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Top takeaways from the best hour in CRE with Dr. Peter Linneman

January 18, 2023

Top takeaways from the best hour in CRE with Dr. Peter Linneman

Dr. Peter Linneman

Leading Economist and Professor Emeritus, The Wharton School of Business

Dr. Peter Linneman shared his thoughts on monetary policy, inflation, the economy, and commercial real estate.

In a wide-ranging Walker Webcast conversation, renowned economist Dr. Peter Linneman and I discussed his views on monetary policy, inflation, what the economic landscape looks like for 2023, and commercial real estate. Here are some of the valuable takeaways for those watching economic developments closely.

The Fed’s recent mistakes

Throughout the past year, the Federal Reserve has been raising the federal funds rate faster than we have ever seen. This, of course, has led to a drastic increase in the cost of borrowing, the likes of which haven’t been seen in decades.

In just one year, the effective federal funds rate has increased from 0.08% in January of 2022, all the way to 4.10% in December of 2022. This has led many to believe that the Fed has considerably overshot where rates should be since the market wasn’t given ample time to react to each rate hike.

This rapid increase in interest rates has reduced lending activity in terms of new loans, leading to a sharp decline in demand for real estate, as well as major price corrections. Additionally, the rapid rise in borrowing costs has also led to liquidity crises for many developers and investors who locked in floating rate debt at the 2021 and early 2022 lows, as their debt obligations have been on the rise each month.

Is the consumer actually faring well?

Linneman pointed out that a key piece of the commercial real estate puzzle is always the consumer. After all, the consumer keeps retail spaces, warehouses, and offices full at the end of the day. Recently pundits have adopted the belief that the average consumer is in a bad place financially; however, that couldn’t be further from the truth, according to Dr. Linneman. He believes that the average consumer has a solid financial standing.

Oftentimes, those who believe the consumer is under-capitalized bring up the recent increase in consumer debt service payments and the decrease in household net worth. Although consumer debt service payments are rising and household net worth has fallen, it’s important to remember that the influx of stimulus in 2020 artificially tampered with these metrics.

As of Q3 2022, consumer debt service payments are roughly flat compared to 2016-2019. Additionally, even though the household net worth is down 10% from the Q1 2022 highs, this metric is still near record highs. This means that the consumer is fairly well-capitalized and should remain resilient, even in the face of a potential recession.

How will interest rates move going forward?

At this point in time, only the Fed chair members know where interest rates are going. However, many believe the Fed will have to begin its taper by the end of 2023. It’s difficult to predict when the Fed will begin its pivot. This is because the Fed relies on what many would consider flawed, backward-looking indicators, such as Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) index inflation.

Once the Fed begins winding rates down, Linneman believes we should see some stability in the lending market, followed by a steady decrease in interest rates until the target rate is reached. This means that now could be a great time to take advantage of the tail end of high interest rates and decreasing property values before rates wind down.

Inflation may soon be history

Although inexpensive capital and an overwhelming amount of quantitative easing were certainly large contributors to inflation, supply chain issues also played a significant role. Over the past year, there have been considerable improvements to the health of global supply chains. Many believe that the recent interest rate increases quelled inflation.

However, Dr. Linneman believes that the recent decrease in inflation can be attributed to increasingly healthy supply chains. He cites that it often takes six to eighteen months to see the effects of changes in fiscal policy. This means we probably won’t see the full effects of recent interest rate hikes until the end of Q1 or the beginning of Q2 this year. If mended supply chains really were the cause of the recent drop in inflation, we will likely see a sharp dive in inflation (and possibly even deflation) in the coming months.

How will a recession affect commercial real estate?

In the grand scheme of things, commercial real estate should remain largely unaffected by a 2023 recession. It’s important to remember that recessions are temporary, often lasting just six to eight months. As long as you have a long-term outlook on commercial real estate and you aren’t taking on excessive risk, a recession shouldn’t have much long-term impact.

In the short term, real estate professionals may have to temporarily tighten up their budgets and defer capital expenditures projects. However, there likely won’t be many long-lasting side effects of a recession in 2023. This is especially true in the case of a potential 2023 recession since the average consumer is still doing quite well.

Although those calling for a major recession in 2023 often refer to the hardships many experienced during the Great Financial Crisis of 2008, it’s unlikely a recession of this magnitude will occur.

What does 2023 hold for investors?

Although the U.S. stock and real estate markets have been hit recently, the underlying economy is still strong. Inflation is steadily decreasing, the consumer is well-capitalized, and interest rates should begin to normalize in the near future. Investors and business owners alike are not out of the woods yet, but the turbulent environment we’re experiencing could bring ample buying opportunities for those who have equity and are well-capitalized.

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