From the start of 2022, the U.S. economy has been plagued by the ongoing effects of COVID-19, war abroad, and supply chain disruptions. Now as the Federal Reserve tightens interest rates in an effort to cease rapid inflation, talks of a recession run rampant. So what does this mean for business investors? In this report, Matthews will analyze the future of the economy and its effect on commercial real estate.
Federal Reserve Takes Action
The Federal Reserve began raising interest rates in March of 2022 in an effort to slow down inflation, which was reported at 8.5 percent in July. That same month, the Fed announced it was increasing its target rate by .75 percent increasing the federal funds rate to 2.25 percent to 2.50 percent. Although the Fed has assured U.S. leaders and residents that the increases will provide a “soft landing” recession, many economists fear that the Fed was too late in its interference and that a “hard landing” recession is inevitable. What this means for consumers is that credit card debt is becoming more expensive and mortgage rates keep going higher, stifling business investment and consumer spending on goods and services.
Economic Impact of Investments
As of August 2022, the U.S. stock market is considered is in bear market territory, meaning the market experiences prolonged price declines and widespread negative investor sentiment. It’s common for a bear market to accompany general economic downturn and it can be cyclical or long term. Company profit expectations start to decline which in turn slashes the price of their stock. Bear markets approximately last a year, but the stock market looks to be on the upswing, entering a more bull market as company earnings performed better than expected in late 2022.
A bear market, although frowned upon, also spurs a fantastic opportunity to build long-term wealth for investors. Entering the market at lower prices, investors can ride out the declines and receive much higher yields. As the saying goes- high risk, high return.
Where to Invest in CRE
Anytime the economy experiences historical ups or downs, landlords, tenants, developers, and investors are affected. Increased prices lead to erosion of principals on bonds, affecting asset values and eventually affecting interest rates. Luckily, commercial real estate has a reputation for performing well during times of high inflation due to the increase in rent and property values. In times of economic distress, plenty of commercial real estate assets still bring security, stability, and profit.
With the ongoing dominance of e-commerce, industrial storage facilities have skyrocketed in value and demand. Online brands and retailers require more warehouse space for fulfillment and shipping operations. Cold storage also grew in need and investor interest as consumers began to order groceries online to be delivered to their front door, and companies like Amazon began to expand their grocery delivery services. In addition, the internet has powered the development and necessity of data centers and logistic storage facilities. Industrial real estate can be held onto long-term and utilized by various tenants, making them a safe bet for investors in today’s market.
A slow economy often helps the multifamily sector of real estate as home prices surge and mortgage rates become unattainable for many would-be buyers. Beyond the issue of increased rates, potential homeowners are being pushed out of building a property, as construction materials are low in supply and high in price. This has forced consumers to stay renters, planning to stick out the economy until looking to purchase again.
Multifamily development is strong in major markets across the U.S., including secondary markets. There is also an increase in townhomes and build-to-rent communities, a niche asset class that features single family homes built specifically for rent, not purchase, oftentimes accompanied with similar features to an apartment complex. The increased need for housing caused by migration throughout 2020 and 2021 has strengthened apartment profits and investors have taken notice, specifically in regions like the Sunbelt and Southeast.
Retail has ups and downs as its very dependent on consumer spending and inflation. But after a rough downturn during the global pandemic, retail entered the year durable, recovering quickly in most major markets as consumers craved the experience of in-person shopping and entertainment. Private investors account for the majority of retail details greater than $50 million at 53 percent.
Some retail property types that have stood out the past year are grocery-anchored centers. Groceries are hitting record numbers in sales due to inflation. Consumers are cooking at home and using online services, such as curbside pick up and delivery. Shopping centers are another type that some retail experts say are a good investment, but most say the center should be a modernized mixed-use, open-air mall to reap profit. Traditional malls have taken a hit over the last decade and are not expected to rebound. Discount retailers, like Dollar Tree and Five Below, are also performing well, as consumers look for everyday items at affordable prices.
One thing to keep in mind is that credit card usage is at a record high among consumers, meaning income isn’t matching rising prices. This could hurt retail investors down the line if a recession does hit and consumer spending drops.
What to Expect
Some positives are occurring in the market, the stock market is expected to exit a bear market in the short term, and job growth and employment have stayed steady. But inflation and interest rate hikes are not going anywhere anytime soon. According to Deloitte’s Economic Forecast Q2 2022, core inflation is expected to remain above the Fed’s target rate in 2022 before decreasing to the two percent range in 2023. Oil and gas prices are expected to stay high and are slightly unpredictable as the Ukraine and Russia war rages on. The federal government has taken a step to fight inflation, with U.S. Congress set to pass the Inflation Reduction Act, a $400 billion energy and healthcare bill. Unfortunately, it will likely take up to two years to see an impact on the overall economy once the bill is passed.
What to Do
Most economists and investors believe that pushing ahead is the right move in the current economy. The market is going to experience highs and lows, and it’s important not to let fear hinder potential opportunities. Although sellers have had the power over the last two years, this power could transition to buyers as the investor pool narrows.
Owners will also reap some benefits. Since inflation pushes all prices upward, owners will see appreciation at a faster pace, as it tries to keep up. Overall, the economy is a hard system to predict, but with high risk comes reward. Consult with an expert, strategize with a specialized broker and curate an investment plan for success.