A steep learning curve

A master class into the U.S. economy, how commercial real estate is expected to fare and a few potential risks

February 22, 2022
  • Ryan Severino

Looking for more insights? Never miss an update.

The latest news, insights and opportunities from global commercial real estate markets straight to your inbox.

Quick takes:

  • Economic lessons from the last two years
  • Using what we have learned
  • Economy making the grade in 2022
  • CRE at the head of the class
  • Pop risks not on our syllabus

This week we presented at Academy, JLL’s marquis annual internal event for top-performing brokers. Held in person for the first time since 2019, Academy offered the perfect opportunity to discuss things we learned over the last two years as well as present our outlook for the year, its implications for commercial real estate (CRE), and potential risks. Here, we discuss some key lessons from Academy.

When the pandemic struck, it was not just our naïve immune systems that got exposed to something novel. The economy did as well. It had been roughly 100 years since our last true global pandemic and clearly the economy changed significantly during that period. Our efficient, integrated global economy of early 2020 did many things well. But it was not designed with something like a pandemic in mind. To a large extent the pandemic was the recession and the ongoing disruptions in the economy. Consequently, restoring growth proved not just a simple matter of “turning the economy back on” as some had suggested. The pandemic hurt both the supply side of the economy by either keeping sick workers home or scaring workers into staying home. It also hurt the demand side of the economy for similar reasons: consumers either too sick or too scared to conduct their normal economic lives pulled back on usual spending patterns in a manner unlike any previous recession. 

Consequently, the economic policy response needed to change. Of course, standard interest rate cuts occurred. But interest rates already sat at low levels heading into the crisis, requiring other measures. The Fed became active again in asset markets, purchasing a greater quantity and variety of assets than during the global financial crisis (GFC). Fiscal policy also responded in an outsized manner. Stimulus spending, to blunt the impact of the pandemic, totaled roughly $6 trillion. That represented the largest amount on an absolute and relative basis of any major economy, much larger than the fiscal response to the GFC. Although it succeeded in supporting households, it could not address the underlying cause of the downturn. Consumers spent income (from all sources), but on goods they could safely consume at home. They largely still shunned services, which get consumed elsewhere, a potential risky proposition in the ongoing pandemic. Yet goods production remained disrupted.

As a result, prices for goods increased most, producing something unseen in over half a century. The headline consumer price index (CPI) increased by at least 5% year over year, on a sustained basis, due to a widespread increase in the prices of various goods. Each previous iteration of that kind of inflation during the last half century occurred primarily because of rising oil prices. While oil and energy prices have certainly increased, inflation has occurred much more broadly. Yet, inflation has not held back demand or economic growth, with the U.S. economy registering its best calendar-year performance in 2021 since 1984. 

Making the grade

But that only brings us so far. This year we must use what have learned. As we continue to better understand and adapt to COVID, its impact on the economy diminishes with each subsequent wave. Although that might not continue, it seems the most probable outcome. This should help the demand side and the supply side of the economy. On the demand side, less disruption means inching closer to pre-pandemic norms. Consumers can shift back toward pre-pandemic allocation of spending on goods and services, even as consumption slows from last year’s torrid pace. For the federal government, it means less need and desire for additional fiscal stimulus, which should produce some fiscal restraint. For the Federal Reserve, it means greater confidence to tighten monetary policy to help slow inflation, without taking away needed accommodation. It would also support net exports. Strong fiscal stimulus has supported domestic consumption of foreign goods while foreign consumption of U.S. goods and services has lagged. A surge in consumption of U.S. services, such as vacations and education, would likely follow. 

On the supply side of the economy, a less impactful pandemic means not just stabilization in the global supply chain, but actual improvement: greater variety and availability of goods. But it does not mean that improvement would occur quickly. Some production inputs will remain structurally limited, including three key ones. The labor shortage will persist, even beyond the pandemic. A lesser pandemic should enable some to return to the workforce, but some will continue to opt out for a variety of reasons such as retirement, ongoing fear of COVID, and because of negative impact on health from prior COVID infection. Moreover, the structural demographic shift that is slowing workforce growth will persist for years, even as demand for labor grows. The semiconductor shortage cannot be fixed by a waning pandemic. Greater investment in production needs to occur. Although planned, increasing that capacity will take years. And energy is transitioning from traditional sources to newer sources. The world will have to manage that process carefully amidst growth in energy demand. 

Economic growth should slow toward the 3.5% to 4% range as demand growth eases and supply growth starts to catch up. Consumers should remain the driving force in the U.S economy, though private investment and net exports should also help growth at the margin. Inflation should slow as both monetary and fiscal policy start to restrain growth, even as consumer spending slows and an improved supply chain supports greater production and wider distribution of goods. It should fall toward the 4% to 5% range, as measured by the headline CPI. 

Head of the class

CRE should thrive in an environment like this. The ongoing economic expansion should support continued improvement in space market fundamentals. That should support performance across property types and geographies in the form of improved net operating income (NOI) and cash flows. CRE’s well-known inflation hedge enables it to outperform inflation on the upside, even though underperforming on the downside, producing positive real growth over time. Consequently, that supports property valuations and cap rates when the economy is expanding, even in the face of rising interest rates. Therefore, CRE handles both elevated inflation and higher interest rates well.  The biggest risk, an economic downturn, remains a relatively low near-term possibility but will require vigilance as we head toward the middle of the decade.

Pop risks

What surprises could upend this positive view? The course of the pandemic could change, upending everything, even potentially reversing progress. Inflation could prove hard to slow. The Fed could tighten too quickly as it tries to hit a moving target of slower growth and lower inflation, though the impact to the real economy would manifest years later. Geopolitical risk, at home and abroad, is increasing, and offers only downside risk. And constraints to production, like labor, could take longer to ease. While none of these are currently on the syllabus, we need to remain prepared for a pop quiz or two this year. 


Contact Ryan Severino

Chief Economist, JLL