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The U.S. Bureau for Labor Statistics recently reported that the consumer price index rose by 0.1% last month and 8.3% year-over-year. Market analysts expressed surprise that the U.S. Federal Reserve increasing interest rates by 2% this year didn’t curtail America’s rising inflation rate. The unexpected outcome also strengthened some experts’ conviction that a recession is imminent.
As the U.S. economy has grown more uncertain, industry insiders have raised the alarm about the effects of mounting inflationary pressure on the commercial real estate sector. Specifically, real estate finance sector professionals believe that the country’s soaring inflation rate will cost the commercial real estate sector $733 billion in financing this year.
Here’s a look at the recession’s anticipated impact on the sector and how it could affect certain asset classes.
Commercial Real Estate Lending Could Fall by $733B in 2022
Soon after the Bureau for Labor Statistics made its announcement, the Mortgage Brokerage Association (MBA) offered a grim forecast for commercial real estate lending in 2022.
The organization expects loans from the sector, and the multi-family segment will total $733 billion, down from 18% from 2021’s $891 billion. Jamie Woodwell, MBA's Vice President for Commercial Real Estate Research, explained that widespread anxiety about the economy, new interest rate hikes, and supply and demand for different property types are the main drivers of the predicted lending crunch. He also noted that declining transaction volumes contributed to financial institutions’ diminished enthusiasm for those markets.
In addition, the MBA predicted that if a recession does happen, it will further restrict lending for commercial and multi-family real estate projects. That said, the firm believes the segments possess strong fundamentals that will enable a relatively quick recovery if a recession is averted. In the best-case scenario, it anticipates that borrowing and lending in the space will rebound in 2023 and 2024.
Although the MBA doesn't consider the recession inevitable, other institutions are more pessimistic.
Kathy Bostjancic, Oxford Economics’ chief U.S. financial economist, told Bisnow she expects the Fed to raise interest rates by 75 basis points this month and another 75 basis points before year’s end. The tighter monetary policy could exacerbate the project cancellation trend commercial real estate developers have endured following this year’s initial rate hikes.
Rajeev Dhawan, director of Georgia State University's Economic Forecasting Center, told Bisnow the sector is already in recession. “It's just a matter of time when it goes to financing, refinancing, restructuring. It's going to show up,” said Dhawan. “The cost of doing business is going to be much higher.”
The Recession’s Impact on Different Commercial Real Estate Asset Classes
While the impact of inflation on the commercial real estate sector is still uncertain, it’s possible to predict the effect it will have on individual segments.
Dhawan pointed out that higher prices will drive consumers to purchase fewer goods, so retailers won’t need as much warehouse space. Consequently, he anticipates the public's changing behavior will cause demand within the industrial segment to decline. Since third-party logistics providers, general retailers, and wholesale users represent 79% of leasing activity in the industrial space, his analysis seems prudent.
Similarly, Thomas LaSalvia, Moody's Senior Economist and Director of Economic Research, believes the current macroeconomic headwinds will prompt a decrease in transaction activity in the industrial and multi-family asset classes. Subsequently, he expects those segments to experience a “wave of refinancing” and a significant increase in distressed loans.
Market insiders anticipate America's recent record-setting inflation rates will impact the office building asset class. Woodwell explained that the segment is especially vulnerable as it’s adapting to the hybrid-work model. Because its future is unclear, investors and lenders are hesitant to invest in that part of the commercial real estate market. When the dust settles, companies could decide to decrease their physical footprints to increase their liquidity amid a recession.
On the other end of the spectrum, the life sciences asset class looks like it will withstand the headwinds generated by inflationary pressure.
The segment has significant long-term growth potential due to changing demographic trends. The world’s middle class is on track to expand significantly in the coming decades, increasing the demand for preventative medical care. Similarly, researchers believe the world's elderly population will reach an estimated 300 million in 2025, intensifying the need for chronic illness treatment and medication.
According to Forbes, recessions have lasted around ten months in America since the end of the Second World War. If the macroeconomic contraction affecting the country follows the established pattern, the commercial real estate sector will be dealing with widespread uncertainty into 2024. But the sector’s strong fundamentals suggest the MBA’s prediction of an election year resurgence will be born out. Until then, real estate developers should arm themselves with information to prepare for the next economic shock.
Tag(s): Real Estate Development
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