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Economists are predicting a potential “Twilight Zone recession” could occur in the next year, an odd scenario where overall growth and output decrease but employment remains stable. Recession conditions, even if unusual, will impact your commercial real estate development operations. By understanding the factors contributing to the current economic moment, and leveraging several key strategies to mitigate risk, your business can weather a downturn of any kind.
The conditions of a “Twilight Zone” recession could result in a long, slow downslide for the commercial real estate market instead of a dramatic drop. For your business, that means being prepared for an extended period of turbulence, where aspects of the market remain resilient but others are at risk of decline. Economic uncertainty has already resulted in a mixed outlook for certain asset classes, such as office buildings and multifamily housing development.
Here’s everything you need to know about a potential “Twilight Zone” recession, and its impact on your real estate development portfolio:
The “Twilight Zone” Recession’s Impact on CRE Development Projects
Earlier in the year, experts were predicting the commercial real estate development market would be headed for a major downturn at the end of 2023 due to a variety of factors. Landlords continue to struggle to fill office space as remote work remains popular. The Federal Reserve’s attempts to quell inflation through interest-rate hikes increased the costs of loans. Bank failures earlier in 2023 also spooked the market, resulting in more timid lending practices from banks and investors. However, the economy has not responded as expected, and analysts are now predicting dips in commercial real estate development valuations will be staggered or in a longer-term decline.
CBRE’s prediction remains that the Federal Reserve’s interest rate hikes will lead to “a gradual and bumpy” recession to close out 2023, resulting in less real estate investing and leasing. The investment firm also predicts the economy will stabilize in early 2024 but investment and leasing might not pick up again until employment growth resumes. You can expect real estate development deals to be more difficult to secure for the foreseeable future, which can have financial repercussions for your overall portfolio.
The Implications for Your Real Estate Development Portfolio
The current economic outlook remains murky, but there are several key takeaways to consider in terms of your real estate development portfolio.
Office space is the most vulnerable asset class.
Office buildings, especially Class B and Class C spaces, are still facing high vacancy rates in the post-pandemic era and are therefore the most vulnerable assets in the event of a downturn. Property owners are looking for creative ways to repurpose vacant office building assets with an unclear future, such as conversions into affordable housing or university student housing. High-interest rates might complicate conversions or renovations, but for defunct properties, updates may prove a worthwhile investment. Class A office space owners are also considering tenant improvement allowances to lock tenants into long leases, which require a steep investment upfront but eventually deliver strong returns.
Diverse Real Estate Development Portfolios Should Remain Healthy
Diversifying your assets is the main way to ensure your portfolio remains healthy in an uncertain economic climate. Portfolios with a mix of property types - such as residential, retail, or industrial buildings - and investments located in different regions or cities will be better suited to weather macroeconomic turbulence. Looking to invest in properties with lower risk, such as mixed-use developments, that combine residential, apartment, and retail space to diversify revenue streams, is also a best practice.
Risk Mitigation Strategies for Economic Turbulence
By implementing several strategies and tools, you can overcome the challenges and pitfalls of a potential “Twilight Zone” recession or other market turbulence.
The current economic conditions are impacting certain markets or asset classes disproportionately, meaning thorough market research and due diligence on your projects will prove more important than ever. Even within the struggling office market, certain asset classes, such as Class A office space with luxury amenities, are performing better than Class B or Class C assets. Finding areas of the market where demand will remain high and properties are likely to remain resilient will help bolster your portfolio in the event of a downturn. Staying informed about zoning laws or regulatory changes that might present new opportunities is also a useful strategy for developers looking to make strategic investments in an uncertain time.
In a survey conducted by Deloitte on the 2024 commercial real estate outlook, businesses reported that expense mitigation was a chief concern. Revenue expectations have dropped to the lowest since the survey began in 2018, and respondents reported talent and office space as areas being eyed for cost savings. Most respondents also reported a desire to use real estate development technology to drive efficiency, with the goal of streamlining processes, and adding agility or resilience to existing processes.
Exploring adaptive reuse development projects can also be a risk mitigation strategy. The trend, which involves repurposing existing buildings to meet market demand, has been on the rise as Class B and Class C office space demand continues to decline. Adaptive reuse projects also typically have lower acquisition costs than ground-up developments and come with preexisting utility infrastructure that can save your team time and money in the development process.
Technology-Driven Firms Will Come Out on Top
CRE investors with billions in dry powder at the ready are reportedly eyeing opportunistic and value-added investments for when the market turns around. Investors are looking to work with forward-thinking, efficient development firms once the economic outlook is clear. Your business can use this time to leverage technology and secure positioning as a forward-thinking, modern firm. When economic conditions become clear, you’ll be able to use your reputation to secure financing more easily.
The Role of Technology in Navigating Recession Conditions
Modern real estate development software can help your team navigate recession conditions and position your firm for success in the next cycle. Northspyre’s real estate development platform can reduce administrative tasks by up to 80%, allowing employees to focus on critical responsibilities. During an economic downturn, your employees can focus on navigating challenging market conditions and critical responsibilities. You can also use data-backed insights to augment intelligence and make decisions faster in an environment where opportunities are limited, giving you a competitive advantage as the first to the deal table.
Download our white paper Maximizing Returns: A Real Estate Developer Recession Guide for additional insight on creating a defensive strategy for difficult economic times.
Tag(s): Real Estate Technology
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