—and anticipation and fear—for another year. The New York Times is also puzzled by the continued re-forecasting of a recession, questioning if the warning cries are merely a mirage in the distance. We wonder the same.
Why Have We Avoided a Recession?
Economists don’t always get recession forecasts right. For evidence of that, you’d need only to go back to the beginning of the pandemic to find a slew of predictions that didn’t quite pan out. That’s to be expected, but this time, it seems experts really missed the mark.
Last week, The New Yorker explored reasons why so many experts got recession predictions wrong. The consumer effect seems to be the cornerstone of economic strength. JPMorgan’s analysis also pointed to consumer spending as the cause behind the positive economic environment. Strong consumer spending has been able to offset slowed investment activity. In fact, predictions of a delayed recession hinge on an expectation that consumer spending will moderate in the second half of the year or in early 2024. If that doesn’t happen, recession predictions will fall short once again.
The story behind consumer spending starts with the pandemic stimulus package, known officially as the American Rescue Plan Act. It pumped $1.9 trillion into the economy, much of it in the form of checks cut directly to American homes and businesses. Those funds helped to stabilize household finances and create economic elasticity to withstand the current headwinds. In addition, wages are now outpacing inflation, with unweighted wage growth at 5.6% as of June 2023 and inflation tempered down to 3%. This has given consumers financial confidence and helped to support economic growth, despite waning investment appetite.
CRE Investment Market Responds to Economic Optimism
Real estate investors have been sitting on the sidelines steeped in uncertainty about the trajectory of the economy. The dynamic has created a wide bid-ask spread on deals and pushed investment volumes down by 70%. As of mid-year, all commercial property sectors continued to show significant declining investment volumes, dropping by at least 54%. However, the resiliency over the last six months has helped revive the CRE investment markets. CBRE’s research team now expects investment volumes to have declined 37% year-over-year in the US, with notable recovery in the multifamily market in the second half of the year. This resurgence could come in response to improving economic reports and sustained resiliency.
However, rising interest rates have hampered underwriting, and many deals—despite economic optimism, consumer spending and rent growth—just don’t pencil. JPMorgan notes that capital markets activity has fallen sharply in response to rising rates, and that this will likely impact valuations for commercial real estate, particularly for office and retail assets. It remains to be seen how the commercial real estate markets will respond to a hardy economic climate with strong demand but also high interest rates. As CBRE’s Darin Mellott said in the midyear economic update, more clarity around interest rates and The Fed’s plans for 2024 will come in the fall. If interest rate hikes are stalling for the near future, real estate investment could gain momentum this year.
Predicting the future is never an easy task, and while it’s important for real estate investors and developers to understand future economic conditions, there are also strategies to help mitigate the impact of an economic dislocation without standing still. Predictive analytics technologies and automation, like those embedded in Northspyre, create efficiencies and provide meaningful insights that strengthen the viability of investment. With predictive analytics, developers receive insights into nuanced market fluctuations specific to their investment, allowing you to pivot and respond as fundamentals change. Ultimately, this information allows developers to realize targeted outcomes on their projects. Automation helps in a different way, by eliminating timely administrative tasks and reducing human errors. This efficiency saves time and money, providing a leaner budget and reducing overages—a tremendous advantage in a time of economic uncertainty.
The last three years have been tough for investors, but the resilient economic performance and waning probability of a recession is a reason to celebrate. It’s still unknown if a downturn is imminent, but investors have plenty of reasons to be optimistic.
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Tag(s): Real Estate Development
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