"I don't want to sugar-coat the message…" economist says before lowering the boom
What’s the commercial real estate outlook for the second half of 2022 and beyond? That was the central question during the Mid-Year Global Outlook hosted by CBRE this week.
Hosted by Spencer Levy, CBRE’s global client strategist and senior economic advisor, the discussion came amid an ominous backdrop of motley patchwork that impacted the industry – supply-chain disruptions, surging energy prices, inflation, Russia’s invasion of Ukraine, and more. “But make no mistake,” Levy said. “The headlines only tell part of the story.”
Participating in the annual webcast discussion were Richard Barkham, global chief economist, head of global research and head of Americas research; Ada Choi, head of occupier research, Asia Pacific; Jessica Morin, head of office research, Americas; Jen Siebritz, head of research, UK; Matt Vance, head of multifamily research, Americas; Mike Watts, president of investor leasing, Americas; and Julie Whelan, global head of occupier thought leadership.
Low consumer confidence, deteriorating business confidence and inflation have combined to exert industry challenges. Yet at the same time, Whelan observed, consumers are still spending while US job growth continues to outpace the supply of workers. Despite some strong economic areas, Barkham said he believes recession – or at minimum a “very serious slowdown” – is likely on the horizon.
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“It’s important to note, despite all the volatility that you’ve mentioned, we are not there yet,” he said. “But I think the pressure on the consumer and on business from rising energy prices, high food prices and, most importantly, rising interest rates, is going to see demand ebbing away by Q4 of this year and into the first half of 2023. We’ve had some slowdown in the United States, but there is more to come over the next 12 months or so. So, I think we’re headed for recession.”
How severe of a recession? “Well, I don’t want to sugar-coat the message, but I think there are factors in play, quite a few of them, that might lead us to a conclusion that we’re going to face a moderate recession,” Barkham said. “On the one hand, corporate balance sheets are reasonably strong. And despite the fact that demand will ebb away, I think because of the war for talent, companies will want to hold on to their labor. So we may not see widespread spiking unemployment.”
Yet consumer spending won’t be as hard hit thanks to the pandemic, Barkham explained: “I would say also that consumers even now have still quite a lot of savings and cash accumulated from the pandemic period. And they can use that. They can draw that down in tough times. So, consumer spending might not dip quite as hard as it might otherwise have done. And I think with regard to inflation, we’re not going to see some multi-year wage price spiral that we saw in the 1970s. This is a very nasty inflation spike. But I think we’ve reached the peak of inflation. I think it’s going to ease over the next six, 12, 18 months and by the middle of 2023, that will allow the Fed and the other central banks around the world to start cutting interest rates so demand can revive.”
Still, it’s not all doom and gloom, Barkham said: “But equally, I think at the moment in the United States, we’re seeing supply chains easing up, we’re seeing inventories building up. And I think we’re about to see inflation easing there as retailers begin to cut prices in order to shift the backlog of inventories that they have.”
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How will this outlook impact real estate markets? “Well, all recessions lead to rising unemployment, and rising unemployment will feed through into rising vacancy,” Barkham said. “Some sectors will be worse hit than others, but rental growth will also ease back quite considerably because vacancy is on the increase. Life sciences, data centers and industrial, the sectors that are powered by the digital economy – they’re likely to fare better than some of the more traditional sectors.”
Given such market turmoil, Watts reiterated advice CBRE has given its clients who own office real estate. “I would say the number one question I get from owners of office real estate, especially those institutional owners with large portfolios, is ‘what should I do with my asset right now?’ And I remind them that real estate is a unique product type and it’s a unique asset in particular office buildings. So it matters what you own, where you own it, and what kind of improvements you’ve done to it, which is really how it should be. So, we’re advising our clients to step back and take a look at their asset objectively, look at where they think it’s strong, where they think it’s weak, and, from there, devise a plan to compete better in a somewhat new environment. Owners understand recessions. But work from home, flexible hours, COVID, that’s a bit of a curveball that everybody is getting adjusted to.”
Morin pointed to favorable trends in the industry. She noted, however, that hybrid work that was accentuated during the pandemic could have a negative effect on demand.
“In the US, the worst really seems to be behind us. Over the past three quarters, we have seen that move-ins have actually exceeded move-outs,” Morin said. “Vacancies are starting to stabilize, although they reached that nearly 30-year high and asking rents are starting to moderately rise.”
The story is largely the same in other parts of the world, she added: “In EMEA (Europe, Middle East, Africa), same thing across major markets - we’ve seen they can see either be stabilizing or decreasing with a few exceptions, like in Berlin and Barcelona. Now on the return to office side in both regions, the US and Europe, it has been slow, but we do expect occupancy levels to really start to pick up in the fall once employers make it clearer what their expectations are for their employees. But with that said, the majority of employers, both in the US and in Europe do support hybrid work. So we do expect employees to be in the office less and that will have an overall net negative impact on demand.”
Morin painted a picture of what recession will look like for the industry, saying she expects more layoffs – the “rightsizing” of corporate nomenclature – as companies assess their makeups.
“A recession will weaken demand for office space and it’s going to further delay the US office recovery,” Morin said. “Companies are going to look for where they can cut expenses. So, I’d expect continued rightsizing and possibly an increase in short term renewals. With that said, we have started seeing this play out. There’s been a few tech companies that have pressed pause on planned office expansions and even their current underway build-out and cities like New York, San Francisco and Washington, D.C. But aside from those few examples of companies, I do think we’ll still continue to see leasing activity over the next several quarters. But occupiers are just going to move even more cautiously.”
While it’s impossible to predict the future, owners need to adjust for what may lie ahead, Watts said: “So I think this is a moment in time in which COVID has dragged on longer than people thought it would. But tenants looking at office space are evaluating experience as much as anything else. Owners need to know that, and they need to adjust accordingly.”