Is Commercial Real Estate Due For a Correction?
Despite the recent resurgence in property values, some experts believe that there’s a market correction brewing. Several signs indicate that the market is in a correction phase, but no one single sign can confirm a correction. Many appraisers and real estate professionals missed the early signs of the last real estate boom, leading to E&O insurance claims, lawsuits, and regulatory disciplinary actions.
Job growth in the United States blew past expectations in January
While many real estate agents are skeptical that the housing market is about to cool off, the January jobs report exceeded expectations. Payrolls rose by 467,000, well above the forecast of a 150,000-job increase. Meanwhile, the unemployment rate ticked up to 4%. However, there is still reason to be optimistic. Whether the housing market will cool off or not is largely dependent on the economy.
The U.S. economy has made a spectacular comeback in the past year and continues to show momentum into 2022. In addition to blazing job growth, the economy is also experiencing historically strong rebound. The job market has stabilized and wages have increased, even for the lowest-paid workers. However, the Fed is about to end its quantitative easing program and raise short-term interest rates, which is expected to further slow the economy. The unflagging pandemic is hurting consumer confidence and is detracting from the fast-growing economy.
The Employment Cost Index, a gauge of wages and benefits, is a key economic indicator that investors monitor. In January, the index rose only a little more than economists had predicted, putting a cap on a year of big wage increases. Despite this, however, the Employment Cost Index failed to keep pace with inflation, a measure of inflation. When wages and salaries are rising too quickly, they do not keep pace with inflation, which can chip away at consumer income and erode voter sentiment. Inflation can be a political liability for Democrats and the Biden administration, especially during a midterm election year.
China’s property sector has been subject to the “boy who cried wolf” syndrome
The property sector accounts for 30% of China’s GDP. It is also responsible for building much of the country’s infrastructure, with land sales providing one-third of the funding needed for these projects. The central government has insisted on completion of pre-paid housing projects. In response to these concerns, the Chinese government has stepped in to control the sector and put in place a risk management committee.
While the overall impact on growth is less than the headline drop in investment, there is still room for downside risk. A managed soft landing is possible, and there are still more draconian policies that will be implemented. While the correction will affect the sector differently in different regions, the overall effect will be modest. The timing of this correction is key. In order to protect the sector, investors must prepare for a possible reversal.
Interest rate hikes would lead to a decline in value of commercial real estate
Commercial real estate brokerages continue to seek out real estate investment opportunities, mainly as a hedge against inflationary markets. While an increase in interest rates would lower the value of commercial real estate, investors are not expected to stop buying properties altogether. While this quarter-point increase would certainly hurt some landlords, overall trends for the industry are still positive. Listed below are five reasons why interest rates could have a positive impact on the future of commercial real estate.
Increasing interest rates would reduce the amount of available financing for investors. Higher rates would lower investors’ access to capital, which would reduce their returns. Moreover, they would limit the amount of escalation available to them. Thus, investors should focus on increasing rents in order to preserve their profit margins. However, if an interest rate increase is accompanied by an inflationary trend, the real estate value could plummet.
As the Fed begins its plan to reduce its balance sheet, it would reduce the amount of money that it lends to companies. Moreover, an increase in interest rates would discourage investors from making capital investments, which would reduce the growth capacity of businesses. This would also have negative consequences on the stock market, which reflects expected cash flows. A rise in interest rates would also cause prices to fall, which would make commercial real estate less profitable.