Impacts fast, recoveries slow
Just as tornadoes, earthquakes, and floods quickly change urban landscapes, so too economic disruptions, erratic business cycles, and pandemics impact real estate expectations and forecasts. Black swan events arrive unexpectedly whereas recoveries from such events are generally slow.
Top down disruptions impact commercial real estate investors, developers, and lenders as price discovery is fluid and continually influenced by incomplete information and mixed beliefs about the future. Market participants seek to understand current events as they unfold and attempt to reasonably predict future outcomes. One rational response is to increase the role of bottom up analysis to counteract top down distortions and improve decision-making processes.
This article examines differences in U.S. retail and office real estate cycles, comparing alternative forecasts to
Retail and office market forecasts…what changed?
Over 300 markets were initially evaluated using a proprietary cycle model that: (a) identifies cycle phase positions in 2022 for each retail and office market, (b) summarizes the retail and office stock for each cycle phase, and (c) calculates the percentage distribution of stock across five cycle phases.
Slippage is a consistent pattern discovered for most of the retail and office markets analyzed. Whereas the Initial forecast may indicate a market improving through 2022 with positive net absorption, declining vacancy rates, and increasing rents, the Revised forecast now shows that same market with negative net absorption, increasing vacancy rates, and decreasing rental rates.
Exhibit 1 illustrates comparisons between Initial and Revised 2022 forecasts for U.S. retail markets. The results confirm significant changes with increases in recession and recovery phases by 2022 and reductions in equilibrium and expansion phases.
Exhibit 2 compares Initial and Revised 2022 forecasts for U.S. office markets with noticeable change in the percentage of office markets in the recessionary phase chiefly explained by slippage of several large office markets (Atlanta, Chicago, Houston, Los Angeles, New York, and Washington D.C.).
Until today’s creative destructive forces fully run their course with retail and office markets, here are four bottom up recommendations to embed in due diligence and valuation methods: