REAL ESTATE RECOVERY WILL LAG THAT OF BROADER ECONOMY
The U.S. economy entered a deep recession due to the COVID-19 pandemic, with GDP plunging by an unprecedented 31.4% in Q2 on an annualized basis. As the economic lockdown was loosened, employment growth resumed in May and GDP grew by 33.1% in Q3. Full-year GDP is expected to be down by only 4.0%, followed by a 4.5% rebound in 2021. CBRE forecasts that the strongest growth of next year will occur in Q2 and Q3—5.5% and 5.6%, respectively on an annualized basis—bringing U.S. GDP back to pre-COVID levels in Q3 2021. CBRE expects the real estate recovery to lag that of the broader economy, particularly for the office, retail and hotel sectors.
FIGURE 1: U.S. ECONOMIC OUTLOOK – CBRE HOUSE VIEW (PERCENTAGE CHANGES)
Source: CBRE Research, September 2020.
FULL RECOVERY DEPENDS ON MEDICAL SOLUTION
A full economic recovery depends on a medical solution to the COVID-19 pandemic. To that end, there are five vaccines in large-scale U.S. phase three trials. Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, has indicated that a vaccine could be available for all Americans by April 2021. Pfizer announced on Nov. 9 that its COVID-19 vaccine was found to be 90% effective and that it will seek emergency authorization from the U.S. Food & Drug Administration. Furthermore, several powerful therapeutics are advancing and will be increasingly available next year. CBRE’s view is that a medical resolution will occur in the first half of 2021, allowing further loosening of economic restrictions in the second half.
ADDITIONAL GOVERNMENT SUPPORT NEEDED
The $2.2 trillion economic stimulus package delivered by Congress in late March was extremely effective in stabilizing the U.S. economy amid the depths of the COVID-19 crisis. Although there is bipartisan consensus that additional stimulus is needed, Congress so far has been unable to agree on the level of funding. Consequently, the pace of the economic recovery slowed in Q3. Our forecasts assume that additional government aid is forthcoming at some point. This will be particularly important over the near-term for the multifamily (rent payments) and retail (consumer spending) sectors. A strong fiscal response also will lay the foundation for a more rapid recovery across all other property types, including office and hotels.
PAYING FOR GOVERNMENT SPENDING
Government debt levels sharply increased in 2020 as emergency aid flowed into the economy. Concerning as this may be, there is no immediate danger that large developed economies such as the U.S. will not be able to fund their debt because of the surplus of global savings that flows into low-risk sovereign debt. Although rising debt is unsustainable over the longer-term, the federal government has various means to address this, including structural reform to entitlement programs.
Additionally, central banks have been purchasing government debt to keep long-term interest rates down and the economy stimulated. They also can tighten monetary policy through interest rate increases and balance sheet reductions when economic conditions allow. Still, governments cannot rely on quantitative easing (asset purchases) alone. Renewed economic growth will generate revenue to service debts. Combined with fiscal policy adjustments (increased taxes and spending cuts), this will reduce overall debt-to-GDP ratios. Over the long term, there is a risk that governments could allow inflation to rise significantly to reduce their debt loads.
FIGURE 2: FEDERAL DEBT HELD BY THE PUBLIC, 1900 TO 2050 (% OF GDP)
Source: U.S. Congressional Budget Office.
FED POLICY CHANGE AND ‘LOWER-FOR-LONGER’
The Federal Reserve recently announced that it would allow inflation to move above the 2% target for several quarters after periods of low inflation. Consequently, the Fed likely will take a much more patient approach to rate hikes, essentially ensuring a “lower-for-longer” rate environment as the economy recovers. For commercial real estate, this likely will translate into greater downward pressure on long-term cap rates.
Though low interest rates are generally good for commercial real estate, there could be other impacts not widely considered. For example, amid extended periods of extraordinarily accommodative monetary policy, central bankers have become more vigilant about preventing asset bubbles from developing, which could destabilize the financial system. This could include requiring banks to set aside more reserves and tighten underwriting standards. Such actions likely would impact loan-to-value (LTV) ratios for real estate.
Another secondary impact of this policy relates to foreign exchange rates. A lower-for-longer environment is conducive to a weaker U.S. dollar. This could make U.S. commercial real estate assets more attractive to foreign investors—particularly in gateway markets—and put additional downward pressure on cap rates in those markets.
FIGURE 3: 10-YEAR TREASURY FORECAST
Source: CBRE Research, September 2020.
GDP is expected to contract by 4.0% this year, followed by a 4.5% rebound in 2021. This will be facilitated by a medical resolution of the COVID-19 pandemic by the second half of 2021 and additional fiscal support for the economy. In addition, we expect that interest rates will remain lower for longer with the timeline for initial rate increases pushed back by several quarters. This will put downward pressure on cap rates, but underwriting standards and LTVs could be affected by efforts to maintain financial stability amid low interest rates.
CBRE expects the recovery in property markets to lag the broader economy, due to the unique impact that the pandemic has exacted on the economy and how space is used. As such, with a medical resolution in sight and continued economic growth, CBRE expects that all commercial real estate sectors will have started to recover by the end of 2021.