Have inflationary pressures started to abate?
December 2022 inflation readings all showed a downward trend but are still too high. CPI peaked at 9% in June 2022 and dipped down to 7.1% in November 2022 largely due to oil/gas pricing coming back down. Core PCE (Personal Consumption Expenditure), the measurement most closely watched by the Federal Reserve, peaked at 5.4% in June 2022, with the November reading down to 4.7%. While these are backward looking indicators, focusing on fresh insights will provide a good indication of where we are now and where we might be headed.
The cost to ship a container full of goods from China to the US decreased by 93% from the height in September 2021, the cost in December 2022 coming back down to basically where it was pre-pandemic. Container traffic to the ports of LA and Long Beach have begun to slacken, as retailers have stocked sufficient inventory in local warehouses to meet their expected demand levels and they also have increased confidence that supply chains are stabilizing.
Commodity prices have come back down, with the price of lumber basically down to the same average price of 2019. The price of steel has dropped from its peak in April 2021, but is still approximately 23% higher than it was in 2019. Oil/gas prices have also come down. Overall, commodity price decreases indicate that supply chains are finally normalizing which will help roll back inflation, although there appears to be some instability in energy prices to continue keeping an eye on.
Effects of Fed Rate Hike
With the Fed decision on February 1 to raise rates by a quarter point, this is the smallest hike since March 2022, which is a hopeful sign that inflation is beginning to ease. However, it will take a few months for the data to truly indicate the market’s reaction.
If economic data isn’t pointing strongly enough toward inflation being under control and rates continue an upward trajectory, the CRE markets are going to experience less liquidity and transaction volume will remain subdued until these dynamics improve.
Economic Signals for CRE Investors to Watch in the First Half of 2023
Digging under the surface beyond inflation and interest rates, below are three metrics to focus on that haven’t gotten as much attention but will have a significant impact on CRE in the coming year.
- Consumer Sentiment – Based on the Michigan University Consumer Sentiment Index, consumer sentiment hit an index score of 50 in June 2022, a record low. Sentiment has only declined into the low 50 range during the global financial crisis and in 1980 when inflation hit 13.5%. The good news is that sentiment appears to be making a recovery in how people feel about their financial situation, with an index score was 56.8 at year end of 2022.
- Cash Savings and Use Of Revolving Credit – Total cash savings continued to grow until August 2022 and the significant stockpile of cash savings could sustain consumption, delaying the real bite of the Fed rate increases until the savings overhang burns off. Based on the current trend, total savings are anticipated to be back to historical norms by the second half of 2023. Consumer debt is not currently outsized when adjusted for inflation so credit card debt is not problematic yet but it’s worth keeping tabs on as a risk indicator in the coming year. Elevated inflation, combined with economic uncertainty, has strained household budgets, which could result in rising credit card debt.
- Labor Shortage – There are approximately 10.5 million job openings as of January 2023 and approximately 5.7 million unemployed people. A 4.8 million labor shortage spread is not the highest we’ve seen but it’s definitely higher than historical norms and normally, there are more unemployed people than open jobs. The Fed would like to see a 4.4% unemployment rate to get inflation under control but with a 3.4% unemployment rate topped with the current labor shortage, it’s uncertain we’ll get there. We need to monitor the job openings data but if that number starts to fall quickly, it’s a sign the economy is weakening. Despite softening employee demand in tech and real estate industries, these sectors represent a small percentage of the workforce and we still have a substantial labor shortage. Overall, the job market appears to remain strong in the near term and sectors such as healthcare, hospitality and retail trade still face significant staffing shortfalls.
A longer term dynamic that remains to play out is commercial loan maturities coming up in the next couple years with the potential for emerging maturity defaults. Upcoming large corporate lease terminations may also contribute to decreased CRE performance with an increase in vacancy rates and downward pressure on lease rates in select metro markets. Property types that appear to be affected the greatest are office, retail and select industrial, based on location.
The lodging/hospitality sector currently is showing strong performance so this may be a bright spot for CRE investors.
The combination of how these economic trends play out in 2023 will have a measurable impact on the CRE market. They’ll also give us some looking forward insights on how the economy and CRE will perform this year.
Source: Marcus & Millichap, John Chang – Sr VP Research Services