Top Economists Debate Rates, Inflation and Impact on CRE

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The headwinds of inflation and rising interest rates may be scaring some investors, but two chief economists who presented their prognosis at a recent panel discussion about the economy remain relatively optimistic. The recent Counselors of Real Estate discussion featured Joe LaVorgna, managing director and chief economist for the Americas at Natixis, a corporate and investment bank, and Mark Zandi, chief economist at Moody’s Analytics.

LaVorgna anticipates that 2022 will naturally be a slower growth year than 2021, when the U.S. continued to recover from the pandemic.

“In 2022, inflation will slow to about 3% or 4%, but GDP will also slow to just 2%,” says LaVorgna. “I don’t anticipate the Fed to tighten its policies as much as the consensus of economists does, although I do think they’ll raise rates in March as expected.”

While Zandi agrees with LaVorgna’s growth prediction, he believes that inflation will moderate even more to 2.25% to 2.5% by mid-2023.

“I’m optimistic that the economy will be fine because the pandemic will continue to wind down and each wave appears to be less disruptive to the economy and to healthcare than the previous wave,” says Zandi.

He anticipates that the global supply chain, the labor market and energy markets will all normalize in the year ahead. Zandi predicts four Fed rate hikes in 2022, with the Federal funds rate landing around 2.5% by 2023.

“I do think it will be hard for the Fed to ‘land the plane smoothly’ after years of supporting the economy, which does present some downside risk, but generally I think inflation will moderate and the economy will do pretty well,” says Zandi. “The predominant risk is that if the Fed pushes the brakes too hard it could trigger a recession in 2023.”

Three factors mitigate that risk, says Zandi, including the lingering impact of the pandemic, the energy market and political implications of the Ukraine situation, and the continued uncertainty of fiscal policy in Congress.

Most investors have priced in Fed rate hikes into their strategies, says LaVorgna, who calls himself a “growth pessimist and an interest rate optimist.”

Supply chain disruption and labor issues

While the U.S. is creatively working to improve supply chain issues, LaVorgna says that not every country is as resilient or is making similar progress.

“The factors that started supply chain disruption are all moving in the right direction,” says Zandi. “Factories overseas, especially in Southeast Asia, are reopening; the transportation bottlenecks, especially the ports, are easing; and some of the labor problems from sick staff are getting better.”

A more long-term concern, says Zandi, is the supply of labor. He says this was an issue before the pandemic because of aging Baby Boomers retiring and less immigration. The pandemic exacerbated the issue because of illness and the lack of childcare.

“The weak labor supply should be addressed by encouraging more immigration of both less skilled workers and well-educated people,” says Zandi. “Policies can be introduced to make the cost of work lower, such as with childcare and eldercare support. We also need policies to increase productivity, such as with labor-saving technology.”

Capital flow and real estate

Investors are anticipated to continue to pour capital into real estate because the returns are excellent compared to the risk, says LaVorgna.

“While some cities are better than others for investors, there’s no overinvestment happening anywhere,” he says.

Commercial real estate investment will do well in the current environment, says Zandi, especially multifamily because of good rent growth.

“Interest rates will rise, and cap rates will rise, so we’ll see a widening spread between risk free rates and cap rates,” says Zandi. “Some CRE prices may flatten because of that, but the main sector that causes concern is for offices, especially in gateway cities.”

Zandi says about 5% of employees worked fully remotely before the pandemic and approximately 20% will do so even after the pandemic fades. He sees a potentially difficult transition for the office market, particularly in big cities.

On the residential side, approximately 18% of single-family homes purchased in 2021 were bought by investors, which is exacerbating supply challenges. Investors are not sellers, so they are buying houses without bringing another house onto the market. Housing market dynamics may impact the multifamily sector in two ways. First, investor-owned properties are an alternative that may appeal to some renters instead of an apartment. On the other hand, the lack of supply may keep some would-be buyers renting longer. 

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