U.S. commercial real estate investment volume rose by 10% year-over-year in Q2 2022 to $167 billion. Multifamily was the leading sector with $78 billion in Q2 volume, due to the resilience shown by this asset class as well as continued housing shortage. Industrial and logistics properties had $32 billion in total volume for the quarter; the pandemic not only created a boom in online retail, but also caused a permanent migration of consumer behavior towards online retail. In third place was office properties with $24 billion in transaction volume, driven by workers returning to the office.

While a sharp rise in interest rate will generally drive down real estate prices, there are many other factors at play. The Federal Reserve’s multiple increases to its target rate have both short-term and long-term effects. In the short-term, rate increases will discount the prices of real estate assets, as the market now demands a higher rate of return on those assets for sale given the same rental income. Furthermore, those assets whose mortgages are structured with variable rate without an interest cap built in will be facing increased monthly mortgage payments, which cut into net operating income and asset value. Lastly, many lenders will experience a sudden increase in their cost of capital (borrowing costs), which may cause some lenders to temporarily pull back from lending altogether. Nonetheless, the long-term impacts to the industry are positive – once the interest rate increases implemented by the Fed takes effect in reducing inflation, the U.S. economy should emerge out of recession relatively quickly and return to growth. Comparatively this is a manageable short-term sacrifice in order to prevent a much more painful longterm decline.

U.S. Commercial Real Estate Investment Volume by Quarter

U.S. Commercial Real Estate Investment Volume by Sector

U.S. Commercial Real Estate Investment Volume by Market (Last 4 Quarters)

U.S. Real Estate – Multifamily Market

In Q2 we saw an increase in the overall U.S. multifamily vacancy rate to 3.1% from 2.4% in Q1. This was the first increase in five quarters, but this vacancy level is still well below the long-term average of 4.9%. The increase was largely a result of high inflation and loss of consumer confidence, causing families to consolidate rather than rent separate units. This increase seemed to be consistent across all classes of multifamily assets in both city centers as well as surrounding areas. Not surprisingly, the average rent per unit also reached a historic new high of $2,080 per month, buoyed by continued inflation and low unemployment rate.

U.S. Multifamily Vacancy Rate and YoY % Change

U.S. Multifamily Vacancy Rate by Class

U.S. Multifamily Monthly Rent and YoY % Change

U.S. Real Estate – Commercial Retail Market

Total retail sales growth dropped to 3.8% even during an inflationary environment, a sign that the recovery in the retail sector is nearing its end, and consumer confidence may be eroding and hurting spending. Retail space absorption fell by 40% compared to Q1 and fell by 20% compared to Q2 2021, also indicative of the end of the retail recovery. Average retail asking rent grew by 2.4% year-over-year, the highest increase in more than 5 years, but it is still lagging the wage growth of 4.4% year-over-year.

U.S. Consumer Retail Sales Growth and YoY% Change

U.S. Retail Sales by Category

U.S. Retail Vacancy Rate by Property Type

U.S. Retail Average Asking Rent

Data Sources: CBRE Research, CBRE Econometric Advisors, CoStar Realty Information Inc., Bloomberg, Zillow Group, Redfin

For additional information, please contact:
Grandway Group
Email:   Info@grandway.com
Tel:        +1 626-357-1200

Markets in the first half of 2022 have been generally disappointing, with sharply rising inflation and interest rates, falling stock prices, a rampant wave of Omicron virus, and Russia’s shocking and brutal invasion of Ukraine. These factors, combined with a partisan political environment, have driven consumer sentiment down to its lowest level on record. On the positive side, however, while real GDP shrank in Q1, recent monthly data suggested solid growth during the course of Q2 as the Omicron variant subsided and spending picked up in the industries that were impacted the most by the pandemic such as travel, restaurants, leisure, and entertainment.

Entering Q3, several factors continue to weigh on economic momentum. After two years of record stimulus, the U.S. economy is facing significant fiscal slowdown, with the federal budget deficit likely to fall from 12.4% of GDP in 2021 to less than 4% of GDP this year, which would pose the single largest decline since the end of World War II. This decline reflects an end to stimulus checks, enhanced unemployment benefits, enhanced child tax credits, and a host of other programs that were supporting lower and middle-income households during the pandemic. In addition, a surge in 30-year mortgage rates is weighing on the housing sector and an 8%+ rise in the trade-weighted dollar year-to-date is impeding U.S. exports. All of this, combined with collapsing consumer confidence, has raised the risk that the U.S. economy would fall into recession in the near term.

The U.S. Federal Reserve has two main mandates: to control inflation and to control unemployment rate. As expected, the extraordinarily strong labor market and persistent inflation have pushed the Fed to adopt a much more hawkish stance. At its June meeting, the Fed increased the federal funds rate by 0.75%, following increases of 0.25% in March and 0.50% in May. In addition, the median expectation among FOMC members is for the rate to be further increased by 1.75% this year and by 0.5% next year, bringing the federal funds rate to a range of 3.25%-3.50% by the end of 2022 and 3.75%-4.00% by the end of 2023. On quantitative tightening, the Fed is also increasing the pace of reduction of their massive bond holdings to up to $95 billion/month by September.

Notably, the Fed expects inflation will fall towards its 2% target over the next few years. The latest Federal Reserve forecast suggests that annual PCE core inflation may fall from its current 4.8% to 4.3% by Q4 2022, to 2.7% by Q4 2023, and eventually to 2.3% by Q4 2024. Futures markets seem to generally agree with the Fed’s forecasts of the federal funds rate for the rest of 2022, but it appears that market participants expect the Fed to ease policy starting in the first half of 2023, suggesting the possibility that the aggressive moves by the Fed may tip the economy into recession and cause the Fed to again start easing monetary policy.

The labor market in the U.S. continues to be a bright spot. In an otherwise gloomy economic environment, the unemployment rate remained at 3.6% for the third consecutive month in May, just 0.1% above its 50- year low in 2019. There continues to be massive excess demand for labor, with roughly 5.45 million more job openings than unemployed workers in May. This excess demand should fade over the next few months, reflecting slowing economic momentum and diminished business confidence. However, it is likely to keep wage gains elevated and hopefully encourage an increase in labor force participation, particularly as an aging baby-boom generation and limited immigration continue to reduce labor supply.

High inflation in the U.S. has been a result of strong consumer spending combined with supply shortages across major sectors of the economy. More recently, this has been amplified by a general recovery in airfares, hotel rates, and rents from their pandemic lows. Inflation has been further exacerbated by continued supply chain problems due to the Russian invasion of Ukraine and China’s attempts to maintain a “zero-COVID” policy. By the end of 2022, we do expect some of the supply-driven issues to fade, alleviating the current inflation. However, the longer high inflation persists, the stickier it gets and the more likely core PCE inflation would remain above 3% year-over-year throughout 2022 and 2023. The potential persistence of inflation above the Fed’s 2% target over the next two years will have major implications for monetary policy.

Following a spectacular 2021, during which S&P 500 earnings-per-share (EPS) rose by 70%, profits are growing much more slowly in 2022. In the first quarter, EPS rose just 4.2% year-over-year and analysts are currently expecting an increase of less than 8% for the entire year 2022.

However, even these estimates may be optimistic. Companies are facing a number of different headwinds – rising wages, higher commodity prices and input costs, higher interest rates and slowing nominal sales growth. While energy companies will continue to benefit from high margins, in most other industries these headwinds are likely to cut into profits. A much higher dollar will also hinder exports and overseas sales, while recession concerns could cause company managements to cut discretionary expenses.

A recession would certainly lead to a sharp decline in corporate profits. However, if this eventually leads to less wage pressure and easier monetary policy, it could create a better long-term business environment all around. Furthermore, gridlock in Washington and the prospect of a Republican takeover of Congress after midterm elections later this year suggest that we are unlikely to see an increase in corporate taxes, suggesting that after-tax profit margins are likely to remain at the current high levels.

The global economy presents a mixed picture entering the second half of 2022. On the positive side, the effects of the pandemic are fading in most parts of the world due to widespread immunity gained from both inoculation, infection, and virus variants becoming less deadly. However, the Chinese economy continues to be impacted by the pandemic as it struggles to sustain a “zero-Covid” policy. European economies are also being badly impacted by much higher energy prices resulting from the war in Ukraine.

Inflation has become a global concern and most central banks are tightening policy to combat it. While we do not expect this to result in a global recession, it should slow the pace of economic recovery around the world. This should, however, relieve some of the pressure on commodity prices if 2023 sees positive economic growth but less inflation around the world.

Data Sources: CBRE Research, CBRE Econometric Advisors, CoStar Realty Information Inc., Bloomberg, Zillow Group, Redfin

For additional information, please contact:
Grandway Group
Email:   Info@grandway.com
Tel:        +1 626-357-1200