A recession is on its way, and whether you’re feeling it yet or not, everyone would do well to take stock of their business and lay a strong foundation for what’s ahead.
The below article from JPMorgan Commercial Banking discusses their outlook on the commercial real estate market in light of the potential for an upcoming recession. Some sectors, such as multifamily housing, are still expanding and should remain relatively unaffected. Other sectors such as industrial and retail, however, are expected to experience a downturn in the event of a recession.
Here are a few key takeaways that companies should consider in order to be prepared for a recession.
- Solidify your team – get a solid team around you that you trust and start discussing the future. Prepare them to respond efficiently to any changes that arise in the market.
- Invest in cost-saving measures – adopt new technologies and processes that can save you time and money as you prepare for an economic downturn.
There is no way to predict with certainty when the next recession will arrive, but it’s always smart to stop and take stock of your business before crap hits the fan.
What are some things your team is doing to help prepare your business for the future?
What a recession could mean for commercial real estate
With high inflation and rising interest rates dominating the news cycle, the potential for a recession is top of mind for commercial real estate. Morrison Foerster’s 44th Economic/Real Estate Poll June–August 2022 found 68% of respondents across the industry believe the U.S. is already in a recession or will be in one by the end of 2022.
To determine how a recession might impact commercial real estate, we spoke with Tom LaSalvia, Senior Economist and Head of Narrative Analytics at Moody’s Analytics CRE, along with several JPMorgan Chase clients and industry experts.
Defining a recession
The U.S. economy already meets the informal definition of a recession—two successive quarters of negative gross domestic product growth. But the National Bureau of Economic Research, which evaluates a broader range of economic factors, may not deliver an official recession declaration for months.
The depth of a potential recession
Al Brooks, Head of Commercial Real Estate for JPMorgan Chase, clocked the likelihood of a recession in 2023 at more than 50%. “We do think there’s a pretty high percentage of a recession next year,” he said. “It’ll probably be relatively mild, but everybody’s got a different position on it.”
“The key here is the depth of the recession,” LaSalvia said. “The labor market would likely feel much less pain than many previous recessions. Unemployment would be expected to rise somewhere between 4% and 5%.”
Ginger Chambless, Head of Research, Commercial Banking for JPMorgan Chase, agreed. “A recession would likely be much shorter and more shallow than the Great Financial Crisis,” she said. “First, the consumer and business sectors—including banks—have far less leverage than they did leading up to the Great Recession. This leverage contributed to the severity of the downturn in 2008 and 2009. Second, because labor markets have been so tight over the past year, and businesses have had a hard time attracting and retaining talent, it’s unlikely companies will sharply retrench in terms of their workforces.”
The impact of a recession on commercial real estate
“A recession has the potential to reduce demand across all real estate asset classes,” said Greg Reimers, Real Estate Banking Northeast Market Manager for JPMorgan Chase.
Climbing interest rates could compound the impact. “If the Fed continues to increase short-term interest rates, the cost of borrowing will increase, sharply decreasing activity in the large fixed-asset sectors. Commercial mortgage activity may also slow as refinancing at higher rates becomes increasingly unattractive,” he said.
Different properties have different considerations should the U.S. enter a recession.
Many would-be single-family homeowners are opting to rent, driving up demand for multifamily properties. Moody’s Analytics found the average single-family home is 43.7% more expensive than it was in 2019. The cost of entry-level homes at the bottom third of the price range has risen the fastest.
Other economic factors may also benefit multifamily properties.
“The headwinds the broader economy is currently facing actually provide benefits to owners and operators of multifamily real estate,” said Roger Daniel, President and Founder of Daniel Management Group (DMG). “Inflation, for example, tends to drive rents higher. Rising costs and delays on new construction tend to constrain supply, which also increases rents on existing properties.”
“Affordable and workforce housing currently have tight market conditions: 2.3% for affordable, 3.1% for class B and C housing,” LaSalvia said. “Demand is high and would likely remain relatively strong for both of these property types. This, combined with weak supply growth over the last decade plus, we expect performance variables to hold up well.”
“Economic downturns tend to not only increase the need for affordable housing, but bring a renewed focus to increasing the supply,” said Vince Toye, Head of Community Development Banking and Agency Lending for JPMorgan Chase.
Nonetheless, the possibility of a recession raises concerns.
Vince Toye, Head of Community Development Banking and Agency Lending, JPMorgan Chase
The ongoing demand to get products in consumers’ hands as quickly as possible means the industrial asset class has continued to perform well. But in a recession, industrial properties associated with elastic goods may feel the effects of reduced consumer spending.
“As consumer demand wains, the industrial sector is likely to slow as inventories are managed down and the demand for industrial space decreases,” Reimers said.
LaSalvia agreed, noting that industrial’s relatively strong runway could be beneficial if demand goes down.
While a recessionary environment would likely slow retail’s growth, the bigger concern is retail’s evolution.
Neighborhood retail centers in densely populated areas continue to perform well. That’s not the case for all retail, though. “B and C class malls are already limping, and a recession would put them through a difficult economic period,” Brooks said.
“Retail performance has steadied. While not growing quickly, the evolution of omnichannel and experiential retail will keep brick-and-mortar retail relevant for the foreseeable future.”
Offices are also evolving as employers try to find the best balance of in-person, hybrid and remote work.
“The trial and error of varying work arrangements will be more influential for office than a short, mild recession,” LaSalvia said. “But a recession could hurt hiring and might cause some firms to delay plans to build or expand offices, at least in the near term.”
Class A office buildings, which offer a breadth of amenities, continue to perform well with limited vacancies. But in a recession, employers may look to B and C properties as an opportunity to save.
“An already struggling office sector is likely to face additional challenges if companies significantly reduce headcount, further reducing the demand for office space.”
Greg Reimers, Real Estate Banking Northeast Market Manager, JPMorgan Chase
How to prepare your business for a recession
As recession fears heat up, it’s important that you continue to operate your business at a high level and ensure your business is “recession-ready” for when it comes. For example, Daniel of DMG is conscious of a potential recession, but his operations are firmly rooted in the present.
“We have put some construction projects on hold because of current pricing and current delays—not because of what we are anticipating down the road,” he said. “We will continue to watch pricing and economic trends to determine when to execute.”
Long-term thinking is also key for commercial real estate as it approaches a recession.
“The best thing you could do—this is critical—is not stretch your balance sheet as we go into a recessionary environment,” Brooks said. “It’s key to have the liquidity and cash flow coverages to make it to the other side of a recession. Then you’ve got the opportunity to pick up some real bargains in great neighborhoods and great markets.”