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Where Do U.S. Property Values Go From Here?

Part Two: Scenarios & Implications for CRE

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The economic outlook is becoming increasingly uncertain. Numerous headwinds have emerged, including higher interest rates, inflation and rising persistent labor shortages. That said, real estate is a long-term investment and will continue to provide healthy cumulative returns. Additionally, market volatility creates opportunity, so now is precisely the time for our clients to diversify and maximize returns. 
 
To help you think through the implications of the shifting macro environment, part two of our series models how U.S. property values will perform under four unique economic scenarios. 


Five Key Questions

The risk of recession is rising in the current environment of high inflation and rising interest rates. In our baseline scenario, Cushman & Wakefield assumes a mild recession beginning in Q4 2022 or Q1 2023. We view this as the most likely outcome for the U.S. economy. However, we also consider a range of alternative upside and downside scenarios given the heightened uncertainty about the economic outlook.

The fundamentals of the U.S. economy are sound, which will help limit the magnitude and scope of a potential downturn. One of the most notable fundamentals is the strength of the consumer, which underpins 70% of GDP. U.S. households still have over $2 trillion in excess savings to manage through a period of higher inflation and weaker income growth. Low debt levels, strong labor gains and wealth effects from higher home equity are also likely to insulate the consumer outlook. Moreover, healthy corporate and bank balance sheets will help mitigate job losses and keep the debt and credit markets functioning through the downturn.

In general, yes. An environment in which economic growth is slowing and bond yields are rising will likely put downward pressure on overall CRE property values. In our report’s baseline scenario—that is, a mild recession—we estimate property values will decline by approximately 20% over the next two years, ranging from 4% to 23% depending on the product type. But beneath the aggregated forecasts, there is nuance. Without question, certain segments of the market will thrive over the next few years, easily outperforming our national forecasts.

First, we can’t emphasize enough that all real estate is intensely local. Not every product type or geography will follow the national glide path. Even within each asset class, a large portion will likely outperform our forecasts, and some will likely underperform. Within that volatility lies the opportunity. That said, we do offer investment themes in our report.

There are many factors to consider in making an investment, and some product types face greater challenges than others, but the question itself raises an important point: Property is a long-term investment. Most investors don’t buy a building and sell it the next year. They hold onto it, and over time their investment generates annual cash flow (income growth) and appreciation (capital growth). Our study shows that since 2012, cumulative unlevered core property returns have grown more than 150%. This rate of return compares favorably to alternative investment vehicles such stocks, corporate bonds and Treasuries. In other words, if an investor bought a building five, seven or even 10 years ago and were to sell this year or next year, even if the United States goes into a recession, on average, the cumulative returns would still be very strong. The long-term demand drivers and reasons for investing in commercial real estate do not change because of near-term ups and downs in the cycle.

 


Four Scenarios Featured in the Report

   01/ Soft Landing | 30% probability: Under this scenario, economic growth slows but a recession is avoided. Bond yields stabilize near their current levels. 
     
  02/ Upside Growth | 5% probability: Virtually all risk factors quickly abate, allowing growth to reaccelerate. 
     
  03/ Mild Recession | 50% probability: Persistent inflationary pressures force the Fed to raise rates aggressively, stalling business investment and consumer spending. A brief recession ensues in late 2022 or early 2023.
     

04/ Stagflation | 5% probability: The Fed is unable to stamp out inflation, which accelerates amid slower economic growth and rising unemployment. A severe recession begins in 2024.
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For each scenario, we model and present forecasted values for the following: net operating income (NOI), capitalization rates (cap rates), as well as implications those have for futures returns and property values for the office, industrial, retail and multifamily sectors.


Impact on Property Values

 

Listen to Key Findings

 

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Scenarios & Implications for CRE

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Part One

Historical relationship between the U.S. economy, inflation, interest rates and commercial real estate price movements.  

Key takeaways from this first report include:  

   
  • U.S. property returns have consistently outpaced inflation historically
  • CRE is thought to provide an effective hedge against inflation risk  
  • Investors gravitate to property during periods of elevated inflation  
  • Upward forces on cap rates have increased markedly
Download Part One

 

Authors

Kevin Thorpe Washington DC Chief Economist
Kevin Thorpe

Chief Economist
Washington, United States


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Rebecca Rockey New York Research
Rebecca Rockey

Head of Economic Analysis & Forecasting
Washington, United States


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James_Bohnaker
James Bohnaker

Senior Economist
Boston, United States


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Rob Miller
Rob Miller

Sr. Global Research Manager
Oakland, United States


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