“We’re all aware and we’re all feeling the impact of the most aggressive financial tightening in the country since 1980,” opened Hessam Nadji, president and CEO, Marcus & Millichap, on a company-hosted webinar this week. “We haven’t seen the Fed being the problem in four decades, in that they’ve always been to the rescue in an economic crisis.”

But now, said Nadji, the injection of liquidity at record levels and the easing of financial conditions have led to sky-high interest rates, a resulting inverse yield curve, and significant drop-off in trading activity.

Nadji’s introduction set the stage for an in-depth conversation on the market’s uncertainty and where the economy and commercial real estate are headed, featuring Mark Zandi, chief economist with Moody’s Analytics, and panelists Wendy Mann, CAE, CEO of CREW Network; Tom McGee, CEO of ICSC; and Marc Selvitelli, CAE, president and CEO of NAIOP.

Nadji shared a Feb. 5 tweet from Zandi, where he stated: “Lots of economists, including many at the Fed, think the economy is well beyond full employment. The current 3.4% Urate [unemployment rate] is well below the full-employment Urate of 4% or higher. Unemployment must increase a lot (aka recession) to quell wage growth and inflation. I don’t think so.”

Zandi said that it’s clear that the pessimism regarding the economy is running thick, noting that economists generally don’t predict recessions until long after they’ve already hit, and the consensus among economists is that we’ll suffer an economic downturn in 2023 or 2024. “There’s good reason to be nervous given that inflation is so painfully high,” he said. “In times past when the economy has experienced high inflation and interest rates, a recession would often follow.”

He noted that many of the leading indicators, including the Treasury yield curve, are signaling recession. “I think it’s going to be tough, but my own view is that with a little bit of luck and some reasonable debt policy from the Federal Reserve, we’ll be able to make our way through without an outright economic downturn.”

Zandi noted a long list of reasons why inflation is a problem today, largely driven by the pandemic and disruptions to the global supply chain issues, which still hasn’t normalized, as well as labor markets, the Russian invasion of Ukraine, and surges in oil, natural gas and food prices. The good news, he said, the fallout from the pandemic and the invasion of Ukraine are fading. Supply chain issues are normalizing, oil prices are dropping, and China has lifted strict COVID-19 policies.

“The single most important leading indicator is consumer confidence,” Zandi said. “A recession is a loss of faith by consumers that they’re going to hold on to their job and therefore they stop spending. It’s a loss of faith by businesses that they’re going to be able to sell whatever it is they produce, and so they start laying off workers.” That hasn’t happened yet, he noted, with consumer confidence remaining relatively stable.

For commercial real estate, Nadji said that we’ve seen the rising tide post-pandemic vary market-by-market and sector-by-sector. Marcus & Millichap began monitoring the pandemic’s impact by property type since March 2020. Today’s supply and demand outlook is positive for life sciences, warehouse/distribution and suburban multifamily, and less so for lower-tier shopping centers, urban office and senior housing. These have been hit harder, Nadji said, because these parts of the industry were already going through massive structural change due to consumer change and e-commerce.

From the commercial real estate (CRE) association perspective, Mann shared a data point from a new CREW Network survey that measured where CRE women thought the market and economy would go in 2023. Responses were 22% optimistic, 28% pessimistic, and 46% neutral, largely driven by the slowdown in transactions at the end of 2022. She said construction delays and costs remain problems for both supplies and equipment.

Is office the diamond in the rough, asked Nadji, and is it a value play right now? “There are some areas where there’s a softening in the market, but other markets are doing exceptionally well, including Florida, New York City and the Sunbelt where office is performing well,” said Selvitelli. He noted that large companies including Bank of America, Netflix and Disney are bringing employees back to the office in larger numbers for the critical collaboration it yields.

Studies show that office occupancy levels have just crossed the 50% mark, well down from pre-pandemic levels. “Teleworking is embedded in the DNA of employees now, and some sort of hybrid working is here to stay. But some sectors are seeing greater remote work numbers than others,” he said, noting that cities with large populations of federal employees and tech employees are seeing larger number of remote workers.

For retail leasing, there’s renewed optimism. McGee said that “Retail is in a strong position even relative to where it was pre-pandemic. Shoppers have rediscovered the joy of physical shopping.” Physical retail has had a rebirth, he said, noting that physical retail sales increased 8.2% in 2022 and outpaced e-commerce growth.

“Leasing activity in the industry is very, very strong. There has not been a lot of new supply of shopping center retail put into the industry since the financial crisis,” he said, noting that demand for space, fewer store closings and a minimal number of bankruptcies over the last two years have put physical retail in a strong position.

Zandi added that the Fed’s rate hikes have not yet been fully reflected in the job market and he expects a substantive weaking in job creation as we move into the spring and summer. Layoffs in tech, health care and financial services are not yet shown in unemployment data.  

“What makes me most worried immediately is oil prices,” said Zandi. “It’s very hard to overstate the importance of the cost of a gallon of gasoline on people’s thinking about inflation and their financial futures.” The current nationwide average for a gallon of regular unleaded gasoline is $3.50. “If it goes back to $4, we have a problem. If it goes well over $4, we’re going into recession.”

Regarding suburban vs. urban investment opportunities and strategies, Nadji noted that millennials who had previously driven demand for urban living are now in their thirties and moving to the suburbs. The result is skyrocketing urban apartment vacancies and oversupply in some markets, with the industry needing to recalibrate in the short-term. For office, vacancies are rising in both suburban and urban markets.

For industrial, there’s been a lot of talk about the softening of warehouse with Amazon putting excess space on the market. “The last two years have been absolute rocket fuel for industrial development. In terms of historical numbers, it’s still doing exceptionally well, although land constraints are real, and we’re seeing a lengthening in the entitlement process.” said Selvitelli.

He noted that the NAIOP Research Foundation’s new report on the economic impact of commercial real estate development shows a significant increase in manufacturing construction spending, which signals another robust year for warehouse demand.

In closing, Nadji asked how investors will react to the current environment as they seek to place capital. “We’re getting back to a more traditional interest rate environment,” said McGee. “What’s different is the trajectory and the speed [of the last two years],” he said, resulting in slowing transaction volume and this period of transition.