Should Commercial Real Estate Investors Worry About A 2023 Recession?

Should Commercial Real Estate Investors Worry About A 2023 Recession?

Even though inflation had a negative effect on the nation’s economy during most of 2022, its growth continued to decrease as 2023 arrived.

This has caused concern among investors and business owners who are planning to buy or lease commercial real estate (CRE), wondering if a recession may eventually arrive, affecting their earnings.

While analysts define a recession as two quarters of falling Gross Domestic Product (GDP) numbers — which, at the time of this article’s publication, hasn’t happened — plenty of investors are viewing the remainder of 2023 with caution. 

Reasons for these jitters include recent news of mass layoffs in the technology and IT sectors since rising unemployment numbers are usually seen before and during a recession.

Statistics suggest that there will be over 40,000 lost tech jobs during January 2023 alone. Tech giant Google recently laid off 12,000 staff, Amazon terminated 18,000 employees, and Microsoft recently announced 10,000 staff cuts.

Here are additional warning signs of an impending recession. 

Warning Signs of a Future Recession

Generally, several economic factors, such as the ones described below, are part of the “recipe” for a recession. Many are the after-effects of a period of inflation.

  • Poor stock market performances. Many investors reduce stock activities or sell to minimize their losses.
  • Consumers spend less. Inflation bumps up prices, causing consumers to limit spending to essential items. Producers of non-essential items may suffer as a result.
  • Too many unsold products. During 2021, consumers spent more than usual on non-essential goods. This spending spree was slowed by 2022’s inflation, which contributed to an excess of unwanted goods that decreased retailers’ profitability.
  • Lenders tighten credit. Lenders may raise minimum credit scores and down payments if other inflationary factors appear, reducing growth.

Are Some Types of Commercial Real Estate Recession-Resistant? 

Successful investors always perform due diligence when considering a new commercial real estate (CRE)  purchase, even in the best of economic times.

This research requires a closer look at how CRE has historically weathered past recessions and recent inflation statistics.

Details of four types of commercial real estate are below, together with data that helps forecast each type’s performance during a recession. 

#1 – Industrial (Storage, Distribution)

Since industrial properties’ success is tied to the demand for business and consumer goods, investors should prepare for a possible loss of income if a recession becomes reality. 

But these losses may be minimal, as recent statistics suggest.

  • Consumer spending did not slow down in 2022, even during months with higher inflation numbers.
  • Many supply chains are still affected by COVID as China put strict quarantines into place from 2020 to late 2022.

The Inflation Reduction Act includes major incentives for domestic manufacturing. This will favorably impact all types of CRE.

#2 – Multifamily Properties (Apartments and Residential Rentals)

While the reasons are very different from industrial CRE, investors in this sector may also experience minimal losses if a recession happens. 

Historically, these properties have outperformed other types of commercial CRE.

One major reason for the steady demand for rental properties: The 40% rise in residential real estate prices from 2019 to 2022. 

  • The onset of COVID resulted in millions of workers “going remote.” 
  • Many chose to move from urban to suburban/rural neighborhoods. This increased demand drove pricing up quickly. 
  • More renters found themselves priced out of the housing market.

Building materials shortages and rising interest rates have affected even new construction. This resulted in more would-be buyers deciding to rent until affordable rates return. 

#3 – Office Properties

Since the arrival of COVID and remote work, investors in office properties began to deal with the possibility of reduced tenancies and income.

While many employers are deciding on a “hybrid” compromise, requiring that workers come to the office for two to four days a week. This may still affect their overall square footage requirements.

A recession could increase the loss of tenants, especially if the office property’s main tenants are already showing signs of vulnerability.

Investors who have chosen Class A office buildings are considered to be at the least risk, as they cope well with all but the longest recessions.

#4 – Retail Properties

Owners of these properties may need to consider new strategies to keep tenancies and income at an acceptable level. 

One of these strategies is to seek tenants whose businesses are always busy. These include: 

  • Grocery and liquor stores;
  • Pharmacies, including sellers of health-related products; and
  • Salvage sellers and “dollar stores.”

Investors shopping for a retail building for sale may want to consider properties already home to one or more of these retailers. 

There are still opportunities for designer-label luxury boutiques. Not all consumers will cut their spending, as those in higher income brackets are undeterred by inflation. 

For example, sales of personal luxury items increased in 2022. The most active buyers were among some of the youngest, with Generation Z shoppers snapping up luxury leather goods in their twenties. 

Recessions and CRE Property Values 

Since nobody can predict the effects of a future recession, economists study past recessions to determine how CRE values may change.

  • During the 2001 recession, CRE values were rarely affected. This was because this was the “ crash,” with failing business websites as the biggest losers.
  • During the 2008-2009 recession, residential real estate took the biggest losses. CRE losses were around 25%.

While many real estate pundits have proclaimed that commercial real estate is “recession-proof,” this isn’t always true. Potential investors should carry out the same due diligence as other types of investments.

Preservation of liquidity is essential when preparing for a possible recession, as it helps minimize the need for credit with possibly high rates.

Diversification is another strategy to keep losses at a minimum, no matter the contents of an investor’s portfolio.

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