You’ve Got Advance Warning Of The Imminent Recession. Now What Are You Going To Do With It?

The indicators that the UK and U.S. are heading toward recession are becoming impossible to ignore. For commercial real estate, recessions are highly damaging. Don’t say you weren’t warned.

A new report from Cluttons Investment Management, called The Next UK Recession — Not If But When, outlines how the company believes it has become clear that the U.S., the world’s largest economy, will go into recession, probably next year. Much of the rest of the world will follow, the UK especially because of the impact of a potential no-deal Brexit.

Forearmed with this warning, real estate investors have the opportunity to position themselves to withstand the downturn, and possibly even profit from it.

“Ever since the recession induced by the Global Financial Crisis ended in 2009, investors have been treated to a stream of forecast warning that a slump is right around the corner,” Cluttons Investment Management Head James McCombe said. “So far, as we are all aware, none of these predictions have been accurate.”

But it believes now is different and that real estate needs to pay attention.

Cluttons pointed to a number of economic indicators flashing red, indicating high likelihood of recession in the U.S. and UK.

The inversion of the bond yield curve is one of the loudest alarms. Now, for the one or two of you who didn’t listen in economics class, that is when long-term interest rates are lower than short-term rates. If it persists, it is a sign that financial markets think rates will get lower in the long term.

Yield curve inversion is seen as a good predictor of a recession. It happened in the UK last week, and in the U.S. in March.

In the U.S., three other key indicators are pointing to an imminent recession, Cluttons said. They include volatility in stock markets reaching heightened levels and the Duke-CFO Global Business Outlook survey, which this month found that more than two-thirds of corporate chief financial officers expect that a recession will be underway by the end of 2020. The trade war with China is seen as a major contributing factor.

“The slope of the yield curve, which plots interest rates on short- and long-term government bonds, has long been considered one of the most reliable barometers of economic health,” McCombe said. “Research suggests that when the yield curve inverts and stays inverted for 90 days then a recession will occur within 18 months. With the first inversion of the U.S. yield curve back in March the 90 days passed earlier this month. Apply the same logic to the UK and the likelihood of a recession in the later part of 2019 or early 2020 becomes increasingly likely.”

The old truism says that when the U.S. economy catches a cold, the rest of the world sneezes. And that is before you take into account the potential negative impact of a hard Brexit.

Cluttons pointed out what a recession might mean for UK real estate. Of all the major financial asset classes, real estate is the most correlated to economic performance: the sector’s growth is 60% correlated with gross domestic product growth, Cluttons pointed out, compared to just 15% for equities.

The last recession had a devastating impact on the UK real estate sector. Transaction volumes fell 42%, values fell 44%, and while London offices and South East industrial assets are worth more now than in 2007, almost every other sector of UK real estate is worth less. That was the worst recession for 70 years, and won’t necessarily be repeated. But recessions are highly detrimental to real estate almost across the board.

Just as economies have globalised, so have real estate markets, and the UK is exposed to the risk of international capital putting its money elsewhere.

So if forewarned is forearmed, what should investors do with this knowledge? Cluttons had four pieces of advice: decide whether to sell off bad assets now while you still can, prepare an asset management plan now that can maintain income when the recession hits, pay down some debt and get ready to buy when the downturn comes.

“If you believe, as we do, that a downturn in the UK commercial real estate market would be consistent with both the global and domestic macro-economic and market led environment described above then proactive, strategic investment management can position portfolios against potential downside risks,” McCombe said. “Whether, as an investment manager, you are prepared to heed the warnings only time will tell.”