US commercial real estate market update - January 2023

2022 was a challenging year for investors and capital markets. Despite 2023 being a new year, many of last year’s pains still linger. Despite last year’s strong start, the year closed with notable slowdowns across interest-sensitive asset classes, as the Fed took liquidity out of the market to slow inflation and cool the labor market.

Now in 2023, market sentiment remains gloomy, and uncertainty is elevated. While there are still signs of strength in the US economy, the macro picture remains filled with mixed signals. These mixed signals have and will likely continue contributing to diverging views and market volatility across multiple asset classes, including commercial real estate.

While consensus is forming amongst many economists that a recession is likely in 2023, the shape and duration of the anticipated recession are still being debated. The recession predictions are complicated further because the current period has many unique characteristics that complicate historical comparisons.

For example, the last two recessions (the COVID/pandemic crisis and global financial crisis) seem too rapid and extreme. In contrast, the bursting of the Tech Bubble in the early 2000s and the preceding Savings & Loans crisis took place in a very different macro environment.

New year, same struggles: Snapshot still mixed

Shifting focus to what we do know, here are a number of the key developments that caught our attention in the last month of 2022:

Economy

• In its last rate decision of 2022, the Fed met market expectations by raising the benchmark Fed Funds Rate by 50 basis points (bps) but surprised market participants with a more hawkish forecast for the terminal rate in 2023. The Fed Funds target band is now 4.50% to 4.75%, while the median FOMC forecast rose to 5.1% in 2023, 50 bps higher than 4.6% in September.

• The US economy added 223,000 jobs in December, more than expected by the market. However, this surprise was somewhat offset by downward revisions to the prior months’ figures and the uptick in labor force participation (to 62.3% from 62.1%).

• US consumer prices continued to show signs of cooling in December, marking the sixth consecutive month of deceleration. Consumer Price Index (CPI) declined ten bps from November, up 6.5% year-on-year, more moderate than the 7.1% YOY pace in November.

• Significantly higher interest payments contributed to a widening US budget deficit of 12% in the first quarter of the fiscal year. 2022’s budget gap was $1.38 trillion, more than half of the $2.78 trillion gap in the prior year.

Markets

• Closing out 2022, most asset classes were down double digits on the year. Broad market equities fell nearly 20% on the year. As companies begin to report 4Q22 earnings, analysts expect a YOY decline in earnings in mid-single digits, the first decline since 3Q20.

• While 2022 was a down year for equities, it was an up year for yields. As central banks worldwide raised interest rates, bonds with negative yields have effectively been eliminated – for the first time since 2014.

• The collapse of FTX in December sent shockwaves through the crypto market, fueling a surge in media and political attention about the burgeoning asset class. While there is still much to be determined, US banking regulators (including the Federal Reserve and FDIC) issued a statement highlighting risks within the crypto market.

Commercial real estate

• Crippled by declining availability and higher costing capital, CRE market activity continued to plummet through December. Preliminary estimates suggest that CRE transaction volume ($ volume of properties transacted in 2022) fell nearly 20% compared to a year before. The sharp decline has hurt price discovery and raised a lot of uncertainty about the direction of the asset values.

• Shares of US publicly traded REITs finished 2022 down nearly 25%. While income returns stayed steady, reflecting still sound fundamentals, the capital return component drove the negative returns. However, the private market CRE indices, which lag public markets, did not fall as quickly, raising diverging opinions in the press and several private funds closing the door on investor redemptions.

US CRE transaction trends