Can the Market Talk Itself Into a Recession? Some Fear Yes

WASHINGTON, DC—Commercial real estate executives are optimistic about 2020, according to the Real Estate Roundtable’s 2019 Q4 Economic Sentiment Index. “Our Q4 Sentiment Index shows that macro real estate markets remain fundamentally sound and reasonably leveraged, with balanced supply and demand,” says Real Estate Roundtable President and CEO Jeffrey DeBoer in prepared remarks. “The markets continue to benefit from business and consumer spending, encouraged by low unemployment, rising wages and low energy prices.”

Yet something is amiss. The Q4 Sentiment Index dropped one point from the previous quarter to register a score of 49; a score of approximately 50 is viewed as positive. In addition, the Q4 Future-Conditions Index, which is part of the overall Sentiment Index, decreased three points from Q3 to reach 45.

The index highlighted a handful of issues that may be concerning CRE executives; chief among them was the fear of recession next year. To be specific, executives surveyed for the index said they were afraid that the markets would talk themselves into a recession. It is easy to see how this could happen. Right now the main driver of US economic growth is consumer spending; business investment, by contrast, has been lackluster. If consumers were to become convinced a recession was on the way, they would undoubtedly scale back their expenditures.

That was the general theme of the survey respondents’ comments. “If you keep talking about a coming economic downturn, the statement becomes self-fulfilling,” said one. This person did indicate there might be reason for concern beyond just self-fulfilling talk. “There are indications that markets are softening; newly created jobs are not paying as well as they used to and they aren’t the caliber of jobs we need to sustain this market,” the respondent said.

Another respondent had a different view of the economy. “The market feels pretty good to us,” this person said, who complained about negative news reports. “I’m blown away by the daily headlines about trade wars and issues; it feels like someone’s always crying wolf when I read the news. My biggest fear is that we’re going to talk ourselves into a recession. I’m worried consumers are going to be talked out of spending as the result of consistently scary headlines. In fact though, the market is doing fine.”

Respondents highlighted other concerns that were reflected in the index.

Troubled International Markets

Troubled international markets threaten to soften US growth, especially as the US-China trade war continues without a definite resolution. Said one respondent: “The world at large is politically unsettled, unpredictable, and to some degree frozen. I say that, then I look at our tenants and they’re highly active, so the macro and the micro are giving conflicting signals.”

Peak Asset Pricing

More than 65% of respondents anticipate asset values to maintain their current level or be somewhat higher going into 2020. Additionally, half also suggested asset values increased over the past year. “The market feels peaky to us,” according to one respondent. “We’ve achieved new levels of valuation in most markets and now we’re worried about prices in most markets.”

Bid-Ask Spread

Respondents consistently suggested the number of buyers for assets was decreasing, which is creating challenging selling and buying circumstances. “There’s a great quantity of money chasing too few deals,” said one respondent. “I don’t see this situation changing soon. Sellers are seeking specific, often lofty, prices and they won’t sell if they don’t hit their number. Low trade volumes can be frustrating for people, and there are always ways to create deals, which is where folks get in trouble.”

“Prices keep going up,” another respondent noted. “Land values are going up like crazy. Rents are growing. I think people are going to get hurt. When groups are buying where they are able, instead of where they should, it’s not going to end well for everyone.”

Ample Liquidity is Exacerbating the Bid-Ask Spread

Respondents pointed to ample liquidity for the CRE markets, which obviously is a benefit. There is a downside to this liquidity, though, which was also highlighted: The availability of capital and refinancing opportunities is widening even further the bid-ask gap. “Coastal markets are still flush with capital and very attractive for a variety of capital sources,” according to one respondent. “We’re seeing sellers hold onto assets if they can’t find capital willing to meet their pricing. The abundance of financing options allows these sellers to refinance rather than sell and we feel like this trend will continue.”

Another said: “There’s enough capital out there that folks who find themselves at the end of their loan term can simply borrow from elsewhere; the pressure of loss is pushed out because of the quantity of capital available.”