U.S. Macro Outlook: Mild Recession ≠ Pleasant

Cushman & Wakefield Research

CUSHMAN & WAKEFIELD RESEARCH U.S. Macro Outlook: Mild Recession ≠ Pleasant March 2023



KEY TAKEAWAYS. .....................................................3 ECONOMY...................................................................3 OFFICE. .......................................................................5 INDUSTRIAL................................................................6 MULTIFAMILY..............................................................8 RETAIL.........................................................................9 NICHE/ALTERNATIVES........................................... 10 CAPITAL MARKETS. ................................................. 11 SUMMARY TABLES.................................................. 13



Other economic indicators also point to weakness ahead. The ISM Manufacturing Index fell below the expansionary threshold of 50 in November and continued to weaken in February, for a fourth consecutive month; of 18 major subsectors, 14 face contractions that represent 82% of manufacturing output. New orders plummeted more sharply than the headline index in January and continued to soften in February, helping to explain why manufacturing production has fallen month-over month for five of the last nine months, with the latest reading flat. Consumer sentiment, as measured by the University of Michigan, hit its lowest level on record (dating back to the 1950s) in June of 2022, and remains at historically low levels as of February. Abrupt changes in confidence tend to coincide with the onset of recessions with little lead time. Weakness in the housing market is another warning sign. As of January 2023, existing home sales were down 37% year-over-year (YoY), and new home sales were down by 19%. Home prices have already fallen by 5% since peaking in May 2022 and will fall further in 2023. On the housing construction side, real residential investment has pulled back by nearly 20% since the end of fourth quarter 2021. There have only been two times when the economy has skirted a recession when this has happened: in the late 1960s, when the yield curve signaled its only false positive; and in the 2001 dot-com recession. Mixed with labor market data, the signals about the economy are, in some ways, cryptic. A perfect example has been the resilience with construction employment thus far, despite the recent decline in real residential investment and the longer trending nearly 25% decline in real non-residential structures investment, which started at the onset of the pandemic. Typically, there is a strong correlation between real investment in structures and construction jobs, and the implied productivity drop-off hardly seems sustainable. In other words, the market data suggests job cuts are needed. The labor market has shown signs of cooling off—a necessary ingredient for quelling inflation. In the fourth quarter of 2022, the U.S. economy created an average of 291,000 net new jobs per month, a significant downshift from the 463,000 pace averaged in the prior three quarters. Still, the pace of 291,000 is well above 2000-2019 average of 183,000. Moreover, the first employment report we got in 2023 showed the U.S. economy added a blistering 517,000 net new jobs. Although we suspect this will get revised downwards and was impacted by seasonal factors, clearly demand for labor remains robust. The unemployment rate hovered in the 3.5% to 3.7% range for most of 2022 and is now at a decades-low 3.4%, with wage

• The U.S. economy will experience a mild recession in 2023. • Office – The age of trifurcation is here; strong demand for high-quality space and not enough of it. • Industrial – This is the year fundamentals will finally start to rebalance. • Multifamily – Looking past the near-term headwinds, the other side is strong. • Retail – No sector is immune, but retail enters 2023 with strong demand drivers. • Capital markets – The good news is there has already been a lot of bad news. • Niche sectors – Specialized sectors are becoming increasingly important to real estate investors. U.S. Economy: Defying Gravity for Now After a “numerically turbulent” year—with negative real GDP growth in the first two quarters—economic growth finished “in the black” in 2022 at an annualized growth rate of 2.1%. However, underlying data reveal that real domestic demand, while quite robust in H1 2022 in contrast to headline numbers, started to lose momentum in H2. Various indicators signal continued slowing in parts of the economy, if not a recession. Most notably, the 10-year vs. two year and 10-year vs. three-month Treasury yield curves have been inverted for months (since July and November 2022, respectively) and are at the deepest levels of inversion since the early 1980s. There has never been a period in U.S. economic history when both spreads inverted, let alone when the inversions have been this deep for this long, that wasn’t followed by a recession. 1 1 There has been one false positive in 1966 when using the 10-year to 3-month spread—that inversion’s steepest point was -49 basis points (bps). The 10-year to 2-year spread has never had a false positive. In our latest outlook report, we acknowledge we are making predictions during a period of heightened uncertainty (hence its 50% probability). To help our clients think through and prepare for all scenarios, we’ve included a base case scenario (which we feel is the most probable scenario based on our modeling and current market conditions), as well other scenarios for your consideration. The results for all of the scenarios we modeled can be found in the summary tables at end of the report.






growth (as measured by the Employment Cost Index and the Atlanta Fed Wage Tracker) in the 5% to 7% YoY range. While receding from peak growth rates, such wage pressure is not consistent with the Federal Reserve’s 2% inflation target, and it is hard to see how wage growth—typically “sticky”— will pull back while the labor market is so tight and imbalanced. Indeed, the mismatch between labor supply and demand is a key downside risk to the monetary policy outlook, especially when markets have optimistically bet the Federal Open Market Committee (FOMC) will pivot by the end of the year.

economic growth without overheating inflation. This is why wage growth is sticky and won’t recede in line with headline inflation. Our view is that the FOMC will continue to raise its target rate with smaller hikes until it reaches a range of 5.0% to 5.25% later this spring, although further rate hikes are on the table. We believe the FOMC will hold the federal funds rate at that level into 2024 to ensure that core inflation (excluding housing) and wage growth are on a sustainable downward path. In 2024, we believe conditions will be ripe for a gradual easing and a concomitant growth pickup. Recessions, even mild ones, are not pleasant. The post-World War II average peak-to-trough decline in real GDP (excluding the pandemic recession) was -2.0%, and our forecast is for a decline of about 1%. Unemployment will increase toward the 5.5% to 6% range, with job losses of about 2.5 million. The post World War II average for job losses is 2.3 million (3.6 million including the pandemic recession). Relatively speaking, the contractions we forecast are below or about average (depending on the measure), as strong balance sheets and excess savings buttress the fundamentals heading in. As the recession passes, we expect the yield curve to un-invert and for the 10-year Treasury to peak in the mid-4% range in the first half of 2024, before gradually trending toward 3.5% over the medium term. NONFARM EMPLOYMENT POISED TO GROW IN 2024 AND BEYOND


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1/1/2007 1/1/2008 Labor Force - Actual Pre-Pandemic Labor Force Trajectory Source: U.S. Bureau of Labor Statistics, Cushman & Wakefield Research 1/1/2009 1/1/2020

Although the labor market boasted a 3.5% unemployment rate prior to the pandemic, the participation of the U.S. population in the labor force was in a very different position then. Labor force participation has been eroded by early retirements but also by more complex factors that have contributed to some working-age workers dropping out as well. More concerning is that the size of the labor force is a full 1.9 percentage points below its pre-pandemic trend, representing nearly 3.2 million potential workers. The scarring of the labor force is widespread too: In two-thirds of the nation’s MSAs 2 , the labor force has not recovered to pre pandemic trend levels, including in multiple high growth Sun Belt markets. Compared to earlier in the pandemic when a lack of international migration was exacerbating worker shortages, currently, the foreign-born labor force is back at its pre-pandemic trend level versus native born workers, who comprise a majority of ‘missing workers.’ This matters because the economy will be in a position where either higher productivity is needed, or more labor market slack is required to sustain

2,000 4,000 6,000 8,000

-10,000 -8,000 -6,000 -4,000 -2,000 0

2020 2021


2023 2024 2025

Nonfarm Net Job Change (Ths.)

Source: U.S. Bureau of Labor Statistics, Cushman & Wakefield Research

Inflation has not been solely a domestic problem; it remains persistently elevated across various parts of Europe and Asia Pacific as well. The International Monetary Fund (IMF) estimates global inflation averaged 8.8% in 2022, more than double the pre pandemic level of 3.5%. The world has gone from a widespread low-interest-rate environment for the better part of the last decade—prime conditions for property—to a higher-inflation, higher-interest rate environment that is creating major headwinds for property. Look no further than real estate

2 Metropolitan statistical areas.




investment trust (REIT) values to know that the commercial real estate (CRE) sector is in for a tough ride. The Dow Jones Equity Composite REIT Index is down 14% YoY, as of January 2023, but is 20% off its recent peak. Some sectors have been hit even harder, namely the Office REIT Index that is down 27% YoY, and 33% from its recent peak. Overall, 2023 will be a difficult year for many sectors of the economy, including property. It will be a year that will likely feature a recession, increased volatility and harsher demand conditions. Of course, all real estate is intensely local, and there will be certain sectors and geographies that will outperform and others that will underperform. Moreover, it is precisely periods like this—periods of volatility—that create tremendous opportunity for both occupiers of real estate and investors, and the stage is set for a growth story to reemerge in 2024 and even more so in 2025. The Age of Trifurcation Is Here U.S. office-using industries catapulted out of the pandemic recession with significant job gains; there are now 1.9 million more office jobs than there were prior to the pandemic. Of those jobs, about 25% were directly tied to technology, which accounted for only 15% of office jobs prior to the pandemic. Even as tech layoff announcements have gained attention in the media, they have yet to result in major net declines in employment, meaning that hiring is offsetting most layoffs. Further, there is tremendous competition for highly skilled tech workers in occupations like software development or programming. The unemployment rate for highly skilled tech workers is just 2.3% compared to 3.4% for all workers. Unfortunately, despite strong job creation by office firms, the office real estate market has experienced a different state of affairs since the pandemic hit, and the historically strong correlation between jobs and demand has decoupled. The U.S. office sector has shed 189 million square feet (msf) of occupied space since the pandemic began and remote working effects took hold. For context, this is nearly double the amount of space shed during the Great Recession and the dot-com recession. U.S. office vacancy now sits at 18.2%, up from 12.9% prior to the recession brought about by the pandemic. From first quarter 2020 to fourth quarter 2022, effective rents—which account for tenant improvements and free rent—have declined by 14%.

The U.S. office market is not a monolith, of course. New construction and office space that caters to hybrid workplace strategies remains in high demand. Over the last three years (2020-2022), this segment of the market registered over 100 msf of positive absorption. Moreover, certain geographies are bucking the national downtrend. Of the 90 markets Cushman & Wakefield tracks, 29 registered positive absorption in 2022. From a demand perspective, the top performing markets fall into one of four categories: 1) major Sun Belt markets, 2) gateway adjacent markets, 3) markets with a strong tech or life science lab sectors, and 4) smaller markets with strong job recoveries.












2019Q4 CBD




2025Q2 Total U.S.



2022Q4 Non-CBD









Non-CBD w/ WFH Total U.S. w/ WFH

Source: Cushman & Wakefield Research

It is important to recognize that signs of recovery were forming through the middle of last year. Net absorption was sharply negative in 2020 and the first half of 2021, averaging -28.8 msf per quarter. But starting in late 2021 and early 2022, the absorption trends became significantly less negative, averaging -3.0 msf per quarter. In terms of the negative absorption, it appeared that the worst was over. Businesses can only cut so much space, and the office sector was on the cusp of absorbing space again. Indeed, in fourth quarter of 2021, absorption was positive in more than half of all U.S. markets, and since then more than 30 markets per quarter were posting positive demand. The recovery was cut short by the factors we mention next, but a demand recovery was underway, and we think these are signs that demand for office space should turn positive once the U.S gets past the recession. Nationally, demand for office space started to recede again in the second half of 2022. A second wave of sublease hit the market as companies started to prepare for softer economic conditions. Some companies had become overextended— especially tech firms that were active throughout the pandemic—and began to return some of the




INDUSTRIAL Fundamentals Set to Rebalance

excess space they had leased. Since the onset of the pandemic three years ago businesses have been aggressively rationalizing their office footprints (a continuation of the multi-decade trend of corporates pushing for efficiency). Occupiers can only cut so much space before it becomes disruptive to their business. The first quarter will be very telling but for now our outlook calls for the steepening in negative absorption that we observed in H2 2022 will continue as the labor market softens and ultimately sheds jobs. This, in combination with the continued remote working downdraft (office space per worker continuing a steady downtrend as leases expire) and greater economic uncertainty will result in -66 msf of absorption in calendar year 2023, worse than the -37 msf observed in 2022. On the supply side, 90.4 msf were under construction at the end of 2022. We estimate that 35-40 msf of that new product will be delivered in 2023 and another 25 msf will come online in 2024. With new supply once again exceeding demand, the U.S. office vacancy will rise from 18.2% in 2022 to 20.2% by the first half of 2024, and effective rents will continue to move downward by another 7% in 2023. The total peak-to-trough rent decline is likely to be around 20% by mid-2024. As the economy pulls out of recession toward the end of this year, office demand will begin to stabilize and turn positive in 2024. Office vacancy will begin to gradually trend lower as office-using job growth accelerates to the point where net absorption exceeds new construction levels. In general, our research conclusively shows that demand for office space is distinctly trifurcated. The Top : Buildings that have been newly constructed or renovated in the last eight years that offer trophy building experiences have registered over 100 msf positive absorption since 2020. Vacancy in this segment is much lower than the national average, and we expect this segment to remain tight over the forecast horizon. The Middle : A large slice of office product (roughly 60% of stock) classifies within a middle ground of commodity or similar office product and in general will require reinvestments and upgrades to remain competitive. The Bottom : Meanwhile, up to 20% of office stock throughout the country is becoming increasingly undesirable and will need to be reimagined and made relevant for the future.

The industrial economy has been whipsawed over the last few years: Manufacturers that were initially shut down in the early days of the pandemic ramped up just as consumers—flush with cash from stimulus and cooped up at home—doubled down on online goods spending. This resulted in supply chains becoming snarled, with elevated backlogs of orders and a multi-year bifurcation in the recoveries between e-commerce adjacent sectors and the rest of industrial—namely, manufacturing, wholesale and transportation (excluding final mile). Employment in the industrial labor market is now 1.3 million jobs above pre-pandemic levels, with 65% of those, or 866,000, accruing to warehousing/final mile, which only represented 9% of the industrial sector’s employment in early 2020. The pandemic boom in consumer goods spending pushed demand for industrial CRE through the roof. Absorption had averaged 287 msf from 2015 to 2019, but fast forward to lockdowns and consumers unable to spend on services, and absorption surged to 561 msf in 2021—the highest ever recorded— followed by 477 msf in 2022. Some of this demand was an accelerated response to a level shift in online shopping—meaning that this demand was pulled forward from future years as companies had to scale sooner and quicker than expected. As 2022 unfolded, a few important trends started to emerge that will define the undercurrents of the outlook in 2023. First, goods spending started to taper back toward pre-pandemic trend levels as stimulus and excess savings were spent, either increasingly on services like travel and entertainment, or on absorbing high inflation. Second, e-commerce growth reverted to its pre-pandemic trend i.e., online sales are still capturing a greater share of total retail sales relative to pre-pandemic levels but the rate of growth has slowed). Third, higher interest rates began to weigh on demand for items sensitive to financing conditions, especially durable goods. U.S. manufacturers started to see demand wane and pulled back on production, with the exceptions of the energy and auto subsectors. Wholesalers and retailers—some bloated with inventories relative to pre-pandemic trends—registered disappointing sales in the second half of the year, further augmenting concerns about overhang. This, combined with a major snapback in housing activity, has led to significant declines in imports. Real imports are off 3.7% from their recent peak levels, but consumer goods have fallen by 15.4%, and durable goods have cratered by 25.9%. Heading through 2023, these headwinds will remain and blow harder as consumers face tighter financial conditions, fewer and less rosy job prospects, and still-high inflation. It is no wonder that producer prices and consumer





goods inflation have been decelerating much more sharply than services inflation. While some predictions sound ominous, there are a few bright spots that will buoy industrial real estate fundamentals in 2023. The e-commerce and third-party logistics (3PL) sectors continue to grow, and a loudening buzz of reshoring is increasing requirements for manufacturing facilities, despite the sector facing contractionary conditions at present. Further, of the massive 683-msf pipeline of new development, 566 msf is speculative. Of that, 424 msf is not pre-leased. Thus, built-to-suit and pre-leasing activity will buttress absorption, which we still believe will be decently positive at 193 msf. Heading into 2024, we believe activity within newly constructed buildings will provide less nominal support to absorption, when we expect only 155 msf of demand. As growth across multiple sectors accelerates in 2024, it will be only a brief time until the industrial market approaches 300 msf of absorption per year again. A slowdown in demand can make it tempting to believe that rents will decline and that there will be some respite for occupiers who have been forced to pencil in 40% increases in real estate costs. Although we expect rent growth will decelerate meaningfully in the near term, it is unlikely to decline. Vacancy is at 3.3% nationwide and the construction pipeline, which is 40% spoken for, has a swift construction cycle, meaning construction will pull back quickly and put a ceiling on how high vacancy can go, despite softer demand. Thus, we see vacancy trending toward 6% by late 2024, which is still historically tighter than at the height of prior business cycles. Rent growth, which occupiers cannot absorb indefinitely in a slowing economy, will moderate toward 5% this year and further toward 1%-2% in 2024. From there, 3%-4% rent growth per annum is consistent with the more sustainable demand fundamentals that we expect to resume. Like all forms of real estate, local dynamics will vary greatly. Some markets are supply-constrained, leading to sub-1% vacancy rates market-wide or at least in key submarkets. Such markets have, in some cases, recorded rent increases of 100% or more since the pandemic began. This is particularly true for primary markets 3 , port-proximate markets and in markets with significant population or migration growth. As few markets will have a large, prolonged imbalance in supply and demand, we remain bullish on the industrial sector, despite some near-term turbulence.



Primary Non-Primary

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80 100 120 140 160 180 200 220 240 260


Coastal Port

Non-Coastal Port











Source: Cushman & Wakefield Research

3 Atlanta, Chicago, Dallas/Ft Worth, Inland Empire, Los Angeles, New Jersey, and the PA I-81/I-78 Corridor.




Looking Past the Near-term Headwinds, the Other Side Is Strong Following booming demand conditions, record low vacancy, and double-digit rent growth in 2021, the multifamily sector cooled off throughout 2022 which helped operating fundamentals re-balance to a more sustainable level. Supercharged household formation during the pandemic recovery began to throttle back, while job and income growth moderated amid high inflation and the uncertain economic outlook. Even abstracting from the new macro headwinds, demand was destined to cool from the blistering pace heading into 2022. Record demand growth (annual change in number of physically occupied units) of 662,000 in 2021 was easily the strongest on record, nearly doubling the average pace from 2018 2020. According to Axiometrics 4 , in 2022, demand shrank by 103,000 units, the first decline since 2007. New supply remained steady, with 346,000 new units delivered, close to the 2021 total and on par with the percentage rate delivered over the past five years. After reaching an all-time low of 2.5% in the first quarter, the national vacancy rate increased in the remaining three stanzas of 2022, ending the year at 4.9%—up 240 bps from 2021. The inflection in demand was the story of 2022. However, despite a softer start in 2023, we foresee a strengthening in demand throughout the year that will put year-end absorption in the ball park of 190,000 units. This is well above the 2000 2019 average of 167,000 units but down from the frenzied pace of the last two years. As the growth cycle gains steam, demand in 2025 should clock in around 265,000 units. Longer term, the multifamily demand outlook is positive thanks to a persistent undersupply of single-family housing and economics that should favor renting over homebuying for several years. The mortgage rate on a 30-year, fixed-rate loan is currently hovering between 6%- 6.5%, and with the Federal Reserve being uneager to revisit zero-interest-rate policies anytime soon, odds point to mortgage rates remaining tethered above pre-pandemic levels. Construction of new single family homes has slowed to a halt, so affordability will also remain a key factor for potential homebuyers, despite modest price corrections in the near term. New supply is emerging as the predominant theme for the multifamily market. With more than 900,000 units under construction—many of which are slated 4 Axiometrics is one source of multifamily data in addition to others like CoStar and Reis. Axiometrics and CoStar report on roughly 18 million units while Reis reports on about 12 million units. Each vendor has a different composition of tracked inventory across classes and markets, but all three have reported a downshift in demand. CoStar recorded positive absorption in 2022 of 144,000 units, down 80% from 2021. Reis reported that 140,000 units were absorbed in 2022, down 40% from 2021.

for completion in the next few years—there are more units underway than at any point since the 1970s. As a percentage of overall inventory, the next two years’ rates of supply growth would be stronger than any time over the past two decades. It is difficult to paint an accurate picture of supply risk without caveats on location. Broadly speaking, development is concentrated in high-growth Sun Belt markets, such as Austin, Miami, Nashville, Charlotte and Phoenix, though several markets like Seattle, Boston, Minneapolis and Denver rank highly as well. Of course, these are the same markets that have registered record demand for apartment units in recent years (both pre- and post-pandemic) and are also widely viewed to have some of the strongest demand drivers in the country, so not surprising to see developers ramping up supply in these fast growing cities. Beyond what is already baked into the pipeline, an economic recession—even a mild one—should give pause to further new supply, especially if development costs remain elevated in a high-interest-rate environment. Multifamily permits already began to taper off in late-2022, and we expect supply growth to fall below its long-run average by 2025.


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2006 Supply (Ths.) 2007 2008




Demand (Ths.)

Vacancy (%, right axis)

Source: Axiometrics, Cushman & Wakefield Research

The pullback in demand that began in 2022 will be exacerbated by a weaker labor market this year. In our baseline forecast, the unemployment rate increases from 3.4% currently to 5.8% by the end of 2023, implying a net loss of around 2.5 million jobs in the U.S. While this rate of unemployment is lower than experienced during the past two recessions, increased joblessness will nonetheless cause more would-be renters to double up with parents or roommates, likely resulting in a slowdown in household growth over the next two years. The wave of construction hitting the market as demand cools will drive vacancy rates higher in the next two years, reaching 6.7% this year





and 7.5% by year-end 2024. The supply wave is destined to temper in 2025 as higher financing and construction costs, as well as higher vacancy, lead developers to let the pipeline lean out. This dynamic and a pickup in demand units and will flip the supply-demand imbalance, allowing the vacancy rate to trend down toward its long-run average in the second half of this decade. Effective rent growth, which was a staggering 17.4% in 2021 and 8.9% in 2022, will moderate in 2024 before reareaccelerating. Loss to lease should help bolster net operating incomes (NOIs) over the next two years, as below-market rents are brought closer to market, even as growth slows. Not Bulletproof, but This Time Is Different Consumers led the way for the U.S. economic recovery in 2021 and remained a relative bright spot last year despite high inflation, pessimistic consumer sentiment and weakening income growth. These challenges will persist this year as the economy enters a mild recession, but resilience thus far is an encouraging sign that consumer demand may hold up better than other segments of the economy. As of January 2023, core retail sales (excluding gasoline and automobile sales) rose 7.4% from a year earlier. Even after accounting for inflation—the consumer price index (CPI) in January was up 6.4% from a year earlier—real retail spending growth has remained modestly positive. In some ways, headwinds to consumer spending (namely, inflation) are expected to improve. Consumer price inflation has steadily retreated from its mid-2022 peak and is destined to moderate further this year, bringing some relief to purchasing power. But households are now bracing for a more formidable challenge in the weakening job market, as the U.S. economy is forecast to shed a net 2.5 million jobs over the course of the year. While inflation is a challenge that consumers can manage by adjusting spending habits such as trading down to value goods—job loss is not. The labor market will be the main factor to watch in 2023. The gloomy outlook reflected in corporate earnings and weaker economic data have not yet decreased retail tenant demand in a meaningful way. In 2022, even while uncertainty was growing, the number of retail store openings surpassed closures by more than 2,400 locations. This marked the first net expansion since 2016, when there was a net increase of 1,100 stores. More importantly, early store count estimates for 2023 suggest further expansion. The recent optimism reflects retailers’ renewed commitment to the long-run profitability of physical storefronts, shifting growth into suburban and

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Total Closure Total Opening Total Net

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Source: Coresight Research, Cushman & Wakefield Research

secondary markets, and the increasingly symbiotic partnership of physical and digital retail. E-commerce will continue to grow, but online sales are no longer the disruptor that shuttered so many storefronts and spawned “retail apocalypse” headlines in the last two decades. Retailers that survived the pandemic have mostly emerged in an even stronger financial position, so the 2023 recession will be nowhere near as destructive as the Great Recession, where the economic woes were compounded with structural imbalances in the retail real estate industry. The state of the U.S. retail market is in concordance with this resurgent demand. In 2022, net absorption in shopping centers totaled 40.9 msf, which was the strongest annual total since 2017 and above the 2015-2019 average. Meanwhile, the vacancy rate drifted down to 5.7%, its lowest level since prior to the Great Recession, as the recent wave of store openings increased occupancy amid a sluggish supply response. Supply-side dynamics are critical, as retail is a distinct outlier compared with other types of commercial property. Whereas the office, industrial and multifamily sectors have undergone building booms in the last few years, retail inventory growth has been muted with less than 40 msf of total new space delivered from 2020-2022, or 0.2% of inventory per annum, compared with the prior decade’s average of 0.6% annually. New construction is down by about two-thirds, and inventory has been further restricted by demolitions, which totaled more than 90 msf from 2020-2022 and included all retail, not just shopping centers. The current demand and supply imbalance will resolve as developers become more interested in retail’s promise and the recession tempers tenant demand, but a large shift in vacancy is unlikely in the medium term. Our baseline forecast projects that the national vacancy rate for shopping centers will level out in 2023, ending the year roughly where it began at 5.6%, before ticking up to 6.1% by the end of 2024




as tenant demand recoils amid tougher economic conditions. For context, the vacancy rate during the Great Recession rose more than 250 bps to a peak of 10.2% in 2009, so this downturn is expected to be much less disruptive than past cycles.

Many investors in this space can contribute to expanding and upgrading the housing stock in undersupplied markets while securing income streams that are relatively less volatile; even in downturns, people need to live somewhere. 2. Aging demographics and the continued advancement of medicine are growing the pharmaceutical, biological sciences and R&D fields. Novel scientific discovery requires collaborative in-person work, supporting a growing need for space among life sciences firms. This space includes high-tech industrial and office-like lab-space assets. Many firms co-locate to capitalize on a shared, skilled labor pool and thus have well-established clusters across select U.S. cities. 6 We see these markets—as well as newcomers like Atlanta, Austin, Detroit-Ann Arbor, Houston, Phoenix and Salt Lake City—as having tailwinds amid a broader economic softening. 3. Commercial and consumer usage of data and cloud services has grown at a rapid rate, doubling global data traffic from 2018 to 2022. The growing demand for digital storage is a direct driver for the construction of data centers. Whether it be Fintech or Insurtech or Healthtech, all industries are becoming more technology-centric and require ever greater data capacity for operations. Well-established markets (like Northern Virginia, Atlanta, Chicago, Silicon Valley, Dallas and Phoenix) have thrived to the point of record-low vacancies in 2022. However, limited available land and power in these established markets are driving interest in secondary and emerging markets like Portland, Austin, Columbus, Denver, Las Vegas, and greater Los Angeles. 4. Healthcare spending has been on a continual upward trend in the U.S., with Center for Medicare & Medicaid Services projecting that spending could exceed $6 trillion by 2028. Per capita spending has similarly grown, with latest estimates suggesting an average of $12,500 spent per year, driven by many of the same demographic trends as life science. The growth of Medical Office Buildings (MOBs) are a direct beneficiary of this, as patients seek more accessible points of care for a variety of specialties. As large healthcare systems have struggled in the post-pandemic against labor shortages, supply chain issues and rising costs, growing opportunities for off-campus and more nimble specialized clinics have opened CRE opportunities across the U.S. Other medical real estate offshoots, like Medtail, are growing in response to the same dynamics. 6 Such as Boston, Chicago, Denver, Greater Los Angeles, New Jersey, New York, Philadelphia, Raleigh/Durham, San Diego, the Bay Area, Seattle and Suburban Maryland.


Resilience Attracts Diversification In the past few years, investors have increasingly flocked to CRE as it becomes more institutionalized globally. Niche assets have likewise become more favored as they show resilience from cyclical movements and offer relatively compelling risk adjusted returns. These sectors have also seen relatively less institutional investment activity over their maturation cycles, so their investment space allows for other investors to capture some market share. In the last few years, this class collectively overtook retail and hotel in terms of annual dollars invested, commanding more than $264 billion of investment sales in 2021 and 2022 combined. Even this understates the degree of investor interest, as life sciences, data center and single-family 5 figures are under-represented in traditional go-to datasets.


$100 $120 $140 $160




$0 $20 $40 $60 $80




Niche Asset Volumes (Billions)

% of Total Sales

Some of the attractive fundamentals these asset types provide fall into several categories: 1. Structural imbalances in the housing market, delayed rates of homeownership, and more recently, higher mortgage costs are pushing aging Millennials into single-family rental and built-for-rent (SFR/BFR). As single-family renters are unlikely to revert to apartment-living, there is likely to be resilient demand for this growing asset class, even in the face of a mild recession. Source: MSCI Real Capital Analytics, Cushman & Wakefield calculations. *Note: Data centers, life sciences and single-family related subsectors are are likely under-represented in the above chart.

5 Such as single-family rental (SFR) and built-for-rent (BFR).




The Ripple Effect of Rising Interest Rates No part of the CRE world has been as immediately impacted by the shift in interest rates as the capital markets. The FOMC increased the target federal funds rate by a cumulative 425 bps in 2022 followed by a 25-bps increase in February 2023, in what has been the fastest rate-hiking cycle since the early 1980s. Despite recent signs of optimism in bond futures markets, we believe that elevated inflation in services (excluding housing) and an extremely imbalanced labor market will support Fed policy in which interest rates remain higher for longer than is expected by the consensus, resulting in ongoing volatility in the financial markets. 7 With the FOMC likely to hike rates at least two more times (our baseline view), there is potential for additional increases (but likely not many). Although the 10-year Treasury rate remains below the short end of the yield curve for now, it is slated to un-invert as growth expectations of a new business cycle reemerge. Therefore, our call for higher 10-year Treasuries and Baa corporate bond rates is in line with our view that after a brief recession, the economy is poised for a new stage of growth. The era of significant cap rate compression over the last few years has ended and the market is transitioning into an “income-focused” phase. Without capital value appreciation driving total returns—particularly this year and next—the fundamentals really come to the fore. We are entering a period of negative capital appreciation returns across property sectors as cap rates increase and as values decline and weigh on returns. However, on a cumulative, rolling vintage-year basis, total returns are still positioned relatively well, given that we are coming off several years of above average (in some cases double-digit) total returns. So, while the isolated, single-year total returns will come under pressure as the shift to higher interest rates plays out, the overall picture for returns is not altogether downbeat. Fortunately for CRE, income returns have proven to be durable and reliable, underscoring a key facet of its attractiveness as an asset class. Assuming our base case scenario plays out, and assuming the Fed begins to cut rates early in 2024, we expect capital markets conditions to bounce back relatively quickly, which will bolster capital returns and provide many buyers with opportunities ahead of that inflection. Although private CRE property values typically lag movements in other asset prices by several quarters, pricing trends between CRE and other investment 7 While financial markets are good at predicting one- and three-month ahead changes in interest rates, they are not good at predicting inflation or interest rates otherwise. In fact, financial markets perform worse than surveys of professional economists and business leaders. Over-weighting market expectations for year-end 2023 should be done with caution.

classes have historically been correlated over previous economic cycles. The degree of co-movement varies depending on factors such as the economic outlook, investor perception of cross-asset class risk and liquidity considerations. Ultimately, investors have myriad options where they can place capital to yield a target return, ranging from the ultra-low-risk U.S. Treasury market to corporate stocks and bonds. CRE falls toward the riskier end of the spectrum, not only due to an illiquidity premium, but also due to inherent uncertainties involved with owning property—occupancy and rent volatility, operating expenses, taxes and regulations, insurance, climate risk, etc.—all of which carry far more risk than a government bond, which is guaranteed at a set yield under almost any circumstance.






































Source: Moody’s/Moody’s Analytics, NCREIF

As a result, relative returns in the bond markets are sure to influence real estate yields, although to what extent is a bigger question. If investors can yield 4% on a 10-year Treasury note, for example, a property expected to yield a similar—or even lower— amount becomes even less appealing, particularly given its risk factors. The upside potential to drive income or capital appreciation growth would have to be enough to justify a lower going-in yield. On average from 2000-2022, all-property cap rates 8 have traded at an average of 98 bps spread to Baa rated corporate bond yields, though this spread has ranged from near zero to almost 380 bps over that period. Since the start of 2022, the Baa yield has tracked Treasury yields higher, rising nearly 300 bps to a peak of 6.3% in October 2022—rates have since drifted down to the 5.5% range, yet are still higher than any time in the last decade.

8 We calculate the all-property cap rate of the four main asset types (multifamily industrial, office and retail) using weights based on capital investment share from 2018-2022.




In fourth quarter of 2022, the all-property cap rate was 163 bps below the Baa rate—an unsustainable position that we expect will correct in 2023 and 2024 as we call for a 260-bps expansion (in the level of the all-property cap rate) over this time. Of course, this is just an average. There is a marked difference in the resiliency of the highest quality assets, particularly those with long-term leases in place, versus the rest of the market. Moreover, there is often a flight to quality dynamic that takes place during economic downturns which limits the downside for prime assets, while riskier assets often experience a more significant price correction. All else equal, one might expect cap rates to follow Baa yields higher at a one-to-one ratio, but that is rarely the case as income dynamics are also a factor. Broadly speaking, real estate fundamentals

have been improving post-pandemic, resulting in income growth and occupancy gains, especially among high-quality assets. Additionally, CRE assets are typically held over a long-term period of more than five years, and interest rates are expected to be lower five years from now, which supports our baseline narrative that cap rates will not increase as much as yields for other financial assets like corporate bonds. The significant amount of dry powder targeting CRE investment is still trending near historical levels, at $242 billion in early 2023, which will also support continued investor demand, insulating cap rates from some upward expansion as compared to past cycles. Said differently, we make a case that we are likely to see tighter cap rate spreads relative to benchmark rates than in prior historical periods and perhaps more on par with those observed in the 2015-2019 period.

Fuller Picture of Investor Returns

It is critical to keep in mind that real estate returns are generated on a cumulative basis over the hold period, and total returns for a given vintage year investment can still be positive given the steady income and significant appreciation returns that have accrued over the last several years. In an illustrative example (see below), we show the cumulative forward returns of an investment made in fourth quarter of 2017. At five years ending in the fourth quarter of 2022, when cap rates were lower than Baa bond rates, an investor would have made a cumulative 73% return, outpacing alternative cross-asset options. If said investor were to exit at the bottom of the market—defined as the trough for values in our forecast—their return would be 33%, still outpacing inflation and several other asset types. Over a 10-year horizon, this investor would benefit from post-downturn tailwinds, subsequently realizing total returns that are attractive across the cross-asset class spectrum. RELATIVE CUMULATIVE FORWARD TOTAL RETURNS Q4 17 INVESTMENT RETURNS BY HORIZON

If Invested in Q4 2017…







5-year horizon

7-year horizon

10-year horizon

CRE - All Types CPI

Baa Bond S&P500 DJ Gold Oil (WTI)

Source: NCREIF, Cushman & Wakefield Research. All types cap rate calculated for four main property types using weights based on capital investment share from 2018-2022.










U.S. Economy Real GDP (AR, %)

-2.8% -9,109






Nonfarm Employment

6,170 1,522

4,867 1,123




Office-using Employment

-1,131 6.8%

-816 5.8% 0.4% 3.3% 5.2% 4.3% 6.9%



Unemployment Rate


3.7% 8.8% 7.3% 3.7% 3.8% 5.6%

4.6% 3.8% 2.0% 3.5% 3.9% 5.5% $66.1

4.0% 3.8% 2.2% 2.8% 3.6% 5.0%

Retail & Food Services Sales

4.1% 18.9%

CPI Inflation

1.2% 0.1% 0.9%

6.7% 0.1% 1.5% 2.4%

Federal Funds Rate

10-Year Treasury Rate BAA Corporate Bond West Texas Intermediate Office Sector Net Absorption (msf)













New Supply (msf)








14.8% 16.8%

18.2% -0.9%

19.8% -7.0%

20.0% 19.8%

Effective Rents





Industrial Sector Net Absorption (msf)

297.5 361.9 5.0%

561.4 361.9

477.3 495.0

193.0 433.9

155.4 387.8 5.9% 0.6%

235.7 290.9

New Supply (msf)




4.6% 4.3%

6.1% 2.8%

Effective Rents

6.0% 12.8%


Retail Sector Net Absorption (msf)


36.0 10.2 6.5% 4.2%


11.4 14.1 5.6% 2.4%

-7.6 14.9 6.1% 1.6%

24.7 13.1 5.8% 1.2%

New Supply (msf)




7.2% 1.4%

5.7% 4.7%

Effective Rents

Multifamily Sector Net Absorption (units, 000s)

303.0 349.1 4.4%

661.4 345.5


190.8 485.6


264.4 220.7

New Supply (units, 000s)


289.6 7.5% 0.5%






Effective Rents

-0.8% 15.6%




*The probability can be interpreted as the economy having a 50% chance of performing as well as or better than this scenario, and a 50% chance of performing worse.

Sources: U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, Federal Reserve, U.S. Census Bureau, Moody’s Investor Services, U.S. Energy Information Administration, CoStar, Axiometrics, Cushman & Wakefield Research


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