July 28 - 2022
In this week’s blog, K.C. Conway, MAI, CRE, CCIM and Red Shoe Economics present the latest state of the economy and vital stats at mid-year in 2022. This is the first blog in a two-part series previewing our September 15, 2022 Webinar – “CRE Headwinds – Rising “IRE”: Inflation, Rates, and Employment Cuts”. In this upcoming webinar featuring K.C. Conway, Principal/Co-Founder of RSE and Michael Mandel, CEO/Co-Founder of CompStak, we will discuss inflation, rising interest rates, and employment cuts and how they are fueling concern of a future economic downturn. We will also discuss the potential impact to CRE, illustrate the trends using CompStak’s best in class transaction data with a highlight on the industrial and office markets and preview what to look out for during the rest of 2022. We hope you’ll join us and save the date for this important discussion!
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The “I”s are in Control: The Federal Reserve kicked off 2022 with a failure to recognize inflation risk at its January 25-26 Federal Open Market Committee (FOMC) meeting and shifted course at its March, May and June meetings, raising interest rates by 25bp, 50bp and 75bp, respectively. On July 27, 2022, the FOMC announced the second consecutive rate increase of 75bp in its July meeting and signaled additional increases to come. Now at mid-2022, with systemic inflation running in excess of 9%, one could argue the “I”s are in control (Inflation and Interest Rate hikes).
Legacy and Updated “Misery Index” rise to new highs: The elevated level of inflation — not seen since the period from 1976 to 1981 —has many consumers and businesses feeling miserable. In fact, the legacy “Misery Index” (Unemployment rate plus Inflation) has surpassed the 12.7% high-water mark reached in 1976. The updated “New Misery Index” (Inflation + Unemployment less GDP and the annual change in the S&P 500) reached a record 29.2 as of May 2022, according to Forbes’ Peter Cohan. Recalculating it today using Cohan’s methodology yields an even higher 31.3 “new misery index”, based on continued rising inflation, a decline in the S&P 500 year over year, and a contracting GDP. And this same level of pessimism and “misery” is not unique to the United States, with sentiment on the decline in the United Kingdom and across Europe as well.
Consumer and Business Confidence Decline: Collectively, 9%+ inflation, four 2022 interest rate hikes of 25bps, 50bps and two consecutive hikes of 75bps, have yielded a steep decline in consumer and business sentiment. The Michigan Consumer Sentiment Index (MCSI) is now 51.1 as of July 2022, up from a record low of 50 in June. In addition, the Michigan Current Economic Conditions subindex is now 57.1 but reached an all-time low of 53.8 in June (vs. 63.3 in May). Finally, the Michigan Consumer Expectations gauge plunged to 47.3 in July 2022, the lowest since May of 1980.
And Small Business Sentiment is in steep decline under the conditions of this “IRE” economy (rising Inflation, rising Rates, and rising Employment cuts). According to the NFIB’s Chief Economist Bill Dunkelberg, “the National Federation of Independent Business’s Small Business Optimism Index dropped in June to 89.5, marking the sixth consecutive month below the 48-year average of 98. Small business owners expecting better business conditions over the next six months decreased seven points to a net negative 61%, the lowest level recorded in the 48-year survey. Expectations for better conditions have worsened every month this year. As inflation continues to dominate business decisions, small business owners’ expectations for better business conditions have reached a new low.”
Changes in Housing Metrics and GDP Suggest a Recession is Ahead: Two additional economic measures reflect the negative impact of inflation and interest rate hikes. The first is housing. When housing prices have risen rapidly as they have over the last two years—the median home price is up by more than 40% in less than 2 years and the average mortgage payment has increased from $1,500 to $2,500 as a result of home price and interest rate increases— the housing industry contracts. Since housing is a substantial part of the United States Gross Domestic Product (GDP) calculation, any drop in housing also leads to a contraction in GDP.
To date, GDP has contracted from +6.9% in Q4 2021 to -1.6% in Q1 2022 (percentage change from preceding quarter). GDP also dropped for the second consecutive quarter in Q2 2022, falling 0.9 percent based on the latest estimate, suggesting that the U.S. may be in a recession soon, if it isn’t already.
Housing starts and permits in the United States continued to fall in June 2022 amid higher interest rates and sharp declines in demand because of elevated housing prices. According to data released on July 19, the U.S. Census Bureau reported that there were 1.56 million new housing starts in June 2022 on an annualized basis, a 2.0% decline from May and the lowest level since last September. This level of housing starts is considered to fall well below the level needed to keep pace with long-term demand. RSM US LLP estimates that 1.7 million new starts are needed to meet this demand.
A Recent Rise in Unemployment Claims Suggest a Softening in the Job Market is Underway: While the unemployment rate has remained a steady 3.6% for the last several months, a recent uptick in company job cut announcements is telling a different story. Initial unemployment claims rose for three consecutive weeks in July before falling slightly for the week ending July 23. Still, they are at their highest level since November 2021, with 256,000 claims filed last week. A slew of companies in the tech sector have announced cuts over the last several months and other major firms like Apple and Google have signaled that they will slow hiring amidst concerns of an imminent economic downturn. However, perspective is in order, weekly claims peaked at 6.2 million during the COVID-19 recession from March to April 2020 and at 665,000 during the Great Financial Crisis.
Thus far in 2022, commercial real estate has escaped the material adverse effects from FOMC interest rate hikes. Rent growth and absorption in the Multifamily and Industrial sectors have been net positive. Cap rates and Property prices have not gone the path of the major stock market indices to date. According to the Green Street Commercial Property Price Index (CPPI), commercial real estate prices have risen over the past 3 and 12 months, however, they declined by 3.7% in June 2022. The all-property index is now down 4.9% from its March 2022 high. Does this turn in CPPI foretell that commercial real estate is the next asset class to feel the impact of rising Inflation, rising Interest Rates and a slowing economy as most recent corporate earnings reports have demonstrated?
For indications of increasing stress in CRE, Red Shoe Economics looks to CompStak to monitor changes in commercial sectors from its best-in-class leasing transaction data. In an upcoming part 2 blog and the September 15 webinar, we will touch on the following questions and more using CompStak’s data with a focus on the office and industrial sectors:
Industrial – Industrial rent growth has outpaced inflation for now…what markets have seen the strongest rent growth and are there any corridors/markets poised for additional growth or some contraction?
Industrial – Could Amazon’s pullback in industrial space impact rent growth?
Office – Have lease terms recovered from pandemic lows, especially in Gateway Markets? Is there any indication that lease terms are shortening again as companies deal with uncertainty in the economy?
Office – What secondary markets have strengthened over the last two years?
Office – Would an economic slowdown impact the recovery to date in Gateway markets? What is the spread in performance between quality space including new construction and older, Class B and C product and will this bifurcation continue?
Is rising inflation and construction costs impacting lease terms, especially expenses and tenant improvement allowances?
In summary, no commercial real estate is not expected to go the path of the major stock market indices of late; however, headwinds are in the CRE forecast. Not all markets will perform the same and more strain is expected in high-cost West-coast and Northeast concentric MSAs. The key question to focus on is: Where can one outrun inflation?
For insights into this question and leasing activity, click here to join CompStak and the Red-Shoe Economist for a special webinar on September 15th
Written by: KC Conway, Principal/Co-founder of Red Shoe Economics