Some cheer in the new year
With recession likely in the rear-view mirror, what’s next for commercial real estate?
- Ryan Severino
Economic Insights returns from holiday break with much to cheer in the recent data. While the economy still faces notable headwinds in early 2023, recent releases demonstrate the underlying momentum and more of a mixed picture than many headlines suggest. The outlook for this year remains challenging and uncertain, but not unambiguously negative.
Goldilocks at work?
The most recent reading on the labor market provides some hope that inflation can slow without the need for significant labor market disruption. The labor market remained firm in December. Although net job gains continued to slow, they came in above expectations. With the labor participation rate rising slightly, the unemployment rate fell back to 3.5%, the lowest level in half a century. Reflecting this dynamic, weekly initial unemployment claims have also fallen back toward 200,000, a small number for a civilian labor force of roughly 165 million people. Nonetheless, average hourly earnings continued to decelerate. While we concede issues with that metric (relative to other measures of compensation), it nonetheless provides hope that inflation can cool without major job losses.
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Recent inflation readings also provide a bit of hope for that outcome as well. December’s consumer price index (CPI) report showed the first monthly decline in the headline index since May 2020. The core CPI continued to slow inconsistently on monthly basis. On a year-over-year basis both the headline and core indexes continued their downward trends. Inflation now appears past its peak, which likely occurred last summer. With major components rolling over, inflation should head downward at a faster pace in 2023 than in 2022.
Additionally, the headline producer price index (PPI) for final demand in December declined by 0.5%, below expectations and the greatest decline since April 2020. The core PPI also came in below expectations. Consequently, the year-over-year changes for both continued to decline, providing more evidence that inflation has passed its peak.
Consumers’ mixed signals
In recent weeks both the consumer sentiment and consumer confidence indexes notched higher, likely due to inflation cooling a bit. Additionally, the labor market remains tight, providing opportunities for the unemployed and those wishing to change jobs. A recent survey indicated that a large majority of workers are considering (if not outright desiring) a job change this year.
Despite consumers feeling a bit more upbeat, retail sales for December came in below expectations, falling for the second consecutive month. That follows our “watch what consumers do and not what they say” mantra. Certainly, consumer spending is slowing along with the overall economy. But we caution against reading too much into the recent data. The labor market remains tight and consumers have not fully exhausted their excess savings. Moreover, slowing inflation should support real consumer spending, even as it slows.
Humbug for business
Yet recent readings for the ISM indexes show that businesses are feeling less optimistic. Both the ISM Manufacturing and Services indexes for December came in below 50. That level represents contraction in activity. The Services index surprised, coming in well below expectations, and falling below 50 for the first time since May 2020 during the acute phase of lockdowns. This downturn in sentiment likely reflects the challenges that businesses face in the form of higher prices paid and higher interest rates. At a minimum, it represents a sign of slowing in economic activity. Reinforcing the issues in manufacturing, industrial production during December declined more than anticipated, driven by a noteworthy decline in manufacturing activity. While the manufacturing sector has been contracting for a number of months, the accelerated pace of decline hints at additional deterioration.
Debt Ceiling Debacle. Again.
Last week the U.S. reached its statutory debt limit of $31.4 trillion. That resulted in a series of extraordinary measures to avoid defaulting on government debt. Some measures will kick in right away and some will play out over time. The government really has until tax season ends (once it has a chance to review its revenues) to know how long it can pay its obligations, probably until at least June. But with a divided government seemingly dug in, the battle over the debt ceiling should prove more contentious than any time since 2011 when the battle resulted in a downgrade of U.S. government debt. The Republicans want spending cuts in exchange for raising the ceiling while the Democrats and the White House want a clean bill. Buckle up, it is likely to get bumpy.
What it means for CRE
The commercial real estate (CRE) market has weathered the slowdown in the economy relatively well. While certain components have gotten hit harder than others, the sector overall is enduring. That said, additional signs of slowing are emerging as the economy slows. Property types that experienced strong demand over the last few years, such as industrial and apartment, are normalizing. Property sectors that have experienced more nuanced performance, such as retail and office, should see those nuances persist and likely widen, with noteworthy differences in performance by subtype, quality and location.
Thought of the week
Recent research shows that salary transparency laws reduce inequity, but also flatten pay ranges, with a smaller difference between high and low performers.