By Ralph Rader
If Socrates can admit his own ignorance, I think we can collectively admit we just don’t know what “inning” it is. Along the bottom of the 9th inning, extra innings, we’re not playing baseball anymore. It’s all code for we’re not sure when this cycle is ending. But that’s no knock on market commentators and prognosticators. After all, the commercial real estate world is a very complex place. It does suggest, however, that understanding the risks that could cause a downturn are going to be more productive than trying to circle an arrival date on the calendar. Instead of when, focus on why a potential slowdown may occur and what it could look like.
The good news for most reading this is that commercial real estate doesn’t appear to among the likely culprits to cause a downturn. Now, we’re a creative and risk-taking bunch of course so that could change quickly, but, so far, the capital markets and developers, owners, and investors have maintained discipline since the recession. There’s certainly been plenty of growth in markets all over the country but the vast majority have been built on a stable foundation of job and population growth. Development pipelines, prices, valuations, and leverage have all maintained sustainable levels as a result.
The outlook for specific property sectors is largely unchanged from 2018. Industrial remains hot due to the continued growth of e-commerce and related logistics demands. It is more and more difficult to find value-add opportunities in multifamily but it remains a strong and recession-resistant sector. Office construction has been more measured this cycle and with the rise of co-working trends has more alternative leasing strategies and uses than just a few years ago. Retail will still be the weakest of the primary sectors at it never fully recovered and continues to evolve in response to structural changes from e-commerce.
The more likely cause will be a macroeconomic risk factor outside of the industry and risk are already on the horizon. The minefield investors find themselves currently navigating includes rising short-term interest rates, volatile equity markets, and a flattening yield curve. There is also an increasingly tight labor market which signals increased labor costs for developers. The biggest, most acute change would likely come via the Fed being unable to execute a soft landing as they look to continue raising interest rates in 2019. With the roller-coaster ride the equity and fixed income markets have been taking lately, we need the Fed to channel their inner-Sully Sullenberger to land this economy.
These factors make it imperative for investors to challenge their existing assumptions when contemplating a transaction or business plan. The landscape is quickly changing with interest rates, cap rates, and rent growth are all subject to significant swings seriously affecting your properties and projects. When we talk of a downturn or at least slow down in the market, it is a question of ‘when’, not ‘if’. But if you can recognize the risks and structure according, you can be prepared. And when you’re prepared, you realize the ‘when’ just doesn’t matter that much.
The author, Ralph Rader, is a Senior Director in the Dallas office of Metropolitan Capital Advisors. Ralph can be reached at firstname.lastname@example.org or at 972.267.0600.