A Recession Is Coming But Real Estate Could Be a Good Hedge, Economists Say
William Pattison is sorry but someone has to say it — a recession is coming.
In fact, Pattison, head of the real estate research and strategy team for MetLife Investment Management, apologized a few times while delivering the dreary news to the thousands of executives attending a panel on Urban Land Institute's semi-annual real estate economic forecast.
The forecast points to a recession hitting next year, which would have implications on real estate ranging from difficulty in accessing capital, a drop in deal activity and continued demand from renters for apartments and single-family rentals.
ULI, the nonprofit real estate research and policy organization, surveyed 43 economists and 37 real estate executives for the forecast based on dozens of economic and real estate indicators. And the economy has only worsened since the survey was completed in mid-October, Pattison said.
"I think this may be for the first time this survey has had as its base case consensus forecast a recession," Pattison told the audience during ULI's fall meeting in Dallas. "This 0.5% number [for gross domestic product growth] of 2023 is for the calendar year, which does imply a recession, if it's not clear."
With the Federal Reserve attempting to rein in decade-high inflation with a rapid series of interest rate hikes, Tim Wang, managing director and head of investment research for New York City-based investment manager Clarion Partners, said it is "reasonable to assume that we'll have a recession" but questions remain on the timing, severity and recovery.
Arthur Margon, a partner at Rosen Consulting Group, a real estate economics consulting firm based in Berkeley, California, said it all depends on the Federal Reserve.
"If the Federal Reserve really wants to get inflation back down to 2%, they will have to induce a much deeper slowdown than the one we are talking about," Margon told the audience. "We think when the Fed sees inflation coming down, they'll stop talking about 2% and say they can hold it at 4%, if they do that you wind up with a mild recession. But if they really want to get back down to 2%, they will have to sort of wring the inflation out of the economy like a wet towel. We don't think that's the most logical implication, but that's the downside danger."
Real estate can be a good hedge against inflation, Margon said, depending on the real estate fundamentals, with countries like Argentina and Israel showing real estate can do well when there's a supply-demand imbalance for a particular property type because inflation can pass through to the end user. If there's an imbalance in the other direction, such as empty office space in Washington, D.C., Margon said it wouldn't be a great hedge because property owners can't pass those increased costs through so readily with a tenant having numerous other options.
Lee Everett, director of research and strategy for Waterton, a Chicago-based multifamily and hotel investor, said wage inflation has been the key driver of success in the multifamily sector over the past two years, with those higher incomes helping fuel the growth of rental rates. At the same time, inflation has negatively affected rents and occupancy of Class C apartments, Everett said.
"Ultimately, it comes down to it's a hedge against some scenarios," Everett told the audience. For institutional high-end apartments, "it's been a strong hedge so far, but you are definitely seeing some people who can't afford to keep up," he said.
Here are some other key points made by the panelists:
"We're increasingly looking at preferred equity opportunities and supporting real estate investors who have a refinance problem or just can't make the math work in today's higher interest rate environment," said Pattison with MetLife Investment Management. "The spread in that space has widened pretty substantially in the last three to four months."
On Deal Volume
"It's tough out there, in March you started to see the bidding pools thin," said Everett with Waterton. "We are still active, but extremely selective, what you see happen is there are really strong levels of returns out there in the multifamily space, but you can't execute on any debt. So, balance sheet buyers have some opportunity now, but the debt side of the equation is going to make the equity trades extremely rare in the next few months and into the next year. "
"Pricing has to continue falling, we are thinking 20%+ longer term," Everett said, pointing to what he believes is negative leverage problems in the industry and difficulty in getting new debt.
"We're suggesting to our clients, you should try to become a turtle for the next year and a half," said Margon with Rosen Consulting Group. "It's really unclear what values are, everyone in this room ... knows they are lower but the question is how much lower. Our sense is — on the equity side — now is the time to pull your head into your shell and wait for clarity unless there's a special situation" that is really attractive for whatever reason.
"On the debt side, part of the problem is banking regulators are telling banks they need to have more capital reserves than they did before and they aren't lending," he added. "Non-debt regulators of capital will still be available, but they will be more expensive than regulated banks."