How Would A Recession Impact Commercial Real Estate?

Throughout the prolonged drama surrounding the so-called fiscal cliff negotiations, there has been a fear that a failure to resolve this crisis by the end of the year would result in a new recession in 2013. While the fiscal cliff talks are still a work in progress, it might be interesting to wonder whether there is a possibility of a recession next year – and, if so, what would it mean for the commercial real estate industry.

On the whole, industry experts are confident that 2013 will not see a recession. However, there is a possibility that a worst-case scenario could come to life.

‘The odds of it happening are uncomfortably high,’ warns Kevin J. Thorpe, chief economist and principal at Cassidy Turley in Washington, D.C. ‘We estimate there is a 30% probability that the U.S. will go into recession. Most of the recent data on employment, consumer spending, confidence, housing and falling gas prices indicate that the recovery should continue. But there are sizable downside risks that include the fiscal cliff, the implications of a credit downgrade, the euro crisis and slowing growth from emerging economies.’
‘Our baseline view is that there will be no recession in 2013,’ says K.C. Sanjay, senior real estate economist at Dallas-based Axiometrics. ‘In our forecast, we placed about a 20 percent probability on the gross domestic product (GDP) turning negative. However, if the U.S. falls over the fiscal cliff, we expect GDP to decline by close to two percent and job growth to decline by 1.2 percent in 2013. We could lose up to 3 million jobs in 2013 if the fiscal cliff issue is not resolved.’

‘If Washington can get bipartisan agreement on avoiding the cliff, then recession will likely be avoided,’ says Greg MacKinnon, director of research at the Pension Real Estate Association. ‘However, if politicians fail to get their act together and the economy gets pushed over the cliff, then a recession is likely. I would like to think that Washington will not steer us over the cliff, but after the credit downgrade of last summer, I don't think anyone should necessarily bet the farm on politicians actually having any sense.’

‘I can't imagine anyone believing our economy is getting better soon,’ says Adam Leitman Bailey, a New York-based real estate attorney and law professor at New York University. ‘It's an impossibility. Uncertainty by government is always bad, and business does not need uncertainty.’
Bailey adds that the commercial real estate industry did not experience the same level of tumult that rocked the residential mortgage space. But, he notes, it doesn't mean there is no reason for concern.

‘The commercial ball never dropped, but it will eventually have to happen,’ Bailey warns.

So, for the sake of argument, what would happen to the commercial real estate industry if a recession occurred next year?

‘If there were another recession, commercial real estate would take a hit – and a significant one at that,’ says Jake Clopton, founder and president of Chicago-based Clopton Capital. ‘Over the next couple years, a huge amount of commercial mortgage-backed securities (CMBS) and other commercial debt is coming due, and if those properties lose tenants or net operating income due to lower rents, they are going to have an even tougher time getting refinanced than they are already having.’

One sector that would be particularly hard hit in a recession would be the hospitality market.
‘Although the hospitality industry has been improving at a significantly brisker pace than the economy as a whole, there is an ineluctable relationship between the GDP and demand for hotel rooms,’ says Jim Butler, chairman of the global hospitality group at Los Angeles-based Jeffer Mangels Butler & Mitchell LLP.

Clopton concurs, noting that hospitality runs the risk of being ‘most likely to suffer the most.’

‘There seems to be a wave of hospitality loans coming due that are barely getting refinanced,’ he says. ‘Any drop in average daily rates or occupancy would be detrimental to this industry.’

Even the relatively sturdy multifamily housing market would not be immune from the chaos.

‘The impact of a recession on the U.S. apartment market would be widespread due to the significant job losses, with properties in the lease-up phase affected the most,’ says Sanjay. ‘Occupancy and rent growth in our 2013 'recession scenario' stands at 93 percent and -1.5 percent, respectively. Our 2013 baseline forecast for occupancy is 95.2 percent and 3.8 percent for rent growth. In the recession scenario, occupancy is expected to decline by 130 basis points (bps) from 2012 numbers, while rent growth will decline 150 bps.’

And while none of this bodes well for the private sector, MacKinnon notes that the public sector would also feel the pain.
‘Overall, a recession brought on by the fiscal cliff would not be good for real estate, especially in regions with high government dependence such as the District of Columbia that stands to be hurt by government spending cuts, but would likely not be catastrophic for long-term investors,’ he says.

MacKinnon predicts that each sector within the commercial real estate industry would be impacted, albeit in different ways.

‘The effects of a short recession on a long-term asset class like real estate may not be as big as one might expect,’ he explains. ‘Even if we go over the fiscal cliff, the Congressional Budget Office is projecting a return to growth in the second half of 2013, so the effect is likely to be of the 'short, sharp shock' type of recession rather than a prolonged situation. Also, it seems likely that new construction would be even lower than it currently is if a recession occurs, so the supply side picture for real estate would remain encouraging for investors.’

And, ultimately, perhaps the conjecture of a potential recession is just nothing but conjecture.

‘With the election behind us, uncertainty has been removed,’ says Richard Zahm, director of Darien, Conn.-based ORFEE Fund. ‘We've got a much better idea of what we're working with, or at least with whom. Dire warnings surrounding the outcome of the campaign will not come to pass – just as they didn't with the 'inevitable' collapse of the CMBS market and the no-recovery-of-the-residential-market-in-our-lifetime: the majority of metro markets are coming back, even if they're being fueled by investors or foreigners or out-of-their-minds buyers.

‘We've got to come to grips that there's a lot about the economy – especially real estate – that we still don't understand,’ Zahm adds. ‘In the meantime, look around you: shopping center parking lots are full, restaurants are packed, houses and old commercial structures are being scraped and rebuilt. All of this belies fears of the future – life goes on.’

(Next week, MortgageOrb will consider the impacts of a potential recession on the residential mortgage industry.)

Phil Hall is the editor of MortgageOrb. He can be reached at


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