US commercial real estate markets

Once again economic prognosis is in fashion. But does it offer any insights? The current situation is quite unique and perhaps too many investors anticipate they can „market-time“ the cycle. Buyer and seller beware! The current mix of data offers no clear view except the need to revisit pro-formas!

The current status of the US economy sends mixed-signals. The advance estimate saw GDP decrease at an annual rate of 0.9 percent in the second quarter of 2022, following a decline of real GDP by 1.6 percent in the first quarter This may indicate potential recession risk. But there is no recession at this time.

Employment remains strong. The unemployment rate edged lower to 3.5%, and employment has recouped the job losses from the pandemic.² The ASA Index showed a strong rebound after the 4th of July weekend, measuring at an all-time high for the month of July.³ This may contradict „recession talk“. Average hourly earnings where up 5.2% from an year earlier, however not outstripping inflation, as measured by the CPI (+ 8.5% before seasonal adjustment).⁴ Consumer confidence surveys show that consumers are both more hesitant about the job markets and about the prospects for the economy.⁵ Several tech-companies including Microsoft and Google have either announced hiring freezes or already intensified laying-off staff during summer 2022.⁶ Office-using employment may take a hit medium-term in certain sectors. Second quarter saw gross office leasing volumes higher than Q2 2021. Transactions in the office sector are already muted by higher financing costs. Office price index is down 1% for the first seven months.⁷ Property performance remained robust, with the second quarter 2022 NPI total return at 3.23%, outpacing the historic average of 2.25%.⁸ Office was the only sector that saw a decline in the appreciation component during this quarter (-0.5%).

The dollar volume of CRE loans is at an historic high.⁹ A younger generation of real estate professionals only accustomed to low financing costs and easy-to-accomplish positive financial leverage effect need to adjust pro-formas. The Federal Reserve may target 4% by the end of this year. But can real estate managers „time-a-market“? Lessons from 2007:

Based on his memoirs, Sam Zell, the former CEO of Equity Office Properties REIT recalls, it was not his ability for perfect market-timing, but the superior price tag on the offer that made him sell the REIT in 2007 before the perfect storm of the Great Recession set in.¹⁰ What is on the agenda facing a multitude of uncertainties?

Position for structural demand shifts: By example Geico insurance recently closed its entire sales offices in California.¹¹ But online is here to stay. Analyse regional factors: By example San Antonio and Phoenix (TX) had the strongest absolute population growth in the nation from 2020 through 2021.¹² From regional data, real estate managers can derive potential for demand growth more insulated from general macro trends in the economy. Account for higher borrowing costs and inflation: Revisit how NOI is impacted for existing portfolios and future projects. Tailor the perspective per client: Regulated German institutional investors may need to look at currency hedging costs implied by key interest rate differentials driven by FED and ECB policies.