A Peek into the Economic Crystal Ball

In this final article of a four-part series, Connect CRE reached out to economic experts for their 2H 2024 forecast. The first three articles, “Economic Recap and Federal Reserve Actions,” “Understanding the Mixed Signals: Analyzing the Economics of Labor and Spending” and “The Banking Sector Status: Strong? Or in Trouble?” are live.

The current U.S. economy could be best described as a mixed bag. The recently released Q2 real GDP estimate showed an annual rate increase of 2.8%. Yet, employment growth is starting to lag. Meanwhile, the Federal Reserve continues its higher-for-longer interest rate stance, wanting to be sure that inflation is on a downward trend before commencing any cutting.

This mixed bag is reflected in economic experts’ discussions with Connect CRE about the economic outlook for 2H 2024. Most agree that the Federal Reserve is probably at a point to start whittling away at interest rates. However, opinions differ on economic and commercial real estate impacts.

Is the Fed Obtaining Clarity?

Anyone who reads the news knows that the Fed decided to keep the Effective Federal Funds Rate (EFFR) at its current high of about 5.3%. Fed Chair Jerome Powell hinted that “a reduction in our policy rate could be on the table” when the Federal Open Markets Committee meets in September.

The economic experts did forecast cuts in the latter half of 2024. But how many and by how much was a matter of conjecture. “If economic growth continues to cool, the labor market continues to normalize, and inflation hovers close to where it’s at currently, the Fed may stay on hold until later in the year and only cut once,” said Trepp Inc.’s Research Director Stephen Buschbom. However, if consumer spending and labor data fall precipitously, “the Fed might be motivated to cut at least twice to avoid over-tightening,” Buschbom said.

Omar Eltorai said the impact won’t automatically galvanize a shift even with one or two rate cuts. “Overall credit conditions will remain tight for companies across many sectors, including CRE,” said Eltorai, director of research with Altus Group.

“Even if short-term rates come down, the combination of already tight spreads and early signs of deteriorating credit quality across many loan books suggests to me that the expected stimulative impact of the first few Fed rate cuts may offset or canceled out by other market conditions.”

Radix Chief Economist Jay Denton agreed that even if interest rates decline, “they’ll be far off from where properties or general business plans were underwritten a few years ago.”

However, Partner Valuation Advisors’ Senior Managing Director Eric Enloe offered another viewpoint, suggesting that a year-end rate cut could be positive.  “We expect that single cut will act as a catalyst for financing and investment transaction activity, especially in the multifamily sector, where operating fundamentals have remained relatively strong,” he said.

But Jonathan O’Kane, vice president of Chandon Economics, expressed that the real estate market won’t be impacted by one rate cut as much as it will be driven by confidence in the 18- to 24-month outlook.

“Expectations will impact the long end of the yield curve more than the FOMC,” O’Kane explained. “Ultimately, I expect the scope of uncertainty to narrow through the end of the year, with leasing and sales likely to see a modest pickup before a more substantial normalization begins in earnest next year.”

Then There’s the Political Angle

The impact of national election results generally isn’t felt until several months after the fact, well after a president or congress members are sworn in and start to introduce policies. This is the case regarding the economy and commercial real estate.

However, what’s being felt now, before this year’s election, is what Eltorai dubbed “market commentary and chatter around U.S. politics.”  That chatter will make it into media outlets and markets, which could lead to market and debt volatility and impact CRE. “In reality, it will also add a lot of noise,” Eltorai observed.

Going beyond the noise, O’Kane anticipates an upcoming congressional budget fight, especially as federal government funding for FY 2024 is set to expire a month before the November election. “The chances that both chambers can pass a comprehensive budget for FY 2025 look fraught,” he said. “Furthermore, this year’s fight will likely look like an appetizer for the battle to come in 2025 when TCJA tax cuts are set to expire.”

O’Kane expressed concerns that a lack of fiscal responsibility and an unwillingness toward bipartisanship could have long-range, negative economic ramifications.

Back to Real Estate and Transaction Activity: Look for More of It

Meanwhile, Ryan Severino, chief economist and head of U.S. research with BGO, is optimistic that investment interest will continue during the second half of the year. “We are already seeing an increase in the number of potential deals in the market,” he said, adding that income returns are proving consistent as appreciation returns stabilize. The combination should continue to push total returns positive over the medium term,” Severino said.

As such, “opportunities to acquire assets, especially portfolios, will occur,” Enloe said. “Look for large investors like Blackstone and KKR to capitalize on those opportunities.”

Though transaction activity could improve in 2H 2024, Eltorai cautioned against comparing what’s happening now to what went on in recent years—and to manage expectations. “Any improvements will pale in comparison to the booming ‘free-money recovery’ period in 2021-2022 and will likely even remain below the more ‘normal’ 2017-2019 years,” he said.

Similar to Eltorai’s view, Buschbom believes that transactions should move forward but slowly, especially compared to 2019 and 2021. Though much capital is on hand for CRE investments, “we’ve yet to see much of that capital deployed,” he said. This could change in the second half of 2024 and 2025 “as bid-ask spreads continue to narrow and some sellers capitulate, especially for debt sales,” Buschbom said.

The Challenges Remain

None of this means that there aren’t any concerns when it comes to CRE. For example, when discussing multifamily, Denton said traffic fell by 10% during this year’s prime leasing season. “The job market is really being propped up by just a few industries, and some markets are showing job loss,” he said. “I’m concerned that the latter part of this year could be a bit rocky if we see job creation weaken.” Buschbom added that on the development side, construction pipelines continue to be slow due to high interest rates and tight lending standards, not to mention inflation and supply chain issues.

Additionally, “despite return-to-office efforts, office absorption is sluggish,” said Ray Perryman, president and CEO of Perryman Group. “Many cities have high vacancy rates.” Furthermore, debt maturity challenges are in play even with anticipated rate cuts.

However, “in areas with solid economic growth, supply and demand will eventually shift back into alignment,” Perryman said. “Moreover, the market has repeatedly shown a capacity for innovation, and history would suggest that the current situation will be short-lived.”