On Friday, November 1, Dr. Sam Chandan addressed the Urban Land Institute’s New York District Council to share his outlook for the US economy and the implications of a probable recession on the real estate industry. Dr. Chandan is the Silverstein Chair and Associate Dean of the NYU SPS Schack Institute of Real Estate and Chief Strategist and Global Head of Strategy and Research at Capri Investment Group. The summary below paraphrases Dr. Chandan’s views on the national real estate market and economy.
Overall, there is an expectation in the market that a downturn in the economy is likely. The New York Federal Reserve Forecast model has assigned a 34.8 percent probability for a recession to occur in 2020, with a slightly lower probability that it will happen in 2021. The real estate industry is unlikely to drive the downturn, as it did during the financial crash and following recession of 2007/08, but the industry will be affected. Higher risk-taking by real estate investors is typical at the peak of the cycle, which is where we are currently, and there have been recent examples of higher risk-taking in the market. However, history has shown that a recession is typically short-lived compared to the expansionary period that precedes or follows it. The main question for real estate industry participants is how to formulate a tenant strategy during a downturn, and how to invest as the market begins to grow again.
One serious difference between the current business and real estate cycles from those prior is the influence of data and technology on investment decision-making. Data and technology are having wide-ranging impacts in real estate and urban planning. On the industry side, more granular and immediate data is available now than ever before. Unlike previous cycles, it is being used by a savvy crop of analysts, associates and decision-makers to inform investment decisions in real time. This reduction in information asymmetry is one likely reason why the current real estate business cycle has been more extensive and risk-taking has been less prevalent late in the cycle. Technology is also changing the built environment. On a micro level, this means office layouts have changed, and retail operations are going through a sea-change.
Two possible causes for the next downturn are falling consumer and investor sentiment and the risk posed by growing corporate debt. According to the WSJ Forecasting Economic Survey, economists have more pessimistic growth expectations for the next two years compared to a year ago. Falling sentiment is important because diminished expectations could lead to a lack of consumption and investment, creating a negative feedback loop that could cause a downturn.
Another major risk is corporate debt, which has risen to 46 percent of US GDP, even while household debt has generally been decreasing and now sits around 36 percent of GDP. The enablers of household debt, those lenders who brought on the Great Recession, have been limited this cycle by prudence and government regulations. Student loan debt is clearly a focus of the moment, but there is not a significant level of delinquency and default, nor an exhibited correlation that suggests it will have a contagious effect on the larger economy if defaults rise. Outside of an exogenous geopolitical event, corporate debt is worrisome because earnings might not be able to catch up to expanding debt service.
The other major macroeconomic trend affecting cities across the country is the interplay between rising housing costs, stagnant wage growth and housing policy. The labor market proves that the past ten years has been a different kind of recovery. It has taken 76 months to get back to peak employment levels, far longer than the 32 months it took following the 1990-91 recession, or the 48 months following the 2001 downturn. Human capital needs and technology have changed the productivity input calculation and some jobs are being automated away. At the same time, there is also a skills gap, exemplified by the skills gap in construction work, which is making some labor fields more costly. In general, a struggling labor market has translated to stagnant wage growth.
Slow wage growth and rising rents have made housing affordability a pressing concern. Rents on primary residences have grown at a faster rate than wages over the last eight years. The high cost of housing in major cities has created political pressure to implement rent control measures. However, controlling rents in multifamily is difficult policy. While rent controls are popular, such policy can detrimentally affect supply by disincentivizing developers.
Higher urban core pricing and the difficulty of developing multi-family affordable housing has meant that most of the new multi-family supply being built is Class A, highly-amenitized and unaffordable for the majority of the workforce. This also creates the potential for a negative cycle, where higher costs lead to more rent controls and still less housing. To break the cycle, developers and policy-makers need to find a new method of addressing supply and pricing concerns.
These issues create serious long-term dilemmas for livability and diversity. Cities that have good transport to downtowns are less affected by these low wage, high rent trends, while those without transportation infrastructure see higher urban core pricing and thus higher political demand for affordable housing. Real estate is a holistic investment that relies on and makes up cities. All participants benefit from access to infrastructure and public services. Cities designed to absorb political, environmental and economic shocks will make real estate investments in those cities more valuable.
Blog Post By: Brian Damron, Senior Consultant, CBRE Hotels Advisory