US economic troubles spill into CRE

The US economy in late 2022 is going through an uncertain period, one kicked off more than two years ago when the pandemic struck. Once the health crisis abated, a rapid and robust economic recovery followed, which spawned a round of high inflation not seen in a generation or more. The medicine to control inflation -- rising interest rates -- traditionally has caused recessions. That is widely anticipated now, though there is little agreement on how severe any near-future downturn will be.

The bears and the bulls both have a case

There are some real strengths to the US economy, such as household net worth, low unemployment and rising wages. As of the end of June, household net worth stood $143.8 trillion, down from 2021, but still historically high. Unemployment was a low 3.7%, and wages in summer of 2022 were $1.50 more per hour on average than they were a year earlier. 

On the other hand, there are real risks to the health of the economy, and the risks seem stronger than even a few months ago, especially inflation and the steps being taken to put a lid on it.

US inflation came in at an annualized 8.3% in August, down from earlier in the summer, but still elevated.

Just in September, the Federal Reserve hiked interest rates another 75 basis points, adding to previous recent hikes. Since the beginning of 2022, the central bank has hiked its funds rate from 0.25% to 3.25%.

A lot of consumers and investors are feeling bearish, believing a recession is either in progress or dead ahead. The reaction to current conditions has been a contraction of consumer sentiment, and a dive in the equities markets across the board.

Still, it is possible that the economy's strengths might mitigate the situation, making a soft landing possible or even likely. Besides household worth and strong incomes, important but lesser-known economic metrics such as business' fixed investments, business inventories and residential investment are all strong.

All of the many moving parts of the economy are thus in furious motion, but even so the outlook for the economy isn't clear as the headwinds and tailwinds fight it out.

Catalysts to watch: The broader economy

The overall direction might not be clear, but there are economic catalysts to watch in the coming months to gauge the direction of the US economy.

The top catalyst is inflation. Only about a year ago, high inflation seemed to be relic of an earlier time (the 1970s and early '80s), but the price of energy, housing and food all rose at eye-popping rates in 2022.

It isn't clear when the Fed will tame inflation, since inflation is a tricky beast, with a lot of factors driving prices higher, and great uncertainty about the impact of rising interest rates.

Financial market forecasters believe that the Fed will eventually succeed in lowering inflation to its target of 2%, but it will probably be a multiyear effort. In August, the Philadelphia Fed’s Survey of Professional Forecasters forecast that the US inflation rate will decline from 7.5% in 2022 to 3.2% in 2023 and to 2.5% in 2024.

Consumer spending is another catalyst to watch, since consumer spending makes up such as large part of the US economy, roughly two-thirds. Currently, spending is only barely growing, and not much at all when inflation is factored in.

In July, personal income increased 0.2% at a monthly rate, while consumer spending increased 0.1%. The increase in personal income was mainly because of an increase in wages and salaries. Americans' personal saving rate was 5% in July, the same rate as in June.

The job market is another important catalyst for the overall economy. The national unemployment rate is still fairly low, a fact that has driven economic activity (and indeed, inflation) over the last year. There are signs that the job market is weakening, however, with some employers cutting back on hiring and even a few industries (such as tech) beginning to lay off large numbers of workers.

Catalysts to watch: The real estate industry

More focused catalysts will drive the commercial and residential real estate markets in the coming months.

For-sale housing market

One to watch is the state of the for-sale housing market, whose health tends to impact the rest of the real estate industry, as vividly demonstrated by the global financial crisis beginning in 2008, when a housing slump sucker-punched other property types.

There aren't many indications that a slowdown in housing sales, which is already under way, will have as drastic an impact this time around as in 2008. But it will have an impact as sales drop (down 6% in July compared with June) and builders cut back on their production of houses.

Retail

As mentioned before, consumer spending is a catalyst for the wider economy. It is also one for the retail real estate sector. So far, the jury is out: Overall retail sales were flat in July compared with June's 0.8% increase.

Industrial

Consumer spending, and specifically spending online, will also shape the future of the industrial market, which has been the darling sector of commercial properties since before the pandemic, but is now slowing down in terms of development and leasing volume.

Multi-family

In the multi-family market, the trajectory of rent increases is a catalyst to watch. Rents have been growing prodigiously since the pandemic, but it is possible that a recession will put downward pressure on them. Nationwide average rents dropped in August compared with July, the first short-term decrease of the year.

Office

For the office market, much now depends on how permanent remote work will be. A recession might put more power back toward employers, who want workers to come to a central office more often. In that case, office space will be in demand. Or remote work might represent a social change too big to undo, even in a slower economy. In that case, there will be a large oversupply of office space.

Macroeconomic turbulence will impact real estate sectors differently, and as is often the case, the performance of individual properties and portfolios, will continue to be driven by local factors. Yet everyone in real estate, whatever the sector, should continue to keep a close eye on the movements in macro factors, as real estate reflects the economy. Both may be in for a bumpy ride ahead.

Macroeconomic turbulence will impact real estate sectors differently, and as is often the case, the performance of individual properties and portfolios, will continue to be driven by local factors. Yet everyone in real estate, whatever the sector, should continue to keep a close eye on the movements in macro factors, as real estate reflects the economy. Both may be in for a bumpy ride ahead.