When Will the Pain Stop? This Economist Says He Knows

Interest rates that will apparently be higher for longer. Lending that has dropped nearly 50% from last year. Plummeting valuations. Everywhere you look, there is pain for the CRE industry. By now we understand the path that got us here. The only question executives want answered is when will it end.  

BGO’s Chief Economist Ryan Severino has his thoughts on the matter.

It will come down to inflation and the Fed, he says. “If the Fed can be patient and let inflation return to target without further hiking, then empirical research shows that historically CRE returns should revert into positive territory. Over the last 6 business cycles, once the Fed stopped raising rates, CRE returns rebounded – cautiously at first but gaining notable momentum after only a couple of quarters.

“We see no reason why something similar shouldn’t play out this cycle. And with the Fed having raised so aggressively, returns could veer toward the higher side of that historical experience, especially with so much dry powder sitting on the sideline.”

Severino also shared his opinions on other economic issues that the industry is watching.

Avoiding a recession: Our proprietary modeling shows that in our base case the economy does not enter an official recession. However, the economy will almost certainly slow in 2024 and could perilously flirt with one.

Whether or not the economy avoids a recession will largely come down to the labor market. Although most people tend to focus on GDP as the arbiter of recessions, the labor market consistently provides the true litmus test for one.

Can the labor market remain resilient? The labor market has shown incredible resilience in the face of first elevated inflation and then rising interest rates over the last couple of years. While it is undoubtedly loosening, it remains tight. Why? The structural, demographics-based labor shortage is causing employers to hoard workers, even in some interest-rate-sensitive industries that would have otherwise seen significant job losses at this juncture. Although the labor market likely cannot remain this tight, it should experience far less deterioration than during a typical slowdown, which could save the economy from recession.

Is the Fed done raising interest rates? How resilient the labor market can remain will largely come down to the Fed and monetary policy. Thus far, interest rate hikes have slowed down the labor market without throwing it into reverse. If hiking has truly ended, the labor market seems as if it can endure the lagged impact of previous hikes. But is the Fed really done? Taking it at its word, that it will not raise again unless inflation meaningfully rebounds, then our proprietary modeling suggests that tightening has ended, even as the Fed left the door open to more hikes.

Will inflation continue to subside? Inflation continues to decelerate, across price indexes and time periods. If we focus on recent changes, ignoring stale data from a year ago, then by some measures inflation has almost returned to target. When looking at the 3-month and 6-month annualized rates, the core personal consumption expenditures (PCE) price index, the Fed’s preferred measure, rests above the technical target of 2%. But they now fall within, or very close, the Fed’s now flexible structure of inflation targeting. Our proprietary modeling suggests that inflation should continue to slow, albeit inconsistently. Can the Fed be patient enough to let this dynamic play out?