The last decade has upended the commercial real estate industry. Retail stores have been closing down in an unprecedented volume over the past few years. In 2023 alone, big names like Bed Bath & Beyond, David’s Bridal, and Party City filed for bankruptcy. And 2020 and COVID-19 saw a mass exodus from office complexes as more companies moved to work from home.
In the second half of 2023, worries about an economic recession loom. This has, historically, significantly impacted CRE with many buildings standing completely vacant for years at a time. Taking the time to understand what a recession is, what causes it, and how to determine whether or not one is on the horizon is essential to understanding the most profitable use for your commercial real estate.
In this article, we’ll be talking about economic recessions and what CRE industries are growing as well as contracting.
What is a Recession?
The economy exists within a cycle of ups and downs. The ups are periods of expansion when the real GDP (inflation-corrected gross domestic product) of the country increases and businesses are generally producing more products and services. This can’t last forever, though, and eventually, there is a downturn when the economy contracts. The real GDP decreases and less money is transferred between hands. With less stuff being produced, fewer workers are needed, which is why layoffs tend to be another sign of a recession.
Although inevitable, economic contraction does not always mean that the country is in a significant recession. The NBER Business Cycle Dating Committee maintains a chronology of US business cycles, where it’s easy to see the many expansions and contractions of the economy. In fact, many recessions are very minor.
Of course, a recession is still generally seen as a bad thing. Businesses, or certain industries, may be irreparably damaged by an economic recession, depending on its severity, and have to declare bankruptcy. Unemployment rises, leading to fewer people who have jobs, which means people have less money to spend on things. It’s a vicious cycle that every industry must prepare for.
But, of course, because the economy exists within a cycle, recessions do not last forever. Within a recession, an economy will eventually reach a low point where it begins to “bottom out” before it turns around. The economy will eventually recover and grow over time.
What Are Signs of an Impending Recession?
There’s no single concrete cause for most economic recessions. Sometimes a significant event can herald a contraction in the economy, such as the real estate crash of 2007, which led to the “Great Recession.” Other economists insist on the “rule of thumb,” which says two straight quarters of decline in real GDP leads to recession, but the Federal Reserve Bank of St. Louis disputes this as measuring an economic recession relies on measuring more than just the GDP.
Many economic issues exist in a vacuum within one particular industry. Some of the key indicators of an incoming recession are:
Unemployment: The unemployment rate has a direct impact on the economic status of a country. It acts as a floor for how much consumers can spend on products every year. New jobs being added to the economy is a sign of economic growth while the unemployment rate is a sign of an incoming recession.
Consumer spending: According to U.S. Bank Wealth Management, consumer spending represents two-thirds of the total economic activity in the U.S. and is extremely important for the well-being of the economy. A decrease in consumer spending is generally a sign of recession.
Manufacturing and trade spending: This can be thought of as the amount that retail stores pay to manufacturers for products. A decrease in the amount of wholesale retail sales may be a sign of a recession.
Bank lending: When a bank lends money to a person, organization, or business, it’s called a loan. Banks distribute loans based on a lot of factors, but when they’re more hesitant to lend money, it can be a sign of an impending recession. However, it’s worth noting that banks also are more restrictive on giving out loans when the Federal Reserve (or Fed) raises interest rates. The Fed raises interest rates in order to combat inflation.
Personal income: The amount that consumers make is an indicator of recession. Decreases in personal income can be a sign of impending recession as consumers have less money to spend.
Of course, a downturn in a single economic factor does not mean an economic recession is around the corner. Some events may independently affect just one or two recession indicators. Other events may be significant enough to plunge the economy into a time of economic recession.
So, are we in a recession?
Taking into account the above factors, no. Consumer spending, job growth, and business investment have been steadily rising in 2023.
What Happens to Commercial Real Estate During a Recession
Of course, the commercial real estate industry can also be thought of as another factor that influences economic recession. But we’re independently interested in this industry as it’s somewhat of a unique outlier. According to a Bisnow article, commercial real estate is historically a bit behind the greater economy.
CRE was hit particularly hard in a few key sectors in YTD 2023. These decreased sectors are:
Offices
Infrastructure (public transportation, roads, power grid, etc.)
Industrial/office mixed
Retail
However, with significant decreases in performance in these sectors come significant increases in other sectors. These increased sectors are:
Data centers
Self-storage
Residential
Health care
Increased interest rates to combat inflation have led to the CRE industry slowing down. Additionally, real estate had some of the best-ever sales in 2021, so a downturn to "right-set" real estate was inevitable in the successive years.
What we see here is a significant shift in what commercial real estate is being used for in 2023. Indeed, location and what the property will be used for will be a significant factor in determining what kind of CRE loans are available to a business.
So, is real estate a good investment during a recession? Well, first, we caution that the information that we present here is for educational purposes only. Don't make investment decisions based on a single blog post.
Your financial advisor will be able to answer whether investing in real estate during a recession is a good idea. CRE and residential real estate tend to be viewed as "safe" investments or even "recession-proof" because they tend to be more stable during economic slow-downs.