When it comes to recessions, it is not a matter of if, but a matter of when. The average American tends to view recessions as massive periods of history such as The Great Depression. In reality, recessions are quite frequent with varying degrees of impact on the individual and on different industries. Based on historical precedence, the US is due for another recession in the coming years. What is more difficult to calculate is the severity and duration of the next recession.
As real estate investors, recession can be viewed as both a scary proposition and also as an opportunity. Today, we will examine past recessions to better understand how investors can prepare for the impact of a future recession on commercial real estate.
The Inevitability of the Next US Recession
While nothing is inevitable beyond death and taxes, a recession is pretty damn close. Beyond the conceptual inevitability of economic ebbs and flows, recent recession indicators have shown that the US is due in coming years. Examples include:
Inverted yield curve: In a healthy economy, a long term, 10-year yield is expected to outperform a short term, 3-month treasury rate. In 2019, the 10-year yield dipped below the 3-month yield for the first time in 12 years. The last time this occurred, the 2008 financial crisis was looming around the corner.
Unemployment rates belie the reality: One of the strongest pillars of the current US economy is historically low unemployment rates. This is a great sign of stability of the nation’s economy. However, a worrying trend is that 2019 saw huge cuts to employee hours. This is often the first step towards higher unemployment rates, as employers tend to cut hours first, before ultimately having to downsize.
New York Federal Reserve recession probability model: The New York Federal Reserve puts out one of the most comprehensive and respected predictive models when it comes to future recessions. According to this model, the likelihood of a recession has approached 40 percent for the first time since 2009. Previous predictions have been accurate with a nearly perfect track record.
2008 Great Recession’s Impact on Commercial Real Estate
The residential real estate market gets most of the attention when it comes to the Great Recession of 2008-2009, and for good reason. Foreclosures and purchasing habits took a massive hit during the following years. However, the commercial real estate industry was hit nearly as hard. In fact, the average price of office space has been slower to recover than average rental rates. While office prices in 2017 had recovered to 30 percent above their 2007 highs, rental rates were performing at 60 percent above their 2007 highs.
Another grim aspect of the 2008 financial crisis was the impact it had on vacancy rates within commercial real estate. 2010 saw peak vacancy rates at 17.4 percent for office space, 10.1 percent for industrial space, and 10.8 percent for retail space. It is important to note that the impact on CRE markets seems to have been a bit more delayed than within the residential market, potentially accounting for some of the slower recovery noted above.
From the years 2007 to 2009, total investments in real estate went from $460 billion to $70 billion. This is one straightforward trend which will likely translate for commercial investment in any coming recessions. The impact may not be so severe, but total investments will almost certainly slow when a future recession hits.
How CRE Investors Can Prepare for a Recession
With all of this in mind, how exactly can commercial real estate investors prepare for this inevitability? While predicting the future is obviously a fool’s errand, there are two primary strategies that CRE investors can use to stay ahead of the curve.
Liquidate assets now to turn investments into cash
The signs of recession are certainly there. Some investors who have seen solid returns on their current CRE investments might want to take a turn-to-cash approach. This essentially takes your skin out of the game until the economy is back on the rise. The fringe benefit of turning current investments into cash is that savvy CRE investors can once again get back into the real estate market when property values hit their lowest points.
Retain real estate assets and weather the storm
Recessions are scary, but as all things, they too will pass in time. Most long-term investors understand that half the battle is staying in the game. All of the figures we have quoted earlier show horrible downturns and also eventual recoveries. In fact, one of the “bad” statistics for CRE was a mere 30% increase in value over a 10 year period.
Recessions are as American as apple pie. They are not to be feared, but they certainly call for some preparation and smart decision making. Commercial real estate is every bit as susceptible to an economy in recession as residential real estate or any other forms of investment. Smart investors will view coming economic downturns as just a part of the greater picture. Just as the CRE market recovered from 2008, so too will it recover from the next recession.