Commercial Real Estate, Fiscal Policy, and the Current Economic Environment
Recent events have us wondering if the economy is falling into a trap that we have seen before. A couple of weeks ago the Federal Reserve committed to support the economy not just in the short run, but also in the long run. Clearly the Fed has taken an aggressive approach to supporting the economy and the capital markets in 2020. The Fed looks poised to continue supporting the economy, attempting to avoid the mistake of withdrawing support too quickly. If you recall, the Fed recently announced it was altering its framework to allow rates to remain near zero for a prolonged period until certain conditions occur: 1) full employment, 2) 2% inflation, and 3) inflation sits above 2% for some period. This reflects the Fed’s new altered policy stance. We could use a bit more clarity on things like timeframe and the level of inflation the Fed would ultimately tolerate, but for now it appears the Fed will leave rates near zero until at least 2023. For perspective, the Fed previously cut rates to near zero in December 2008 and did not raise them again until December 2015.
Meanwhile, fiscal policy remains stuck in neutral after benefits for most households expired at the end of July. The Senate and the House remain far apart on a spending package, leaving many that once depended on government support twisting in the wind, increasingly reliant upon the portion of their benefits that they managed to save. The sides have made little progress in recent weeks. We already worried that Congress was running out of time with the election looming just weeks away and campaigning for many in the Senate in the House set to kick into a higher gear, likely requiring them to return to their home states. The death of Justice Ruth Bader Ginsburg potentially throws a wrench into the works as the Senate begins to take up a vote on a nomination for her replacement, Amy Coney Barrett. That could siphon time that might otherwise get spent on the next spending package.
That ultimately brings us to a familiar concern: that we will continue to rely too heavily on monetary policy and not enough on fiscal policy. While the economy has started its recovery phase, fiscal stimulus clearly played an important role in the process. Without it, the economy likely faces a headwind after what should prove a snapback third quarter, a headwind that monetary policy alone will likely not overcome. We could see the economy face similar challenges to the ones faced during the last business cycle when interest rates remained near zero, but fiscal policy remained relatively limited. The data already shows signs of this becoming a problem. Improvement in the economy continues, but at a declining pace. Retail sales for August grew, but came in below expectations and declined relative to the rebound over the prior few months. Industrial production also continued to recover in August, but similarly at a declining rate. Unemployment claims remain elevated on an initial and continued basis, with a clear loss of momentum. And consumer sentiment remains depressed, even with some slight improvement. In short, the economic recovery clearly lost momentum in the latter half of the third quarter.
But this familiar concern comes with a twist. The imminent change in the weather compounds our concern. We are heading into the colder months as we move into the later stages of the year. Colder temperatures will force people indoors, stymying the ability of restaurants and bars to service customers outdoors. Moreover, people spend more time indoors in places with poor ventilation and viruses have a propensity to travel more efficiently in cold, dry air. This shows in higher cases of seasonal colds and influenza during the fall and winter every year. Will COVID show a similar pattern? While hard to say for certain, we note that daily case levels remain elevated. Although they have declined since peaking in July and August, they remain well above the levels from June. More than half the states are already seeing a rise in the number of new cases. Together, some key risks remain squarely in play: austerity from the expiration of fiscal stimulus, potential lockdowns if cases increase at concerning rates, and the potential for consumers to alter their behaviors of fear of falling ill increases.
Housing remains a bright spot
The housing market remains a bright spot. Demand for housing remains strong, spurring a rebound near pre-pandemic levels for housing starts and permits. The risk in the market remains limited supply, particularly with surging demand and continued upward pressure on prices. Even if the recent spike in the homeownership rate is overstated, we don’t doubt the underlying dynamic. This stands in stark contrast to the Great Recession, which centered on the housing market. Not only did prices and volume tumble but starts and permits activity remain well below activity from the 1990s and 2000s despite continued population and household growth.
What it means for CRE
For commercial real estate (CRE), the downturn has not yet manifested itself in space market fundamentals, but that is very likely coming. We predict deterioration in rents and vacancy rates across markets and property types heading into the balance of the year, though clearly not on a uniform basis as performance differs significantly across scenarios. If we get another stimulus package and the pandemic does not meaningfully intensify, then we could gravitate toward a more positive outlook. But if we don’t get another spending package, and a resurgent pandemic becomes an impediment to economic activity, then we’re likely to see much more negative fundamentals. The economy has clearly improved since its low-point in April, but asymmetrical risks remain clearly in focus.