After a couple of great years, today’s real estate investors are staring down a vexing variety of economic variables. Is inflation under control yet? What will the Federal Reserve do next? Does a recession loom in the near future? Is work from home the death knell of the office sector?
In June, the answers to all of those questions remained frustratingly fuzzy. It was a month when the central bank’s Federal Open Markets Committee (FOMC) finally slowed its fight against inflation. After raising rates at 10 consecutive FOMC meetings in 2022 and 2023, the Fed hit the pause button in June. The central bank wanted to give its rate hikes time to work.
For a time, it seemed that perhaps the Fed had moved out of its hawkish phase, and that investors could look forward to the central bank soon reversing course. But Fed officials quickly made clear that they’re not done raising rates. When he testified to Congress in late June, Federal Reserve Chairman Jerome Powell hinted that more rate hikes loom, perhaps as early as the FOMC’s July 26 meeting.
“Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go,” Powell told the House Financial Services Committee on June 21.
Investors faced a period of intense volatility early in the pandemic, followed by a couple years of outsized returns. The return to reality, and to economic uncertainty, illustrates the importance of a strategic approach.
Feldman Equities remains laser-focused on ground-up development of best-in-class properties in Florida, a state that has proven quite resilient. The Fed’s actions could also make it the perfect time for Feldman Equities’ aggressive program of acquiring underperforming office buildings in the greater Tampa Bay market.
The inflation picture
The Fed was challenged by an outbreak of inflation spurred by the pandemic. Back in early 2020, the Fed aimed to avert economic catastrophe by slashing interest rates to zero, a policy mirrored by central banks across the globe. The Fed also became a major buyer of mortgage-backed securities. Meanwhile, the U.S. Congress and White House pumped trillions of dollars of stimulus into the economy.
The rescue mission saved the economy from meltdown, but it also created fertile ground for inflation. Workers and employers quickly shifted to remote work, and pharmaceutical companies rolled out effective vaccines with surprising speed. The result was an economic boom – and runaway inflation. By June 2022, the U.S. inflation rate topped 9%. It was the highest inflation since the stagflation era of the early 1980s.
The Fed at first downplayed any threat of inflation, then pivoted to inflation-fighting mode. From early 2022 through May 2023, it pushed rates from zero to 5%. The tightening has worked. As of May 2023, the U.S. inflation rate had cooled to 4%, according to the Bureau of Labor Statistics. Still, as Powell suggestion, that’s still well above the Fed’s target rate.
The relationship between inflation and real estate values is complicated one. Inflation can lead to an increase in the value of real estate. This is because as the cost of goods and services increases, so does the cost of constructing new buildings. As a result, the value of existing buildings goes up, as those properties become more valuable relative to the cost of building new ones. What’s more, inflation can spur higher rents. On the downside, inflation leads to higher interest rates, which means the cost of borrowing to buy or refinance the property goes up.
Overall economic activity
Despite continued predictions of a recession just around the corner, the labor market keeps humming along. In May, the U.S. economy created 339,000 jobs, a strong number. While unemployment rose to 3.7% from 3.4% the previous month, the economy remains at or near full employment.
There’s plenty of noise in the national numbers. For one, an increase in job openings caused the ratio of job openings to unemployed workers to increase. In addition, average hourly wages increased 0.3% month over month, and 4.3% year over year, to $33.44 an hour.
The national numbers are one thing, but the Sunshine State continues to outpace the nation in labor market indices. The state’s unemployment rate was just 2.6% in May, more than a full percentage point below the national average. And the state’s year-over-year job growth was 3.7%, trailing only Texas.
Source: U.S. Bureau of Labor Statistics
Job growth is a crucial driver of demand for the office market. And despite national headlines about distress in office markets in New York, San Francisco and Los Angeles, Tampa Bay’s office market is still thriving. In early 2023, notable lease transactions in Tampa included a 53,272-square-foot deal involving Morgan Stanley and a 46,675-square-foot commitment by Elite Insurance Partners.
Meanwhile, office vacancy remains muted, especially in Class A buildings in downtown markets. As of the first quarter of 2023, office vacancy was 11% in the Tampa central business district (CBD) and just 5% in St. Petersburg’s CBD, according to Avison Young. Suburban markets, by contrast, had a vacancy rate of 21.2%.
As employers and employees gravitate toward amenitized buildings in bustling downtowns, Feldman Equities strategy is hitting the sweet spot. Our strategy is focused on both repositioning struggling office space and building new space, both in downtown markets.
Not that the news is all good. For the first quarter of 2023, the U.S. Bureau of Economic Analysis revised gross domestic product (GDP) growth upward 0.2 percentage points to an annual rate of 1.3%.
Indeed, a recession does seem to be looming, says Richard Barkham, chief global economist at real estate services firm CBRE. However, Barkham expects the coming downturn to be mild, and nothing like the Great Recession.
Barkham sees a number of factors propping up the U.S. economy. One is demography — population growth and a generational bulge of young, educated workers will spur output. So will an ever-evolving tech economy.
“Even though we’re going into a recession,” Barkham told the National Association of Real Estate Editors in June, “we’ve still got these fundamental drivers of demand for real estate.”