Commercial real estate firm Cushman & Wakefield recently projected that CRE property values could fall as economic growth slows in its August report, “Where do U.S. Property Values Go from Here?”
“Economic prospects have worsened, and the outlook is becoming increasingly uncertain,” Cushman & Wakefield wrote in its report. “Numerous headwinds have emerged – rising inflation, persistent labor shortages, continued supply-chain challenges, the war in Ukraine and risks of a Fed policy mistake. The economic outlook for 2022 and 2023 have been revised down sharply and recession risks are rising fast.”
The firm modeled how CRE property values would perform under four different economic scenarios: soft landing, upside scenario, mild recession and stagflation. “Mild recession” was deemed the most likely at 50 percent while, “soft landing” registered at a 30 percent probability. “Upside Scenario” and “Stagflation” were least likely, at five percent each.
For each scenario, Cushman & Wakefield modeled and presented forecasted values for net operating income (NOI) capitalization rates (cap rates) and the implications they have for future returns and property values for different sectors.
In the mild recession scenario, Cushman & Wakefield’s research showed that NOI decelerates for all real estate types (multi-family, retail, industrial and office), but stayed positive for all except for the office sector. The firm also noted that even though NOI would slow during a mild recession, it’s a lot more resilient compared to past recessions such as 2001, 2009 and 2020.
“The resilience is a function of relatively strong leasing fundamentals entering into the potential recession,” the report said.
Meanwhile, cap rates are projected to increase across property types in the mild recession scenario, most acutely in the 2022-2023 period, Cushman & Wakefield said. Additionally, cap rates are expected to trend lower in the outer years (starting in 2024) as Treasuries stabilize and risk premia decline. The firm also projected that industrial and multi-family properties should see the largest cap rate increases symmetric to the extreme compression they experienced in 2020-2021.
The report also noted that there continues to be a noticeable split within the office sector. The newest, highest quality Class A office buildings have consumed a majority of the new leasing. Rent premiums have also widened from pre-COVID-19 levels. The newer Class A assets are getting rent premiums that exceed 30 percent from other Class A buildings — the premium was just under 20 percent prior to the pandemic.
CRE outlook amid a recession
Looking ahead, Cushman & Wakefield said economic indicators point to weakness and a recession is looking, “more likely than not.”
“Property values almost always decline during recessions; this one won’t be different,” the firm said.
In the mild recession scenario, Cushman & Wakefield estimates property values will drop by about 20 percent during the next two years — ranging from 4 percent to 23 percent depending on the product type.
Despite the dim outlook, the company expressed reasons for optimism. It noted that real estate is a long-term investment, and most investors will reap “healthy cumulative returns” even if there’s a recession.
“All real estate is intensely local,” the report said. “Not every product type/geography will follow the national glide path; many assets will outperform. Market volatility creates opportunity. Now is precisely the time to revisit real estate portfolio strategies to diversify and maximize returns.”