Fed Economists Warn CRE Valuations Could Take A Tumble

Although the staff economists at the Federal Reserve say the U.S. financial system faces only moderate risks in the near future, they warn that serious economic pain may be ahead, including for commercial and residential real estate.

“In particular, the staff noted that measures of valuations in both residential and commercial property markets remained high, and that the potential for large declines in property prices remained greater than usual,” the central bank said according to the minutes of its February meeting, released last week.

CRE loan growth on domestic banks’ balance sheets remained “robust” in Q4 2022, the minutes say, but the issuance of commercial mortgage-backed securities remained slow in November and December amid high interest rates.

The economists were relatively optimistic about inflation, however. As energy prices drop and food price inflation moderates this year, they expect total inflation “to step down markedly this year,” with both total and core price inflation near 2% by 2025.

On the other hand, sluggish consumer and business spending could easily tip the overall economy into a recession this year, staff economists said.

“The sluggish growth in real private domestic spending expected this year and the persistently tight financial conditions were seen as tilting the risks to the downside around the baseline projection for real economic activity, and the staff still viewed the possibility of a recession sometime this year as a plausible alternative to the baseline,” the minutes say.

Not all economists are on board with predictions of a recession this year. In early February, the National Association for Business Economics surveyed 48 economists about the state of the U.S. economy in 2023, and the results were mixed.

Some 58% of those surveyed by NABE said there will be a recession this year, which is the same percentage who said so in NABE's December survey. But only a quarter of those said the economy is on the cusp of a recession — one that will begin by March, that is. In the organization's December survey, twice as many thought a recession would start in March.

“Estimates of inflation-adjusted gross domestic product or real GDP, inflation, labor market indicators, and interest rates are all widely diffused, likely reflecting a variety of opinions on the fate of the economy — ranging from recession to soft landing to robust growth,” NABE President Julia Coronado said in a statement.