With so much media coverage of a potential recession in 2023, real estate investors are rightly concerned about how to invest and protect their portfolios during an economic downturn. And whether the Federal Reserve’s efforts to tame inflation result in a soft landing or something more protracted, you can help your clients prepare for changing market conditions.
A Looming Recession?
Many industry analysts suggest commercial real estate is already experiencing the effects of an economic slowdown. Through October 2022, the benchmark Green Street Commercial Property Index was down 13% YTD for all industry sectors.1 And according to a recent survey by the National Association of Business Economics, “only 13% of economists were confident or very confident that the Fed could bring down inflation to its target range without causing a recession.2”
By most measures, many property sectors appear to be entering the late stages of the real estate cycle, as noted in PwC’s 2023 Emerging Trends in Real Estate report.
“The whopping growth and profits property investors and managers enjoyed post-pandemic have fallen back to earth and are “normalizing.” - PwC
On a positive note, however, experts interviewed for PwC’s report indicate that if we experience a recession, it should be relatively “short and shallow.” And it’s important to remember that opportunities may exist for investors during all phases of the cycle, including when the industry is contracting.
“Although real estate capital markets are constricting, they are still open for business. Investors are still buying high-quality properties, lenders will continue to lend, and companies should move forward with cautious optimism through this current cycle and prepare to adapt to market changes.” - Byron Carlock, PwC U.S. Real Estate Leader
Diversification Tactics
You can provide a valuable service for your clients who own investment property by sharing these tactics that may help them identify investment opportunities amidst changing market conditions. Encourage your clients to focus on diversifying commercial real estate holdings by:
Sector
While sectors like office and retail may be more subject to the impacts of a slowing economy, other properties can tend to be more resilient through different cycles. For example, self-storage, healthcare, and manufactured housing are generally viewed as needs-based assets that remain in demand during good times and bad.
Quality
There is no guarantee that premium properties won’t be affected by a recession, but quality does matter. Well-located Class A properties with low leverage, stable, credit-worthy tenants, and low vacancy rates are usually positioned to withstand challenging economic conditions better than lower-quality assets.
Geography
Not every market will react to late-stage real estate cycles similarly. Markets with low unemployment, a younger, highly educated workforce, and stable economic growth will likely sustain rent and property valuation better than other areas. So identifying properties in strong markets is another valuable way to diversify real estate portfolios.
The Best Defense? An Experienced Sponsor
Perhaps the best guidance you can provide your clients who invest in commercial real estate is to only work with sponsors who have owned and managed properties through many different real estate cycles.
The few sponsors who overcame the challenges the industry experienced during the market collapses of dot.com in 2002 and the housing debacle of 2008 today are the leaders with the scale and strength of balance sheets to perform for investors whatever market conditions may lie ahead.
Now is an excellent time to review your clients’ commercial real estate investments and explore opportunities for late-stage investing.
1. https://www.greenstreet.com/insights/CPPI
2. https://www.cnn.com/2022/08/22/economy/nabe-economists-recession-inflation/index.html
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