How Can CRE Professionals Prepare For A Potential Recession?

In Q2 2022, Moody’s Analytics predicted a 40% chance of recession occurring in the next year. However, even one fiscal quarter can make a major difference, as the company’s Q3 2022 Economic Briefing increased that likelihood to 55%-60%.

Jeffrey Havsy, commercial real estate practice lead at Moody’s Analytics, said that while it is too early to say that a recession is definitely coming, the signs — a negative yield spread between the two-year and 10-year Treasury bonds — point to a strong possibility.

“We’re definitely not in a recession yet, but as interest rates continue to rise, given the supply chain issues and global turmoil, the chances of things going wrong has increased, which can tip us into a recession,” Havsy said. “The economy isn’t as resilient as it was six or 12 months ago, and while in the past it could handle sudden changes, currently, because the risks are continuing to compound, the economy is more likely to stumble.”

While the CRE industry has a history of staying resilient during inflationary periods, investors should still be aware of how their assets may be affected.

First, the good news: Moody’s Economic Briefing showed that in Q3 2022, there were declines in vacancies in both the multifamily and industrial sectors. At the same time, rent prices in both sectors were increasing.

Blake Coules, senior director and commercial real estate practice lead, said while both the multifamily and industrial sectors have shown signs of strength, economic slowdowns coupled with rising rates can lead to uncertainty in future performance.

“If there’s a significant change in the outlook of the multifamily sector, it will impact the demand for financing new and existing assets,” Coules said. “Additionally, on the industrial side, some big players are giving back development areas and laying off workers, which may be an indicator of slowdown.”

Moody’s Economic Briefing stated that office vacancy was at 18.4%, with three metro areas — Boston, Dallas and San Francisco — experiencing the highest increases.

“One of the biggest drivers in real estate is job growth by market, which correlates with office absorption,” Havsy said. “Job growth will also impact spending power in other sectors, affecting whether people can afford to spend money on shopping or on buying an apartment, or how much industrial space is needed if people are buying fewer goods and services.”

A period of economic downturn can cause investors, brokers and lenders to hit pause on major deals. However, both Havsy and Coules said that these CRE professionals should stay up to date on the performance of their sector to determine how to take advantage of opportunities. These opportunities include purchasing new assets or revitalizing current assets as well as helping others navigate the turbulent market.

Havsy said investors can use knowledge of how the economy is impacting the market to invest in distressed assets — assets that are being sold at less than their current value — or revamp an existing asset. 

Havsy also recommended that investors not overlook the potential of additional property types  such as student housing, senior housing or affordable housing.

“People should be paying attention to these alternative property types, as a way to either diversify risk or potentially have different income streams, depending on what the asset is and where it's located,” Havsy said. “However, it’s important to keep in mind this isn’t about buying anything you want. Investors need to look closely at the underlying fundamentals of that asset in that market because there could be value there.”

Additionally, because brokerages have seen layoffs and a decrease in transaction volume, it becomes even more important to assist clients in making the most of their property, cutting back on spending or pursuing a financing plan, he said.

“The more you know about the market, the better you understand the economic and tax situation, where the opportunities are to add value and what assets might be distressed,” Havsy said. “At this point in the economic cycle, you need to prove your value, and you can do that by adding to your knowledge base.”

Coules said that lenders should be thinking about the types of assets CRE clients are looking to invest in and comparing that to the general health of the market where the asset is located. 

“Given interest rate increases, lenders should assess the performance risk of existing assets in their portfolios, with particular focus placed on those assets in which the financing is maturing over the next six to 12 months," Coules said. "For new transactions, lenders will need to ensure the assets can survive in the current environment. For example, a retail plaza may have a grocery anchor taking up 70% of the lease payments, with other retail tenants paying the remaining 30%. If they are not paying attention to the dynamics of the market, they could wake up one day and find out the cash flow from any of those businesses could be gone.”

Coules said that when CRE lenders are assessing the market demand and staying on top of their own portfolio's performance — or leveraging their market insights to help clients make the best decisions for their portfolios — it helps with getting ahead of competitors.  

“Having a constant review of your portfolio and the inherent risks helps with understanding what you have, what actions you can take and what conversations to have with your clients, in the case of banks,” Coules said. “Being disciplined about these aspects will go a long way assisting lenders in navigating the uncertain times we currently live in.”

This article was produced in collaboration between Studio B and Moody's Analytics. Bisnow news staff was not involved in the production of this content.

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